Trends in Verizon’s Earnings Alarmed Apple Analysts

Source: http://www.flickr.com/photos/gonzalobaeza/

The Tuesday release of fourth-quarter earnings from Verizon (NYSE:VZ) — the largest wireless carrier in the United States — has sent analysts scrambling for calculators to estimate the number of iPhones the company activated in the past three month period, a number that will help analysts predict the number of smartphones Apple (NASDAQ:AAPL) sold in the last three months of 2013.

Verizon activated a total of 8.8 million smartphones in the fourth-quarter, a drop of 1 million from the year-ago period. Part of that drop is a function of T-Mobile’s (NYSE:TMUS) growing strength; Verizon’s smaller but nimble rival has begun to add new subscribers at an alarming clip of 2 million per quarter, while the nation’s largest carrier gained only 1.6 million in the last quarter, significantly fewer than the record 2.1 million gained a year ago. The other reason for the decrease in smartphone activations is that the “smartphone penetration” rate is growing, a trend that holds true across the industry.

Wells Fargo analyst Maynard Um believes that to be the case, and Verizon data backs up that opinion. According to the company’s fourth-quarter results, 70 percent of its customers owned a smartphone. Though unlike many Verizon earnings releases of the past, the company did not break how many iPhones were activated, which leaves analysts to estimates to describe what implications the carrier’s numbers have for Apple’s iPhone sales.

“While [Verizon] didn’t break out iPhone activations, it noted there were fewer smartphone upgrades this year due to some of the policy changes it implemented and also because last year benefited from iPhones becoming free for the first time on its network,” wrote Um in a research note obtained by Barron’s. The iPhone would have to account for 51 percent of all smartphone activations in the fourth-quarter — the same percentage as the previous quarter — to meet his prediction that Verizon accounted for 4.5 million iPhone activations, a level that represents approximately 8.2 percent of the Wells Fargo analysts’ 54.8 million total iPhone sales estimate. That sales figure is below the eight quarter average of 11.3 percent.

Um also noted that every 1 million iPhone units ships equates to approximately 22 cents in earnings per share share, if all else is equal. While increasing smartphone penetration is a problem for Apple, the Wells Fargo analyst described the growing phenomenon as a benefit for wireless carriers. Thanks to the fact that “smartphone penetration” is growing, “there are early signs of a balance of power shift back toward operators from handset vendors, which may put more of a focus on emerging and international markets.”

Similarly, Cantor Fitzgerald’s Brian White discovered through sifting through data that smartphone activations are noticeably dropping with respect to seasonal trends. Verizon “highlighted smartphone activations of 8.8 million” in the fourth-quarter of 2013, he wrote in a research note obtained by Barron’s. That figure compares to 7.6 million in the third-quarter of 2013, which equates to approximately 16 percent sequential growth. “This performance compares to average December quarter sequential smartphone activation growth of approximately 41 [percent quarter-over-quarter] over the past two years,” White added.

In the third-quarter of last year, the iPhone represented 51 percent of all smartphone activations at Verizon and historically, the carrier has either directly or indirectly given information on iPhone numbers. “However, we did not hear any comments around the iPhone” on Verizon’s Tuesday earnings conference call, he stated. Analysts, such as Um and White, are so interested in the Verizon iPhone numbers because over the past 10 quarters, the carrier has accounted for approximately 11 percent of Apple’s total quarterly iPhone unit sales.

Slowing iPhone sales is a widely-held concern. Analysts at Société Générale downgraded shares of Apple to hold from buy on Tuesday. Their fear is slowing sales of the iPhone 5S — the latest iteration of the company’s flagship smartphone that introduced the biometric authentication application, Apple ID Touch, a next-generation CPU, the M7 motion-tracking chip, and an improved camera. Technology reviewers at CNET called the device “the fastest and most advanced Apple smartphone to date,” but noted that it was not a “required upgrade.” That commentary suggests, as does Tuesday’s downgrade, that the iPhone 5S may not be the obvious choice for the first-time smartphone buyer. Apple is no longer the clear frontrunner; its rivals have caught up, meaning smartphone penetration is not the only problem for the iPhone maker.

“Usually, we would expect Apple to outperform the market in [the fourth-quarter] as the company has just issued new products,” wrote the analysts in a research note acquired by MarketWatch. “However, our research suggests that volumes may come in below expectations.” Société Générale’s Andy Perkins explained that the firm has calculated Apple sold 52 million smartphones in the final quarter of 2013, with the iPhone 5S selling much better than the its cheaper counterpart.

In fact, he postulated the company has sold 4 iPhone 5S units for every iPhone 5C. But even though the lower-cost iPhone 5C, which features a colored polycarbonate shell, is selling fewer units, the device is still expected to negatively impact profits. “With the lower-priced 5C model in the mix, our assumed average selling price for [the first-quarter of 2014 is 4 [percent] lower than the previous year,” Perkins added.

Perkins and his team of analysts decided to stick to a price target of $575 for share of Apple. The stock opened on January 21 at a price of $540.99, making their target price an increase of a little more than 6 percent. Already, in the past three months since the debut of the company’s latest devices, Apple investors have bid shares up approximately 7 percent. However, if demand falls faster-than-expected or if competition significantly intensifies — thereby impacting the iPhone maker’s pricing and margins — the stock may not reach that target. Apple will report fourth-quarter earnings on January 27.

More From Wall St. Cheat Sheet:

Follow Meghan on Twitter @MFoley_WSCS