Is the iPhone Holding Verizon Back?

From Verizon’s (NYSE:VZ) fourth-quarter earnings, it’s clear that the margins of the United States’ largest carrier are no longer increasing. Verizon and AT&T (NYSE:T) are not likely to lose their dominance in the wireless market any time soon, but both companies will face some downward pressure if they make an effort to keep Sprint (NYSE:S) from narrowing their lead, reported The Wall Street Journal on Monday.

For the three-month period ending in December, Verizon reported Tuesday that its wireless-service margin was smaller than in the year-ago quarter, citing high device subsidies, especially those coming from Apple’s (NASDAQ:AAPL) iPhone, as the reason for the drop. The New York-based company also posted a fourth-quarter loss of $4.22 billion, or $1.48 per share, as results were pushed down by costs from Superstorm Sandy-related damages and a change in the valuation of its pension liabilities.

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A record number of new wireless subscribers, 2.1 million, translated into a huge number of smartphone subsidies and caused the company to miss earnings estimates. Fourth-quarter earnings amounted to 45 cents per share, while analysts polled by Bloomberg had expected earnings of 50 cents per share…

Smartphone subsidies are necessary for the company to make high-end devices more affordable and to convince consumers to lock into contracts, but the cost of iPhone subsidies has become increasingly burdensome. USB told the WSJ that subsidies for iPhones are now 30 percent to 40 percent higher than those for higher-end models of Google’s (NASDAQ:GOOG) Android phones.

Despite the subsidies, the iPhone was good for Verizon and AT&T initially, leading customers to use more expensive plans and reducing the rate at which subscribers left. However, as more customers have signed up for the smartphone — 53 percent at Verizon and 64 percent at AT&T by the end of the third quarter — that has changed; the small revenue gains from selling the phones have decreased dramatically.

Dropping the subsidy is one option for carriers, but that choice carries a risk. Thanks to an investment from Softbank (SFTBF.PK), Sprint is in a better position now to take advantage of any customer defections to boost its market share. As the WSJ reported, Softbank’s Chief Executive Officer Masayoshi Son has a reputation of pricing aggressively and has “expressed a willingness to endure short-term pain to gain scale.”

While Verizon’s wireless service margins have increased year-over-year in each of the first three quarters of 2012, Sanford C. Bernstein expects that the company’s full-year service margins to come in at 46.8 percent, in line with 2010 results, due to this quarter’s drop. AT&T, which will report results on Thursday, has also said it expects pressure on wireless-service margins.

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