Smartphones Pulling AT&T and Verizon

In its second quarter results, AT&T (NYSE:T) reported that it activated 2.4 million iPhones in the quarter and its total number of iPhone customers is 9 million. It is not just AT&T that has benefited from the iPhone, even Verizon (NYSE:VZ) has benefited from the spurt in smartphones created to challenge the iPhone and the ensuing competition in prices and features. The latest challenger, Palm Pre, is expected on the Verizon carrier by early 2010. Let’s take a closer look.

AT&T, the leading wireless carrier with annual revenue of $124 billion, reported its second quarter results that beat expectations. Q2 revenue was down 0.6% to $30.7 billion as growth in wireless and advanced wireline data services offset revenue declines in voice and legacy data products. Net income was $3.2 billion or $0.54 per share versus $3.8 billion or $0.63 per share last year. Analysts expected earnings of $0.51 per share on revenue of $30.6 billion. Earlier coverage is available here and here.

AT&T activated 2.4 million iPhones in the quarter, up 29%, and its subscriber base increased by 1.4 million in the quarter to 79.6 million, versus 72.9 million last year. With a new iPhone 3GS launched this quarter, its churn reached an all-time low of 1.09%. The iPhone 3GS priced at $200 also resulted in an increase in acquisition costs as well as operating expenses and margins. However, the bright spot is that ARPU increased to $60.21 and data revenue grew 37.2% to $3.4 billion. Also, to clear out its older stock of iPhone 3G, AT&T is selling refurbished iPhones for $49.

As for its wireline business, the company added 248,000 U-verse TV subscribers to reach a subscriber base of 1.6 million. It added 209,000 broadband connections in the quarter. Wireline data revenue grew 5.2% to $6.6 billion, led by 17% growth in IP-based revenue.

Cost-control measures are in full swing at AT&T: its workforce declined by nearly 6,000 in the quarter and 14,000 in the first half of the year. Free cash flow was $8.4 billion and the company ended the quarter with $7.3 billion in cash, up from $1.8 billion at the end of 2008. It paid dividends worth $4.8 billion and since mid-year 2008, it has reduced debt net of cash on hand by more than $9 billion.

AT&T is currently trading around $26 with market cap of about $152 billion.

Verizon, on the other hand, still leads the industry in terms of lowest churn at 1.01% and a subscriber base of 87.7 million. Yesterday, it reported Q2 revenue of $26.9 billion, up 11.3%. Excluding the Alltel purchase, revenue was up by just 1.9%. Net income was $3.16 billion or $0.52 per share versus $3.4 billion or $0.66 per share last year. Non-GAAP earnings were $0.63 per share, beating Wall Street estimates.

Wireless revenue grew 27.7% to $15.5 billion with data revenue growing 52.6% to $3.9 billion. Verizon added 1.1 million customers in the quarter (versus AT&T’s 1.1 million) and excluding the Alltel acquisition, net additions declined 0.6%. In the earnings call, Verizon admitted that the new iPhone 3GS at an affordable $200 has affected its sales. In retaliation, Verizon has lined up competitive handsets including BlackBerry Tour launched on July 12. It also plans to refresh BlackBerry Storm and have the Palm Pre and devices based on Google’s Android on its network. The Verizon App store is also expected to launch by the end of the year.

Wireline revenue declined 5.2% to $11.5 billion with the total number of lines declining 9.9% to 34.3 million. Verizon added 300,000 net FiOS TV customers and the total FiOS TV customers increased 82.1% to 2.5 million. It added 303,000 FiOS Internet customers, taking the total number of FiOS Internet customers to 3.1 million, up 56.1%.

Cash flows from operations totaled $14.1 billion for the first half of 2009, up 11.9%.  With capital expenditures at $8.1 billion, free cash flow in the first half of 2009 was $6.0 billion. Net debt is $64.1 billion and it completely repaid the $12 billion bridge loan for the Alltel transaction. Verizon already cut 8,000 jobs last year, mostly in its legacy telephone business. It is now looking to cut another 8,000 staff and contract jobs in the second half of the year.

The stock is currently trading around $31 with market cap of about $88 billion.

AT&T’s exclusive deal for the iPhone is expected to lapse next year. Many believe that Apple might not renew it and the iPhone might be available on other networks. In such a case, the quality of the network would be the most important differentiator, an area where AT&T fares poorly right now. Verizon meanwhile is rumored to be in talks with Apple to distribute two new iPhone-like devices. Verizon, back in 2007, had passed on the opportunity to be the exclusive carrier for the iPhone.

Meanwhile, in today’s news, Sprint (NYSE:S) announced plans to acquire Virgin Mobile USA for a total equity value of approximately $483 million. The No. 3 wireless player is doing all it can to keep with with the leaders.