As most of you hopefully know, Pierre Ferragu, who covers Apple at New Street, has had a phenomenal call on Apple’s iPhone sales falling short of expectations (see his downgrade to Sell HERE). He was right on 3Q volumes, and the call has been building into 4Q as Apple’s suppliers, one after another, warn of cancelled orders (details HERE).
Lower iPhone volumes may not be great for Apple, but they helped margins at the carriers in 3Q (see our US Wireless Trends report HERE), and we suspect they will help again in 4Q.
Pierre is calling for a mid-to-high single-digit drop in volumes year over year; higher than the decline seen in the quarter just reported. The benefit to the carriers in the US will be in the hundreds of millions rather than the billions of dollars, given the change in the subsidy model and the adoption of ASC 606, but it is still material.
The US carriers will have another EBITDA tailwind in the fourth quarter that doesn’t seem to be properly reflected in consensus expectations – the benefit from the adoption of ASC606 will increase to $1.5BN from $1BN, on our estimates. While most investors will adjust for the accounting impact when analyzing financial trends, it will make for strong headline numbers for EBITDA and EPS on earnings day.
EBITDA estimates look too low for all the US carriers and most significantly for Sprint, and for AT&T. AT&T is the stock we like least among the four in general, but they have low expectations and a low multiple playing in their favor as we go into year-end results. We expect T-Mobile to beat on EBITDA too, though we expect them to beat on adds by a lot more, and this will mute the margin benefit.
In 3Q the group gave most of the benefit back with free iPhones and other promotions. It remains to be seen whether the industry will give back the benefit again; the fourth quarter selling season, with all its promotions, will begin in earnest next week. Think how weak Apple’s volumes might be if the carriers in the US weren’t giving so many iPhones away for free.
In our US Wireless trends report (LINK), we posited the thesis that the revenue growth we have observed in wireless isn’t quite what it seems; while carriers are competing less on price, they are competing more on subsidies and promotions. For all but Verizon, EBITDA is stagnant despite higher revenues. Reported EBITDA numbers in 4Q will likely be stronger than they were in 3Q. We will have to adjust for the accounting benefit and for the tailwind from lower volumes to get a sense for what the carriers spent on acquiring and retaining customers.
Japan is another market where Apple has historically had 50% handset share. IFRS-15 will blunt the benefit from lower handset sales. Nevertheless, a 5% reduction in Apple volumes would boost operating income for the MNOs. KDDI would be our top pick to play the margin benefit of lower volumes (see HERE and HERE). In Japan, demand spikes in the March quarter, prior to the start of fiscal and student years which start in April.
iPhone volumes don’t matter much for carriers in Europe, where iOS market share is half what it is in the US, and IFRS15 would blunt whatever impact there is. Only in the UK is iOS market share close to 50%, but there is limited stand-alone way to play this mobile market as an investor.
For those of you that haven’t engaged with Pierre and his research, we would recommend that you do. We can’t imagine having a fully informed view on the companies he has focused on recently without having seen his work. That is particularly true of some of his more controversial calls on companies like Apple (LINK), Tesla (LINK), AMD (LINK), and Nvidia (LINK).
For the full weekly review and updated comp sheets, see HERE.
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