Did AT&T give too much for iPhone?

By Sinead Carew-Analysis

NEW YORK (Reuters) - Has Apple Inc done it again? After setting the pricing agenda for digital music to suit its own needs rather than those of the record industry, the iPod maker has now clinched an iPhone deal with AT&T Inc that may allow it to do the same in wireless.

AT&T's plan to subsidize the next iPhone is almost certain to boost the No. 1 U.S. service provider's customer growth and revenue from data services like Web surfing. But in return, it appears to be taking a much bigger upfront risk than Apple.

The high-speed version of iPhone goes on sale July 11 at $199 with 8 gigabytes and a $299 model with twice the memory.

Instead of paying Apple a portion of service fees each month as it did with the last iPhone, AT&T will shoulder part of the price of Apple's latest device to the tune of $200 to $500 per phone, according to analyst estimates. AT&T said the subsidy, aimed at boosting volume sales, will cut earnings per share by 10 to 12 cents in 2008 and 2009.

Apple, on the other hand, is expected to see its earnings dip only about 3 cents a share this year, according to some estimates, as it forsakes the percentage of recurring monthly service revenue it got from AT&T's iPhone users.

While some applauded the new deal for its promise of wireless customer growth in a slowing market, investors pushed down AT&T shares and analysts worried that the unusual earnings hit signaled too big a concession from the U.S. phone company.

"With dilution running at levels we never fathomed, we believe AT&T is assuming more risk than the previous arrangement," JPMorgan analyst Michael McCormack wrote in a research note. "We question whether a handset exclusivity agreement should warrant such a dramatic financial impact while other successful carriers have not found it necessary."

Subsidizing handsets to boost demand is widespread among U.S. service providers, which sometimes offer free phones in exchange for lengthy contracts. But even so, investors are not used to operators cutting earnings expectations as a result of subsidies, especially from an individual phone.

"Clearly Apple had the upper hand in the negotiations," said Stifel Nicolaus analyst Chris King. "That's a big hit to earnings for one product set for AT&T."

A day after the news, analysts forecast AT&T calendar 2009 earnings per share before items at $3.44, according to Reuters Estimates, giving the company a trading multiple of about 11. Apple is expected to earn $6.41 per share for its fiscal year ending September 2009, or about 29 times.

SUBSIDY NECESSITY

As 85 percent of U.S. consumers already own cell phones, King said AT&T is under more pressure than ever to lure customers from Verizon Wireless, Sprint Nextel Corp and Deutsche Telekom's T-Mobile USA. Verizon Wireless is owned by Verizon Communications Inc and Vodafone Group Plc.

"They're going to need to push the iPhone heavily to offset this dilution," King said.

Other analysts saw AT&T's move as a sign of intensifying competition in the U.S. mobile market, where subsidies are one of the few ways carriers can boost growth.

Credit Suisse analyst Chris Larsen saw the move as "mildly negative" but necessary as AT&T's rivals are also courting customers like the typical iPhone user, who can afford big bucks for phones and add-on fees for data services like email.