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The iPhone Covers AT&T's Warts, for Now

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In the annals of corporate history, I'm guessing that AT&T's (NYSE: T  ) multiyear exclusivity agreement with Apple (Nasdaq: AAPL  ) for U.S. distribution of the iPhone will be remembered as the equivalent of finding a winning lottery ticket on the sidewalk. Had Apple not been taken in by the allure of a massive subsidy, and instead chosen to do business with multiple U.S. carriers, chances are that versions of the iPhone would also be offered right now by Verizon (NYSE: VZ  ) , Sprint (NYSE: S  ) , and Deutsche Telekom's T-Mobile.

But instead, AT&T has exclusive distribution rights that last at least into 2010, and as its Q3 earnings release shows, that shiny little device has been quite the saving grace for the company.

Coming in at $0.54 per share, AT&T's earnings beat analyst estimates by $0.04 per share, and the wireless division clearly deserves most of the credit. Driven by 3.2 million iPhone activations, net subscriber additions topped 2 million, well ahead of the consensus estimate of 1.5 million, and very impressive for a country where the wireless penetration rate is now above 90%. Wireless service revenue grew by 10% annually, and over the same time, the Wireless division's operating margin soared from 18.9% to 24.6%.

What's more, with the cheapest iPhone plan costing $70/month, AT&T's average revenue per user grew by $2.24 annually, to $61.23. And with every iPhone user a data-services subscriber, data revenue managed to grow by 33% annually, to account for more than 26% of total wireless revenues.

But, alas, AT&T isn't merely a wireless service provider. The company also has a wireline division that still accounts for the majority of its revenue. And this division depends on a local phone business that's slowly unraveling, as consumers and businesses ditch their traditional landlines either for cellular connections or cheaper voice over Internet protocol (VoIP) connections from the likes of Comcast (Nasdaq: CMCSA  ) , Time Warner (NYSE: TWX  ) , and Vonage (NYSE: VG  ) . Wireline voice revenue fell by more than 14% annually, and the division's income fell by 30% to $1.9 billion -- well below the $3.4 billion earned by the smaller wireless division.

AT&T has long touted its U-verse initiative for offering a "triple play" of VoIP, Internet, and TV services as its answer to dealing with the nonstop decline in traditional voice revenues. But while some initial progress has been made -- there are now more than 1.8 million U-verse TV subscribers -- much more work needs to be done, considering that AT&T lost nearly 1 million consumer phone lines last quarter. But instead of accelerating the pace of U-verse deployments, AT&T seems to be slowing things down, with net additions to TV subscribers up only 8,000 from the pace set last quarter.

The slowdown in the U-verse build -- likely a major reason why AT&T's 2009 capital expenditures are down considerably from 2008 -- has helped boost the company's free cash flow over the short term. AT&T badly needs that cash to keep trimming its massive debt load, which still stood near $73 billion at the end of Q3. But it's also likely to hurt the wireline division's profitability over the long run, since it gives cable and wireless service providers more time to woo away AT&T's local phone customers.

Without a surge in U-verse sign-ups, the wireline division's revenue and profit declines could easily continue for years to come. And if AT&T's exclusivity agreement for the iPhone ends next year, it won't be long before the wireless division is no longer able to offset wireline's weakness.

Fool contributor Eric Jhonsa has no position in any of the companies mentioned. Apple is a Motley Fool Stock Advisor recommendation. Sprint Nextel is a Motley Fool Inside Value selection. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 23, 2009, at 2:29 PM, susan40dd wrote:

    Why do I stay with Apple?

    Because they have the iphone. I love the hardware. I love the 85 *THOUSAND* apps I can run.

    Why do I stay with AT&T?

    Because of great service? No.

    Because of extremely low prices? No.

    Because of great coverage everywhere? No.

    Because of great quality? No.

    I stay with AT&T because I'm *FORCED* to.

    If you want to keep your customers. Offer a great product. Don't keep them because you are forcing them to stay.

  • Report this Comment On October 23, 2009, at 2:34 PM, susan40dd wrote:

    But if the iphone hadn't be heavily subsidised by the AT&T agreement, user's wouldn't have wanted to pay the actual $600 price.

    ... so the phone wouldn't have suceeded as it did.

    Overall, it will workout ok: Sign an agreement with an awful carrier... that's will to pay a large subsidy. Get the iPhone ball rolling... and then drop AT&T.

    Apple's no fool.

  • Report this Comment On October 24, 2009, at 12:43 PM, beetlebug62 wrote:

    One, the cheapest iPhone plan is $60. Lots of people still use the EDGE iPhone. In fact, some people, like myself, that do not live within 100 miles of a 3G service area, have 3G iPhones but pay the EDGE rate of $60 a month. And yes, when I am in a 3G service area, I get 3G speeds.

    While AT&T's coverage is only adequate, and its connections can be spotty, I doubt Verizon would be better. Alot of the problems are because the iPhone is so demanding on the network. And, Verizon would never let the iPhone be the iPhone. It would be crippled, as they have cripple so many phones in the past. I mean, would they really allow the iPhone to bypass VCast for free?

  • Report this Comment On October 25, 2009, at 2:02 AM, knighttof3 wrote:

    I agree with Beetle about Verizon.

    It's frustrating that Nokia, Motorola, Samsung and other cell phone companies put so many good features in their phones; only to have them disabled by Verizon because they don't contribute to Verizon's revenue. I wish Google had broken the oligarchy of Verizon, AT&T and minor players (Sprint, T-Mobile, et al) in thw wireless spectrum.

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