U.S. Cellular's announcement last week that it said no to Apple's (NASDAQ:AAPL) offer to sell the iPhone came as something of a shock. What carrier, at this point in time, says no to the iPhone, a phone that sold 4 million units in its first weekend of availability?
U.S. Cellular's decision highlights something that may be hard for a lot of people in the industry--and for consumers at carriers that don't have the iPhone--to swallow: The iPhone is not right for every carrier. It might not be right for the brand, for the network and--perhaps most of all--it might not be the right fit financially.
U.S. Cellular CEO Mary Dillon wasn't that specific in her answers on why the company decided to pass on the iPhone. According to a Seeking Alpha transcript of her remarks on the company's third-quarter earnings call, she said Apple's "terms were unacceptable from a risk and profitability standpoint and would have forced us to compromise in our commitment to offering an unparalleled customer experience." She also said that the iPhone "didn't make sense for our business economically. And so we'll focus on really playing to our strength, and feel that we're at a competitive position."
After speaking with a few financial analysts and reading between the lines on Dillon's statements, it seems clear that U.S. Cellular said no to the iPhone because the revenue and profit U.S. Cellular would generate from selling the iPhone likely wouldn't be enough to justify the subsidy the carrier would have to pay Apple (it's reported to be around $450 per device).
"If the operator is not generating EBITA [earnings before interest, taxes, depreciation and amortization] per customer or keeping the customer long enough to justify the subsidy, they obviously wouldn't do it," BTIG analyst Walter Piecyk told me, while stressing that he does not have specific insight into U.S. Cellular's financials. "Some operators may say, we are getting a certain profitability over the lifetime of our customers, so why would I do this?"
In the third quarter, U.S. Cellular reported an increase in operating margin from 21 percent to 22.5 percent, an increase in postpaid average revenue per user from $51.84 to $52.41 and a 62 percent increase in net income to $62.1 million. Clearly, whatever U.S. Cellular is doing right now in terms of pushing its customers to adopt to Android smartphones, it's working from a financial perspective. So why would the company want to sink billions into a long-term iPhone contract?
In comparison, Sprint Nextel (NYSE:S)--which has roughly 10 times the number of subscribers than U.S. Cellular--made a four-year, $15.5 billion commitment to Apple. Thus, it's fair to assume that U.S. Cellular would have to make a substantial commitment, perhaps around $1 billion to $2 billion. Sprint, in explaining its decision, said it expects $7 billion to $8 billion in "net present value" during the carrier's four-year contract with Apple. Sprint executives said the iPhone generates 20 percent higher monthly margins than other devices, and that they expect the iPhone to account for 20 percent to 40 percent of its postpaid gross additions and upgrades during the carrier's four-year Apple deal.
I don't know the size of the commitment that U.S. Cellular turned down, but it was likely too big for the carrier. What's clear is that U.S. Cellular doesn't have the margins to give up to get the iPhone. Verizon Wireless (NYSE:VZ) reported a 29 percent wireless operating margin in the third quarter and AT&T Mobility (NYSE:T) reported a 29.6 percent wireless operating margin.
Contrast U.S. Cellular's decision not to sell the iPhone with C Spire Wireless' decision to jump at the opportunity. C Spire is privately held, and so doesn't have the same kind of investor pressure or financial scrutiny as U.S. Cellular. C Spire also likely has a higher operating margin, and thus has more of a margin to give away in iPhone subsidies.
As for Sprint, the carrier decided it needed the iPhone to compete on a national stage with Verizon and AT&T. U.S. Cellular, on the other hand, is a regional player and thus faces a much different competitive position than Sprint.
The bottom line appears to be that U.S. Cellular weighed the costs and benefits of the iPhone and decided it wasn't worth it. The iPhone has certainly helped AT&T attract customers and has given Verizon a boost. Sprint clearly hopes it will do wonders for the company's postpaid subscriber numbers. But it's not for everyone. --Phil