AT&T Feels the iPhone Pinch


Shares of wireless giant AT&T were under pressure during last night's after-market session as well as in pre-market trading this morning, although they were able to claw their way back to green turf shortly after the opening.

When pensions attack!
The culprit was a form 8-K that Ma Bell filed including tidbits on various fourth quarter happenings. The company says it expects to record a non-cash pre-tax charge of roughly $10 billion due to actuarial gains and losses on its pension and post-employment benefit plans.

The charge resulted from the company lowering its assumed discount rate to 4.3%, causing an actuarial loss of close to $12 billion. That's a full 1% lower than the 5.3% it was assuming a year ago. This is because lowering the assumed discount rate increases the net present value of pension liabilities, which it owes to retirees under the plan.

The hit was mitigated by a gain that was $1.9 billion higher than the company's assumed rate of return of 8.25%. Macroeconomic uncertainties are also causing AT&T to reduce its long-term expected rate of return by 50 basis points to 7.75%.

Most companies nowadays shy away from using pensions and other defined benefit plans for employees, but a lot of older companies still have them. Instead, companies tend to prefer defined contribution plans like 401(k)s nowadays.

Pensions are very much a risk factor in their own right since the company bears all of the investment risk while guaranteeing future benefits. The accounting behind them is a total nightmare because of the plethora of assumptions required in forecasting that far out into the future, including discount rates, expected returns, employee retention rates, average retirement ages, how long retirees live in retirement, and average salary increases, among many others. What a mess.

The company is preparing to report fourth quarter and full year 2012 results on Jan. 24, but at the end of 2011 its pension was underfunded by $10.2 billion. Investors will have to wait for the 2012 annual report to get a glimpse of where the plan now stands, but this charge won't help.

Pension happenings are included only in consolidated results, but don't affect operating results.

When iPhones attack!
As far as operations go, AT&T said it sold 10.2 million smartphones in the fourth quarter, a little more detailed than it previously provided last week. At the time, Ma Bell said that included a record number of Android and Apple iPhones.

The filing last night added that the "high subsidies on these devices" are going to hurt operating income, margins, and earnings in the fourth quarter. The iPhone is a notorious margin-sucking beast due to its subsidies, and AT&T's smartphone sales have always been predominantly iPhones. In fact, iPhone activations as a percentage of AT&T's total continues to increase, further pinching its results.

Source: Earnings press releases.

Apple fetches an estimated $425 subsidy per iPhone, and AT&T's prior iPhone record was 7.6 million units in Q4 2011. That means the company is likely on the hook for at least $3.2 billion in subsidies, but that bill could easily approach $3.5 billion if 80% of those smartphones were iPhones. We won't know the exact mix until AT&T reports, but for context, rival Verizon recently said its holiday smartphone sales of 9.8 million activations were driven by a "higher mix of Apple smartphones."

When the iPhone 4S launched in 2011, AT&T saw a huge spike in iPhone sales, jumping from 56% of smartphones to a whopping 81% of smartphones.

Once you subsidize, you can't stop
It's no secret that carriers aren't particularly fond of subsidies, especially those sent to Cupertino since they're far higher than what they have to pay for rival devices.

The problem is that weaning themselves off subsidies is easier said than done. T-Mobile is going to experiment with that notion this year. Verizon CEO Lowell McAdam recently said that Big Red would be open to such a move -- except consumers love them.

Ultimately the consumers have the final say, and they're quite fond of the subsidy model. Carriers in other countries that have never adopted the subsidy model can resist adopting the practice, but ones that have given consumers a taste of subsidies can't stop because consumers just want more.

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