No Sprint, U.S. Cellular Gives Phone the Stiff Arm

U.S. Cellular Corp. (NYSE:USM), the country’s sixth-largest cellphone company, announced last week that it had the opportunity to carry Apple’s (NASDAQ:AAPL) iPhone but turned it down because Apple’s terms were unacceptable. ^[1] It might seem shocking at first that a carrier would turn down the iPhone considering that the latest version, the 4S, sold more than 4 million units in its opening weekend alone. However when looking at the terms that Sprint (NYSE:S) had to agree to in order to get the phone it’s actually not terribly surprising. Sprint disclosed in its most recent earnings call that it had made a $15.5 billion, four-year commitment to Apple to sell the iPhone. C Spire Wireless, a tiny wireless competitor, has also jumped on the iPhone bandwagon with its recent announcement to start selling the iPhone 4S from November 11th onwards. ^[2] Competitors AT&T (NYSE:T) and Verizon (NYSE:VZ) have also been selling the iPhone for some time now.

The base model of iPhone is sold for about $200 by carriers in the U.S. market. However, Apple charges around $600 for each iPhone sold. The balance of $400-$450 is subsidized by the carriers upfront in return for a two-year contract with the subscriber, during the course of which they hope to make their money back in service fees.

Our price estimate for Sprint is $4.25, which is about 70% higher than the market price

See our full analysis of Sprint’s stock here

Reasons for the Denial

We believe that U.S. Cellular turned down the iPhone offer because the revenue and profit U.S. Cellular would generate from selling the iPhone likely wouldn’t be enough to justify the subsidies the carrier would have to incur. In the third quarter, U.S. Cellular reported an increase in operating margin from 21 percent to 22.5 percent, an increase in postpaid average revenue per user from $51.84 to $52.41 and a 62 percent increase in net income to $62.1 million. ^[3] Clearly whatever U.S. Cellular is doing in terms of pushing its customers to adopt Android smartphones is working from a financial perspective. So why would the company want to sink billions into a long-term, risky iPhone contract that may not start paying back for another several years? Even with Sprint’s pretty optimistic forecasts, the benefits from the iPhone are not expected to exceed its costs until 2015.

Sprint decided that it needs the iPhone to compete on a national stage with Verizon and AT&T. Verizon and AT&T’s healthy operating margins of around 29% give them the cushion to incur subsidies when selling the iPhone. U.S. Cellular, on the other hand, is a regional player in a much different competitive position than Sprint. Also, its comparatively low margins do not provide it with the cushion to take the iPhone risk.

In any case, we think Sprint has taken a gamble with the iPhone, especially with the timing of its LTE network upgrade that will also cost the company significantly in the form of capital expenditures. They are taking significant gambles on two separate projects. If it works out, then the company will be in great shape. However if they run into any issues it could have a substantial impact on their performance and liquidity. ^[4]

Understand How a Company’s Products Impact its Stock Price at Trefis

1. US Cellular: We Turned Down iPhone, Businessweek, Nov 2011 [↩]
2. Pre-register the iPhone, Company website, Nov 2011 [↩]
3. United States Cellular CEO Discusses Q3 2011 Results, Seeking Alpha, Nov 2011 [↩]
4. UPDATE 5-Sprint eyes new financing as iPhone swells costs, Reuters, Nov 2011 [↩]