Apple’s newest iPhone is proving to be a mixed blessing for wireless carriers and their Wall Street investors as company margins suffer from the subsidies paid to woo customers with discounted phones.

The biggest winner remains Apple, which charges between $649-849 for an iPhone 5 that IHSiSuppli estimates costs between $207-238 to manufacture, depending on the amount of memory included. Regardless of how much you pay for your next iPhone with a 2-year contract, Apple gets a much larger wholesale price, upfront.

Barclays analyst James Ratcliffe estimates AT&T, Verizon Wireless, and Sprint are providing nearly $400 in advance subsidies to reduce the contract price of the iPhone to between $199 and $399. That subsidy is 60 percent higher than comparable Android smartphones.

“We always say an Apple a day keeps the profits away,” Neil Montefiore, chief executive of Singapore wireless carrier Starhub said during an August earnings conference call.

Wireless carriers have to report the subsidy on balance sheets as a drop in earnings before interest, tax, depreciation and amortization (called EBIDTA on Wall Street). AT&T and Verizon typically don’t see profits from Android smartphone customers until 5-6 months after selling them a new phone. Apple iPhone customers are unprofitable for up to nine months.

According to Reuters, profit margins will fall for America’s two largest cell phone companies because of the newest iPhone.

AT&T’s margin is expected to fall from 45 percent in the second quarter to 40.8 percent in the third quarter and 35.7 percent in the fourth quarter. Verizon’s margin is expected to fall from 49 percent in the second quarter to 47.4 percent in the third quarter and 43.6 percent in the fourth quarter.

Sprint CEO Dan Hesse

Under pressure from investors, wireless carriers are trying harder than ever to reduce the financial hit from the endless two-year upgrade cycle most North Americans have gotten used to over more than a decade.

For most, changing data pricing has been the key to earlier profits. Both AT&T and Verizon Wireless have eliminated unlimited data plans for new customers, and Verizon has taken away subsidies for customers holding onto a grandfathered unlimited plan. As contracts expire, customers seeking upgrades must either purchase their next phone at the unsubsidized price or give up their unlimited plan for good.

Sprint continues to bank on its unlimited data offer bundled with Apple’s iPhone 5 as an important marketing tool to attract new customers. It has worked for them, but the company may eventually capitalize on that growth with increased prices, but not before Sprint completes an ambitious upgrade to a 4G LTE nationwide network.

“We have a competitive disadvantage in terms of LTE footprint,” CEO Dan Hesse told investors. “You don’t increase your price when you have a network footprint disadvantage. You want to wait and think of that until you get to that point.”

The foundation for future profits come from data usage.

Verizon’s chief financial officer Fran Shammo believes Verizon Wireless’ foundation for higher profits will come from their new family shared data plans.

“When you think about revenue growth into the future, the shared revenue plan and what I’ll call revenue per account if you will, is really the critical piece because there are two functions,” Shammo told investors last week. “One is get people to share so that data becomes the most significant piece of the plan and the more data they consume the more they will have to buy up in bundles.”

“And the second one is make it easier for customers to attach more devices. So when you think about that future of the car, the home, medical devices, and anything else that you want to attach to that wireless network, […] I get incremental dollars for each device that’s attached and that is really what drives the future revenue growth.”

[flv width=”640″ height=”380″]http://www.phillipdampier.com/video/CBS Sprint CEO talks iPhone 5 and unlimited data strategy 9-20-12.flv[/flv]

Sprint CEO Dan Hesse last week appeared on CBS’ “This Morning” to discuss the arrival of Apple’s newest iPhone and the company’s unlimited wireless data plan.  (4 minutes)

November 7 will be an important day if you are a rural AT&T landline customer. On that date, AT&T, in concert with Wall Street, plans to announce the future of its rural and “tier two-smaller city” landline business.

