Free iPhone 4 Will Help Sprint Meet iPhone Commitment

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The iPhone 5 may have hogged most of the attention since its launch last week and seen the most launch-day pre-order interest of any iPhone as well, but two of Apple’s (NASDAQ:AAPL) U.S. carrier partners will be excited for a completely different reason.

When Apple launched the iPhone 5 last week, it also slashed the prices of its older models, making the iPhone 4 free with a two-year contract. That, in itself, may not very interesting considering that this isn’t Apple’s first free subsidized offering – the iPhone 3GS was also available for free. But the 3GS’ inability to work on CDMA meant Verizon (NYSE:VZ) and Sprint (NYSE:S) had to live without a free iPhone for a year, while AT&T (NYSE:T) got a free ride. This will change however with the free iPhone 4, which incidentally was the first Apple built with CDMA-support. It makes both the CDMA-players, Verizon and Sprint, eligible to carry a free iPhone for the first time.

Of the two, however, this probably means the most to Sprint, not only for the fact that it breaks AT&T’s exclusive hold on the only remaining iPhone bastion but also because it makes it easier for Sprint to meet its highly expensive commitment to Apple made late last year.

See our complete analysis for Sprint

iPhone strategy paying off

Sprint’s decision to carry the iPhone last year came as a solution to its continued postpaid subscriber loss problem as the company believed that the iPhone will help attract more number of subscribers to its core CDMA platform and mitigate the loss of subscribers on the iDEN platform. However, since Sprint was a tad late in jumping on the iPhone bandwagon, it had to make a huge upfront commitment of nearly $15.5 billion to Apple over a four-year period. This was a massive bet considering that the company had a highly leveraged balance sheet with about $26 billion in debt on its books compared to what was its market capitalization of only around $7.5 billion then.

However, with the company reporting three strong quarters of postpaid net adds on its core Sprint network since the iPhone addition, we believe the bet is working out for Sprint. Sprint added a net 442,000 subscribers to the Sprint platform last quarter, almost twice as many as it did in the year-ago quarter and 70% higher sequentially. While this figure was boosted by the number of iDen subscribers Sprint was able to migrate to its core CDMA network, it also came in a highly saturated market that is causing behemoths Verizon and AT&T to add fewer postpaid subscribers this year.

iPhone 4 to help in meeting commitment

The carrier has sold 4.8 million iPhones so far in the first three quarters since the iPhone made its debut at Sprint. If Sprint is able to maintain this rate for the next four years and sells an average of a little more than 6 million iPhones every year, it will only just be able to meet its $15.5 billion minimum commitment at a cost of about $630/iPhone (accounting for all the cheap iPhones it sells and using Apple’s iPhone ASP for 2011). Of course, Sprint has only just started out with the iPhone and it could sell more than 6 million iPhones every year. But having a free iPhone, no matter how many generations old, will surely help Sprint get a few more iPhones out of the door and make the target more comfortable to achieve.

Apple doesn’t give out its iPhone sales mix, so it is tough to get a clearer picture of how many iPhone 4 units Sprint could sell going forward. But Apple CEO Tim Cook has indicated in the past that the lower price points have had a significant role to play in the company’s iPhone success. While discussing Apple’s Q2 FY2012 earnings, when Apple managed to sell about 35 million iPhone units, Tim Cook had this to say:

On the iPhone, we continue to be very happy with the moves that we made in pricing just a few months ago on the iPhone 3GS and the iPhone 4. And both of them contributed to our ability to achieve 35 million in sales, which is our second highest quarter of all time.

Margin pressures offset by ARPU gains

Selling the cheaper iPhones will however not decrease Sprint’s subsidy burden. The iPhone 4 may be free for the end buyer but Sprint will still have to pay Apple about $450 on each iPhone sold, the same as it will for the iPhone 5 and the 4S. However, since iPhone buyers are generally heavy data users, most of them would choose its unlimited data plans which start at a minimum cost of $80 per month and go on up to $110 per month. Sprint’s current postpaid ARPU (for the Sprint network) stands at $61, as of last quarter; so there is a significant room to drive postpaid ARPUs up by increasing adoption of unlimited plans through iPhone sales. This would help Sprint more than make up for the upfront subsidy cost by locking in the user for the term of the contract period, i.e, 2 years.

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