U.S. wireless carriers will eventually shift to smartphone leasing and away from equipment installment plans, according to analysts at Macquarie Capital. Further, they think the operators could get a boost in leasing by partnering with Apple (NASDAQ: AAPL), which would stand to benefit from a move to leasing.
In a research note, Macquarie Capital analysts Kevin Smithen, Ben Schachter, Will Clayton and John Merrick said that they expect "smartphone leasing to continue to replace subsidies and eventually EIP plans in the U.S., especially at market share gainers" T-Mobile US (NYSE:TMUS and Sprint (NYSE: S).
Verizon Wireless (NYSE: VZ) recently introduced new plans that do away with two-year contracts and subsidized smartphones for new customers. Meantime, AT&T Mobility (NYSE: T) has heavily pushed its Next EIP program; Sprint has been offering leased phones for nearly a year and plans to shift entirely to that model by year-end; and T-Mobile in July introduced its "Jump! On Demand" program, which lets customers upgrade smartphones up to three times every 12 months but requires them to lease and turn in their phones when they upgrade.
The Macquarie analysts said that Verizon launched its new plans "in response to recent successful lease promotions from Sprint and T-Mo." They note that carriers get "significant accounting benefits to their EBITDA from EIP plans and even more so from lease plans." As such, carriers "were incentivized to aggressively push customers onto EIP plans in 2013 and 2014."
The analysts noted that "consumers need additional incentives to renew EIP plans, in our view." They pointed out that, under most EIP plans, customers can obtain a lower monthly bill after they pay off their phone -- "if the consumer's smartphone is working well, the consumer may opt to keep his/her existing device until it breaks."
Further, carriers can save money by moving to leasing plans. "The main advantage of a third-party lease facility over an EIP plan is to transfer that capex cost [of purchasing a smartphone] to the third-party," the analysts said. "Sprint has announced plans to utilize an off-balance sheet leasing company partially funded by SoftBank. We believe that T-Mo is working on a similar 'LeaseCo' arrangement which should be finalized by year-end."
Those leasing arrangements could save Sprint and T-Mobile $1 billion to $2 billion per quarter in handset capital expenditures once leasing plans are fully penetrated, the analysts said. They also said leasing plans transfer risk to the third party instead of the carrier.
How does all of this play for Apple? The analysts think Sprint's "iPhone for Life" and other leasing plans are much better for Apple than EIP plans "because they force the consumer to turn in the phone and upgrade after two years rather than allowing the customer to keep the device as in EIP. This should drive higher iPhone sales regardless of product innovations."
However, the problem for the carriers, and Sprint and T-Mobile specifically, is that they do not have the money to contribute a few billion dollars each in equity to fund a leasing company, the analysts said.
And that's where Apple might come in. The analysts think Apple could set up leasing arrangements with the Tier 1 carriers. Apple would benefit by getting customers to upgrade their iPhones sooner, gaining 5 to 7 million more iPhone sales per year. The analysts said Apple could then sell those phones as "certified" used phones for $200 to $350 into the international or U.S. prepaid markets.
"Because of this potential windfall on the residual value, we believe that Apple may be able to incentivize the consumer to switch to leasing plans by offering discounted or free lease payments for a few months," the analysts said. "The carriers would benefit from not having to tie-up equity in the LeaseCos and the consumer would benefit from getting a new phone every two years."
Verizon: Existing customers with 2-year contracts and subsidized smartphones can keep them
Sprint to abandon 2-year contracts by year-end, embrace leasing exclusively
Analyst: T-Mobile to trail Sprint with Jump On-Demand adoption, 25% of subs will sign up in 2016
T-Mobile unveils 'Jump On Demand' program, lets customers upgrade 3 times per year
AT&T's de la Vega: 2-year contracts will eventually go away