Why Investors Are Divided Over Sprint iPhone Deal

The Wall Street Journal reported that Sprint (NYSE:S) will begin selling the new version of the Apple (NASDAQ:AAPL) iPhone in October of this year. ^[1] After the announcement, Sprint’s stock has been pretty volatile as investors are divided over whether or not the benefits of the iPhone outweigh the costs for Sprint. Sprint’s stock shot up by 10% on the day this news arrived on August 23rd. However, Sprint’s stock shed these gains towards the end of the week to return to previous levels. Our $4.75 price estimate for Sprint stock is about 45% above market price.

Deal positive from subscriber and ARPU standpoint…

In our note titled Sprint’s Stock Finds New Life on iPhone 5 Announcement, we discussed that this deal will help put Sprint on the same footing as AT&T (NYSE:T) and Verizon (NYSE:VZ) which both already sell the iPhone. We believe that the iPhone will not only help Sprint gain more subscribers and reduce churn, but also push up the average revenue per customer as iPhone users are generally considered to be heavy data users.

… but may be dilutive to margins

However, the higher subsidy costs associated with the iPhone will likely be dilutive to Sprint’s margins. Generally carriers bear a subsidy cost of around $400 per iPhone assuming the carrier sells the iPhone at an average price of $200 and pays Apple $600 per unit. We estimate the average revenue that Apple earns by selling an iPhone is around $615. See our complete analysis of Apple stock for more information on Apple.

The carriers hence incur losses of around $400 (loss margin of 200%) for each iPhone. For Sprint, the profit margin from selling phones is currently approximately -160%, which you can see in the above chart.  Once the iPhone arrives at Sprint these losses will increase. Should the margin from selling mobile phones decline to around -200% by the end of the Trefis forecast period, there could be downside of around 10% to our price estimate for Sprint stock.

Margins may also be impacted by an increase in data traffic over Sprint’s network as iPhone users are heavy data users and Sprint is the only major carrier to offer unlimited data plans.  Uncapped data usage by iPhone subscribers could congest Sprint’s 3G network resulting in a need to either spend more to improve the network or eliminate unlimited plans (which CEO Dan Hesse has been personally touting in some of Sprint’s advertisements).

iPhone deal also damaging to argument against AT&T/T-Mobile

One additional factor to consider is Sprint’s ongoing fight against AT&T’s acquisition of T-Mobile.  One of Sprint’s principal arguments against the merger was that a duopolistic market would result in Sprint not having access to the best handsets.  ^[2] That case will be difficult to make if Sprint does indeed get the iPhone in addition to its extensive line of Android phones.

While we believe that the benefits of having the iPhone outweigh the costs in the long run, these short-term issues help explain why Sprint’s stock has declined by over 10% since Wednesday’s open.

See our complete analysis for Sprint stock here

1. Sprint to Get iPhone 5, Wall Street Journal, August 24th, 2011 [↩]
2. Sprint iPhone’s unlikely cheerleader: AT&T, CNNMoney, August 2011 [↩]