The implications for customers are enormous. AT&T could elect to exit and auction off its rural customers to companies like Windstream, Frontier Communications, CenturyLink, and FairPoint Communications. AT&T could also announce it will aggressively petition the Federal Communications Commission to decommission its copper landline facilities in favor of a new wireless IP network based largely on its national 4G LTE expansion, or it could be a combination of both: keeping existing landline facilities but transitioning them to Voice over IP technology with a gradual shift towards wireless.

AT&T CEO Randall Stephenson delivered important clues about the company’s direction in remarks at yesterday’s Goldman Sachs Communacopia Conference, attended primarily by Wall Street investors. Stephenson drew clear distinctions between valued customers in areas upgraded to AT&T’s U-verse platform and more problematic customers in smaller communities where AT&T refuses to invest in landline upgrades.

“Where you look at the footprint where we have deployed U-verse technology we do very well,” Stephenson said. “In fact we are the share leader in virtually all U-verse markets. Those markets grow nicely. Where we have not deployed fiber and U-verse technology, we are losing share and those markets are in decline and that is the whole reason behind this analysis and evaluation that we will be laying out Nov. 7. What do we do with those markets? Because we have demonstrated if you go invest you can grow the market.”

Stephenson

“We said coming into the year that we have to find a broadband solution for these assets that is cost-effective or we need to look at selling them,” Stephenson said. “I would just tell you at the 30,000 foot [line length] level we think we’re finding line of sight to some investment theses here. We can get a good competitive broadband product to a large portion of our footprint and would avoid us having to go through a number of regulatory approval processes to sell [landlines] across a large geography. There will probably be a mix of actions here, but the bottom line is we think we may have line of sight but we will flush that out on Nov. 7 in an analyst conference here in New York.”

Early indications suggest the company is considering deploying DSL extenders to reach a larger share of rural customers without a complete overhaul of its copper wire network. The upgrades could deliver results similar to what Frontier Communications has been doing in territories it acquired from Verizon Communications, which includes extending fiber optics further into neighborhoods and finding ways to reduce copper wire length to improve speeds. Frontier has set its sights on delivering up to 25Mbps over copper landlines, a speed it feels is competitive with cable broadband. AT&T could come close to these speeds without the amount of investment required in a typical U-verse deployment.

But just as likely is a largely wireless broadband solution to replace the company’s aging copper wire-based DSL service. Stephenson says he strongly believes that a wireless solution exists for rural America over the company’s new LTE 4G network.

“I don’t envision in major metropolitan dense population centers that LTE will serve as a broad-based fixed-line replacement or surrogate,” Stephenson said. “I do believe in less dense markets and especially when you begin to think about rural America and tier two towns, that LTE can become a fixed line replacement or even better than what you can get in fixed line out in those markets. This is one of the exciting things about the WCS spectrum [AT&T plans to acquire]. It allows you to truly begin to think about investing in and doing this.”

But AT&T’s solutions will come with strings attached: a lobbying effort to get the FCC to loosen up on regulations, acquire more wireless spectrum, and allow the company to dispose of its landline infrastructure.

“You don’t go out and put in LTE capability in rural America and leave up all your copper infrastructure in the long haul,” said Stephenson. “It just wouldn’t make sense to do both. So this is the big regulatory issue. The FCC would require us to leave that copper and TDM fixed-line infrastructure up by some mandated rules and you can’t do both. You can’t support both infrastructures. We have got to work through the regulatory implications of this, but I think LTE can prove over time to be a fixed line replacement in rural and less dense populations. I think in a five year time horizon that can become significant.”

Thus far, AT&T has been unwilling to consider upgrading smaller communities to its U-verse platform, primarily because of the cost and return on investment. The company is content with its current U-verse footprint and has begun to enjoy increased wireline margins from a growing number of urban customers as programming costs decline.

LTE: AT&T’s wireless rural broadband solution?

