Apple's iPhone 7 is shaping up to be a big success, but that could mean bad things for wireless margins.
Sprint S 1.92 % and T-Mobile TMUS 2.40 % said earlier this week that opening weekend preorders for the iPhone 7 exceeded those for the 2014 launch of the iPhone 6 by nearly five times and nearly four times, respectively. The upgrades are good news for Apple, but will be costly for carriers.
The U.S. wireless industry is particularly vulnerable to a downturn right now. The last three years have been marked by record profitability, with wireless margins on the basis of earnings before interest, taxes, depreciation and amortization hitting a high of 40.1% in the second quarter, according to UBS. The gains surprisingly have taken place amid tougher competition as the industry switched to a model where companies sell phones to consumers on installment plans rather than give them low upfront device costs that they earn back with high service fees.
Carriers sell phones at cost. Under traditional plans, they book $200 in revenue upfront when an iPhone is sold. Assuming the phone costs $800, a carrier would take a one -time $600 hit to Ebitda. Under the new plans, carriers book about $750 of the device revenue upfront. That means the hit to Ebitda is significantly smaller.
The accounting change alone improved margins. Carriers got a further boost because the new plans have meant consumers are keeping their smartphones for longer, which has made switching phone companies less common. Those trends have helped carriers cut costs substantially.
The benefit from the accounting shift is nearing an end. About 65% of subscribers are on these installment plans and 80% of new sales are done with handset financing, UBS says. Now the new iPhone looks likely to spur a wave of phone upgrades, which will bring an uptick in carrier switching right along with it.
The combination of these forces could mean a sizable, unexpected hit to margins. Analysts have predicted upgrade rates will remain roughly flat in the second half of the year. An increase of 1 percentage point in the upgrade rate for both the third and fourth quarters of 2016 would mean a hit to full-year Ebitda of $422 million at Verizon, VZ 0.21 % $239 million at AT&T, T 0.80 % $80 million at T-Mobile and $79 million at Sprint, according to New Street Research.
On top of this, recent changes in pricing are lowering the value of increased data consumption for carriers. New unlimited plans from T-Mobile, Sprint and AT&T remove the ability to charge more for more data and eliminate overage charges. Verizon doesn't have an unlimited offering, but it is selling larger amounts of data for the money. The trend should weigh on average revenue per postpaid user at AT&T, Sprint and Verizon, pushing them closer to T-Mobile's industry-low level.
Verizon and AT&T may feel the impact most. T-Mobile and Sprint already have lower margins, and investors in those companies are likely more willing to trade profitability for subscriber growth. The arrival of the iPhone 7 should be a wake-up call for wireless investors.
Write to Miriam Gottfried at Miriam.Gottfried@wsj.com
Source: New iPhone Could Be Bad News for Wireless Industry
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