Lots of Static for AT&T's iPhone Strategy

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Telecom titan AT&T (NYS: T) faced a double-whammy last week that points to challenges in the near term, and potentially the long term, for old Ma Bell and her investors.

Earlier in the week, AT&T's $39 billion proposed merger with T-Mobile USA suffered a setback when influential members of Congress weighed in with concerns regarding the deal. The Federal Communications Commission also issued a letter on Wednesday seeking to temporarily "stop the clock" on the review of the potential merger. In the business world, especially when it comes to mergers, time is money.

And on Thursday, the telecommunications giant showed that despite a slight increase in its second-quarter revenues, its net profits didn't fare as well and fell by 10%. AT&T, in an effort to hold onto its Apple (NAS: AAPL) iPhone dominance in the United States now that archrival Verizon Communications' (NYS: VZ) joint venture Verizon Wireless can sell the handsets, engaged in deep slash-and-burn discounting of its older iPhone 3GS devices. With the anticipated release of the iPhone 5 in September or beyond, AT&T will lose its advantage to discount the older iPhone 4, since rival Verizon can now do the same after having entering the iPhone market earlier this year.

Antitrust angst: Whammy No. 1
AT&T, through its deal with Deutsche Telekom's T-Mobile USA, is seeking to bolster its available spectrum and build out its network. That, in turn, could go a long way toward reducing customer complaints of dropped calls caused by a crowded network and could also accelerate its development of next-generation features and services.

But as with most megamerger deals, critics abound. The company faced pushback from Congress about the potential effect to the market, consumers, and American jobs, as well as about the bandwidth efficiencies AT&T is seeking. Meanwhile, the FCC stopped its review of the transaction while AT&T introduced some new metric models to justify the deal. The FCC doesn't plan to restart the clock until it's reviewed the materials and had a chance for third parties to weigh in on AT&T's new models.

Management said in its earnings call Thursday that it remains confident the deal will close in the January-to-March timeframe next year, but megamergers have been known to drag out much longer than expected. Just ask Renata Hesse, the FCC's senior counsel to the chairman for transactions who is reviewing the T-Mobile merger. Hesse is a former legal eagle with the Justice Department, which filed a lawsuit years ago to block the contentious and lengthy hostile takeover of PeopleSoft by Oracle. Ultimately, the DOJ lost the case, but it took 18 months for Oracle to close the deal from start to finish.

Deep-discounting advantage lost: Whammy No. 2
During the last quarter, AT&T managed to activate 3.6 million iPhone subscribers, of which 24% were new customers to the telecom behemoth. That total surpassed Verizon Wireless' 2.3 million iPhone activations in the quarter. In addition, the number of AT&T iPhone users who fled the carrier was down slightly in Q2 from the previous quarter, when Verizon began offering the iPhone on its network.

But AT&T took the deep-discount route to achieve that performance. And the long-term viability of such a plan may soon be lost. AT&T, offering older iPhone 3GS models for $49 a pop with a two-year AT&T service contract, faces the prospect that Verizon Wireless will heavily discount the iPhone 4 when Apple's next-generation iPhone 5 is released -- and according to industry reports, that could happen around September.

Verizon was shut out of any 3GS discounting strategies, given that the iPhone 4 was the only Apple phone built to work on its network when it signed aboard as Apple's second U.S. iPhone carrier early this year. In other words, the two carriers will now be on equal footing for deep-discounting iPhone 4 strategies heading into the fall.

If AT&T steps away from deep-discounting its iPhones, it runs the risk of more iPhone subscriber defections and fewer new iPhone subscribers. And for the carriers, it's all about locking in more calling-plan and data subscribers, even if that means continuing to subsidize the sale of each phone at a steep loss.

And, more importantly, investors should be wary of the refresh-cycle syndrome that may hit AT&T this month. Apple historically has released its iPhone upgrades in late June, just as it did with the iPhone 4.

That means the crush of consumers, or early iPhone adopters, who locked themselves into a two-year AT&T contract in late June and July of 2009 will soon be free agents. And when they do, they now have the option of bolting to Verizon and its iPhone offers.

Investors may want to keep a wary eye out for any AT&T ads that tout a $49 iPhone 4.

To stay updated on AT&T's merger and any future iPhone happenings, or to follow the other companies mentioned here, add them to our free My Watchlist service today:

At the time this article was published Fool contributorDawn Kawamotoholds no shares in AT&T, Verizon, or Apple, but she's an AT&T customer and has been known to wrestle her daughter for time on the family's Mac. The Motley Fool owns shares of Apple.Motley Fool newsletter serviceshave recommended buying shares of Apple and AT&T and creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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