“The U-verse margins continue to expand,” Stephenson noted. “U-verse is one of those where you go make a really significant capital investment and then you go in as a new entrant to do programming contracts and you’re paying multiples of what the big scale guys are paying and then as you scale that over time then margins really begin to expand. We’re riding that right now and we’re getting really good margin expansion just out out of scaling U-verse and getting better economics on content terms as well.”

Wall Street has been applying pressure to Stephenson to extract higher margins and cut costs from its traditional landline business. Stephenson sought to placate concerns about the cost profile of AT&T landlines before investors.

“We have done a nice job controlling our labor costs and that has been very helpful to continue to sustain margins in the fixed line business,” Stephenson said. “Those labor costs savings we take and reinvest back in the business in the form of U-verse and looking at some future investments as well.”

Stephenson hopes the FCC will eventually let AT&T abandon traditional landline service everywhere, which could also deliver serious cost savings for AT&T.

“I do believe if we can find a path to an all-IP infrastructure in not just your major metropolitan areas but your tier two markets there are significant cost savings in the five or six year time horizon that could come out of these businesses as well,” he noted.

AT&T CEO Randall Stephenson took questions at Goldman Sachs’ Communacopia Conference about its wireless network and the future of the rural landline business. (September 19, 2012) (41 minutes)
You must remain on this page to hear the clip, or you can download the clip and listen later.

Free Press’ campaign against AT&T’s Net Neutrality violation (click image for further information)

When AT&T customers take delivery of their new iPhone 5 or install Apple’s latest iOS 6 software update, the popular video conferencing app FaceTime will become available to the company’s mobile broadband customers for the first time, if they agree to switch their service to one of AT&T’s new, often more-costly “Mobile Share” plans.

Until now, FaceTime has been limited to Wi-Fi use only, but objections from wireless carriers and some technical limitations kept the popular app from working over 3G or 4G wireless networks.

AT&T’s decision to block the FaceTime app unless a customer changes their current mobile plan has sparked a notification from three public interest groups that they intend to file a formal Net Neutrality complaint against AT&T.

“AT&T’s decision to block FaceTime unless a customer pays for voice and text minutes she doesn’t need is a clear violation of the FCC’s Open Internet rules,” said Free Press policy director Matt Wood. “It’s particularly outrageous that AT&T is requiring this for iPad users, given that this device isn’t even capable of making voice calls. AT&T’s actions are incredibly harmful to all of its customers, including the deaf, immigrant families and others with relatives overseas, who depend on mobile video apps to communicate with friends and family.”

Free Press is joined in the forthcoming complaint by Public Knowledge and the New America Foundation’s Open Technology Institute.

“AT&T’s decision to block mobile FaceTime on many data plans is a direct contradiction of the Commission’s Open Internet rules for mobile providers,” said Sarah Morris, policy counsel for the New America Foundation’s Open Technology Institute. “For those rules to actually protect consumers and allow them to choose the services they use, the Commission must act quickly in reviewing complaints before it.”

AT&T earlier responded claiming they still allow the app to work over Wi-Fi (yours or theirs), so it cannot be a Net Neutrality violation. The company has spent an increasing amount of energy trying to convince regulators that wireless networks, including Wi-Fi, are largely equivalent. So long as a customer can access an app on one of them, there is no violation according to AT&T.

The company also claimed that since FaceTime comes pre-installed on phones, it is exempted from Net Neutrality regulations.

Whether the FCC will believe arguments that access over Wi-Fi is suitable enough to escape scrutiny for blocking an app on AT&T’s own 3G and 4G networks is open to debate.

The Obama Administration’s FCC has taken a lukewarm approach on Net Neutrality, adopting a compromise that is being attacked in court by MetroPCS and Verizon Wireless and considered insufficient protection by most consumer groups.

House Energy & Commerce Committee

The House Energy and Commerce Committee plans to hold a hearing Friday to review the Federal Communications Commission’s actions regarding the now-bankrupt wireless firm LightSquared, which proposed a nationwide 4G network later found to create major interference problems for GPS users.

