Sprint's iPhone: The Gift That Keeps on Taking

Sprint Nextel (NYS: S) CEO Dan Hesse has put great emphasis on the iPhone being the key to good fortune ahead. At the beginning of Sprint's third-quarter conference call he stated, "We believe the number one reason new customers don't try Sprint has been 'No iPhone.'"

And his point was proven with Sprint's fourth-quarter earnings announcement that of the 1.8 million iPhones Sprint sold during the fourth quarter, 40% went to new customers. Those new subscribers helped the carrier to a net gain of 1.6 million users for the quarter, bringing up the company's total base to more than 55 million. That breaks down to 33 million postpaid, 14.8 million prepaid, and 7.2 million wholesale customers.

However, the lure of the iPhone came at a price. Check out the chart below. It shows Sprint's revenues for the fourth quarter (beginning in October, which was also when Sprint began offering the iPhone) zooming up precisely as its operating margin falls.

Sprint's revenues vs. operating margin
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Source: YCharts.

Sprint's deal with Apple (NAS: AAPL) was for the carrier to buy $15 billion worth of iPhones over a four-year period, but from the chart it looks like the more iPhones Sprint sells, the deeper in the hole it's going to get. For during the fourth quarter, that hole became $1.3 billion deeper. That wasn't helped by Sprint's OIBDA, or operating income before depreciation and amortization, falling to 9.5% during the quarter, down from 16% during the same period last year.

Could this be what CEO Hesse meant during his third-quarter conference call when, in a tortured Moneyball analogy, he compared Sprint's getting the iPhone to a baseball team signing A-Rod to score runs and fill the seats in the stadium? "iPhone has an expensive contract, but he's worth every penny," he said.

To be fair, Sprint is not the only carrier facing the iPhone paradox, the need to entice customers to sign long-term contracts by offering the iPhone even though the company must eat much of that phone's cost. AT&T (NYS: T) , which sold 7.6 million iPhones during the fourth quarter, saw the same rising-revenues-with-falling-margins-iPhone phenomena:

AT&T revenues vs. operating margin

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Source: YCharts.

Verizon (NYS: VZ) , which sold 4.2 million iPhones, wasn't immune, either:

Verizon revenues vs. operating margin
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Source: YCharts.

Apres iPhone: LTE
Capital expenditures also contributed to Sprint's negative bottom line. The costs of building and maintaining the company's infrastructure ate up $3.13 billion for the year, compared to $1.94 billion for 2010. But to stay competitive with rivals AT&T and Verizon, Sprint must be able to produce a 4G LTE network. Verizon already has 195 markets covering 200 million people. AT&T has 26 markets covering 75 million. Sprint plans on have six markets served by its LTE network by mid-2012.

Sprint's LTE plans have been much discussed in 2011. It's continuing partnership with Clearwire (NAS: CLWR) faced doubt when the carrier signed a deal with LightSquared as its future LTE provider. But as LightSquared's continuing problems with the FCC -- the company's inability to put to rest doubts about its network signals not interfering with GPS devices -- and the specter of a bribery accusation from Sen. Chuck Grassley (R-Iowa) hanging over its head, Clearwire's future with Sprint has started looking more secure.

Indeed, Hesse, when asked about the Clearwire-Sprint relationship during the conference call, said that Sprint would continue to use Clearwire's 4G WiMAX network services for the foreseeable future, and that " ... probably, in the 2013 timeframe, you'd begin to see devices that we'll start offering that will work on Clearwire's new LTE network."

Nextel-be-gone
Sprint has also announced that it will be phasing out its push-to-talk iDEN network, the "Nextel" part of Sprint Nextel. The decommissioning of iDEN in the 250 Nextel markets will begin in 2013, with the Sprint planning on migrating those customers over to the same service on its CDMA network. The company will also be ridding itself of 44% of its cell towers, dropping down to 38,000, which, it says, will reduce 3G and 4G roaming costs. Some would say that the whole Nextel deal was a no-go from the beginning.

Inside a bad baseball analogy
But going forward, there is still going to be the law of the iPhone's diminishing profit margins for Sprint to contend with. To torture the baseball analogy a bit more: It's like the Washington Nationals signing A-Rod to a $15 billion four-year contract with a $1 million bonus for each home run he hits. After a while, the owners may start hoping he'd become a singles hitter instead.

Apple obviously has certainly pulled in large profits from its iPhone, but investors shouldn't overlook those companies that supply the chipsets and other bits that Apple and the other smartphone makers need to produce their devices. For an inside look at three such companies that The Motley Fool's analysts think are good bets, get this special report. It's free!

At the time this article was published Fool contributor Dan Radovsky owns shares of AT&T. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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