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Is Apple’s Golden Goose About to Be Cooked?

Verizon iPhone 4
Don Emmert | AFP | Getty Images
Verizon iPhone 4

Even though Apple reported record second-quarter revenue and earnings, shares have given back all of their gains and then some. We now may have a reason why: It looks like the carriers are starting to fight back.

Apple depends so much on its iPhone for growth, which accounted for $22.7 billion in revenue, nearly 58 percent of quarterly revenue. It’s Apple’s largest product segment by far, and any dent in revenue could dent Apple’s stock .

U.S. carriers Verizon Communications, AT&T, and Sprint Nextel could either cut back on carrier subsidies or extend the life-cycle of their contracts, and evidence is mounting that it may happen.

There are signs across the industry that carriers are becoming more disciplined with subsidies, Credit Suisse analyst Jonathan Chaplin thinks.

“If this discipline holds, we believe there is upside to margins and earnings growth for all carriers,” Chaplin wrote in a research note. He upgraded AT&T and Verizon to “outperform” and raised his price targets to $36.50 and $45, respectively.

Most contracts for cellphone customers are about two years, and Chaplin noted that the upgrade eligibility has been pushed out over the past year, from around 13 months to around 20 months, while implementing upgrade fees to offset the subsidy paid to the handset makers. Apple’s subsidy is exceptionally high, given the iPhone retails for $649 without the subsidy. The average subsidy on phones is around $265, but Chaplin thinks it could go as low as $250 per phone, as fees are added and eligibility gets pushed out.

While this is a potential negative for all handset makers, Credit Suisse analyst Kulbinder Garcha cut his estimates for Apple as evidence mounts of a shift in subsidies.

Garcha noted that North America counts for 38 percent of total units over the past six months for Apple, and cut his earnings estimates for 2012 and 2013 as a result.

“We maintain our view that Apple will continue to gain smartphone share globally, driven by a compute advantage and its ability to drive distribution led growth, not to mention innovation. We now forecast iPhone volumes of 140 million/187 million in calendar 2012/2013 (implying global share of 21 percent/22 percent, up from 19 percent in 2011),” Garcha said in his research note. He reiterated his “outperform” rating and $750 price target.

Apple CEO Tim Cook was asked about carrier subsidies on the second-quarter earnings call, and said Apple is just focused on making the best smartphone in the world. But he did make mention that the monthly payments are not that large across a 24-month contract.

"For ... from a carrier's perspective, I think it’s important to remember that the subsidy is not large relative to the sum of the monthly payments across a 24-month contract period. And any delta between iPhone and maybe another phone is a ... an even smaller level of difference,” Cook said on the call.

Cook seemed to brush off the subsidy issues, as he mentioned that the iPhone will entice customers to upgrade from a regular mobile phone to a smartphone, and called it a “win-win-win” for Apple, the carriers, and the customer. That doesn’t sound like he’s terribly worried about a subsidy cut, although given the price action in Apple’s stock recently the market is saying otherwise. Apple’s stock fell from a high of $617 following the report to around $566, where it currently trades.

All is not lost for Apple as it continues to innovate and attract new carriers and new customers around the world. Morgan Stanley analyst Katey Huberty wrote that she expects “robust 2013 iPhone growth despite U.S. carrier actions to reduce smartphone sales as growth shifts toward emerging markets.” Huberty rated Apple “overweight,” with a $720 price target.

Even Credit Suisse’s Garcha noted that Apple can expand its smartphone market share in 2012 and 2013, to 21 percent and 22 percent, respectively, up from 19 percent in 2011. That would imply 140 million and 187 million iPhones in 2012 and 2013, though lower than the initial projections of 151 million and 205 million, respectively.

“Part of the lure of Apple is the ability to deliver a seamless compute experience across smartphones, tablets, and PCs. This could mean that Apple consumers actually deal with and accept higher potential charges from carriers, meaning demand is less impacted than our current estimates,” Garcha said.

—By Chris Ciaccia, Technology Reporter, TheStreet.com

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Additional Views: Why We ‘Don't Buy’ Apple’s Low-Ball Guidance: Analyst

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