At issue are the circumstances surrounding the conditional waiver the company received from the FCC to move forward with its network in 2011. Some Republicans are questioning whether the FCC rushed the approval process without independently assessing whether LightSquared would interfere with GPS services located on nearby frequencies.

The hearing, requested by the Republican majority, will explore whether the FCC skipped its own procedures and ignored policy to hurry approval.

Sen. Charles Grassley (R-Iowa) has raised questions about the FCC and LightSquared owner Philip Falcone, who has donated nearly $100,000 to the Democratic Party.

“Without transparency, and with media coverage of political connections in this case, there’s no way to know whether the agency is trying to help friends in need or really looking out for the public’s interest,” Grassley said last September after unsuccessfully trying to get the FCC to pass along documents regarding the venture.

The Center for Public Integrity found numerous political connections between LightSquared and the Democratic Party:

• Several major Democratic campaign contributors and longtime Obama supporters have held investments in the company and its affiliates during its tangled decade of existence. They include Obama’s good friend and political donor Donald Gips, his former White House personnel chief, who now serves as U.S. ambassador to South Africa. Records show that Gips maintained an interest, worth as much as $500,000, as the FCC was weighing LightSquared’s request.
• Obama himself was an early investor and came to the presidency a firm believer in expanding broadband. He remains close to other early investors, like Gips and investment manager George W. Haywood, inviting some to luxe social events at the White House and more intimate gatherings like a night of poker and beer.
• Obama installed one of his biggest fundraisers, Julius Genachowski, a campaign “bundler” and broadband cheerleader, as chairman of the FCC, whose staff granted LightSquared a special waiver to operate.
• LightSquared’s current majority owner, hedge fund manager Philip Falcone, made large donations to the Democratic Party while his broadband request was pending before the FCC. He and LightSquared executives met with White House officials. Neither Falcone nor the White House would comment on what was discussed.
• LightSquared employs lobbying firms that wield formidable Democratic firepower: Ed Rendell, former governor of Pennsylvania and onetime chair of the Democratic National Committee, as well as the firm of former House Majority Leader Richard Gephardt.
• Jeffrey J. Carlisle, the company’s vice president for regulatory affairs, served with Genachowski and Gips on Obama’s transition team.

With nearly $3 billion sunk into the venture by hedge fund owner Falcone and his backers at Harbinger Capital, fierce lobbying pressure was applied to win the conditional FCC waiver, granted by the FCC before it reviewed comprehensive reports affirming interference problems.

When independent tests showed LightSquared’s service would overwhelm sensitive GPS receivers and render the location-tracking service nearly useless, last February the agency withdrew its permission for LightSquared to operate, beginning a death spiral for the 4G venture, which filed for bankruptcy in May.

AT&T customers upgrading to Apple’s newest iPhone will be able to keep their grandfathered unlimited data plan and purchase the phone at discounted prices starting at $199, with a new two-year contract.

AT&T’s definition of “unlimited” has, for at least a year, actually meant up to 3GB of usage before throttling your 3G speeds to something comparable to dial-up Internet. But with the iPhone 5 ready to run on AT&T’s higher capacity 4G network, the company is increasing the limit to 5GB per month.

AT&T has been working hard to hold onto its significant base of iPhone owners, who have endured dropped calls and slow data in many cities for the last several years.

Customers planning to leave AT&T will find a considerably less-friendly attitude at Verizon Wireless, where new customers are compelled to sign up for a Share Everything plan that starts with just 1GB of usage per month.

Sprint is retaining its unlimited smartphone data plan with no hidden limits or speed throttles, but Sprint’s overburdened 3G network is not known for fast and reliable speed, and the company’s aging 4G Clearwire WiMAX network cannot perform as well as Sprint’s forthcoming LTE counterpart, which has only appeared in a handful of cities so far.

The iPhone 5 will be the first Apple phone ready to take advantage of 4G LTE speeds, which could give those new networks a real workout as millions of new iPhone owners pile on.