I am anticipating a major war, and I'm not referring to any Middle East conflicts. I am talking about the price war that's about to occur in wireless services -- one that will quite possibly leave Apple (AAPL) as collateral damage. As is often the case, my thesis has been bubbling for some time, but it's recently crystalized from real-life experience as a customer, as opposed to my abstract desk research as an investor.
The U.S. wireless-carrier business has consolidated down to a three-company race, with Verizon (VZ) and AT&T (T) commanding the heights as Sprint Nextel (S) struggles to keep up. As with most human situations, desperate but viable third-party competitors can often cause massive dislocation if they are given a helping hand. In this case, I believe Sprint is about to painfully disturb the margin structure so carefully nurtured by Verizon and AT&T.
Here is the real-life experience that clinched my thesis: My oldest daughter turned 13 recently, and it came time to buy her a phone. My family has a plan with Verizon already, and we've been grandfathered into unlimited data. The plan is probably average for most people but, at $90 a month, it's not inexpensive. As you all know, Verizon and AT&T are aggressively trying to cap data usage in order to return to the old "overage" revenue model, which is lucrative but incredibly annoying to consumers. Adding my daughter to our family plan would have required us to give up unlimited data, which I did not want to do -- so I started looking at other carriers.
Virgin Mobile -- which resells Sprint bandwidth -- offers a compelling deal, especially when it comes to shopping for a teen. We signed up for $35 a month for 300 minutes, unlimited text and unlimited data. I will concede that Verizon still has some small advantages -- better coverage, mostly -- but for essentially the same service at a 60% discount, the Virgin deal was irresistible. In fact, when our Verizon contract is up, we will probably all move to Virgin/Sprint.
Until a few months ago, I might have worried about Sprint's ability to upgrade its network and sustain service levels. But the recent deal with SoftBank, which has the firm taking control of Sprint, has completely changed the equation. Sprint now has the capital access and an aggressive "godfather" with the track record and ability to drive profound change. Sprint CEO Dan Hesse may not have had the chops alone to take on Verizon and AT&T -- but Masayoshi San, the SoftBank CEO, certainly does. If my consumer experience -- compellingly low price and equal service levels -- translates into the core strategy for Sprint/Softbank, the U.S. wireless market is about to get very good for consumers, and very bad for legacy carriers.
Apple looks primed to become the collateral damage. Apple's beautiful margins are only sustainable because the carriers subsidize the iPhone. The quid pro quo on $35-a-month service is no phone subsidy; you pay full price, thank you. Our daughter got a Samsung/Google (GOOG) Android phone for around $200, roughly the same price as that for a subsidized iPhone.
Don't get me wrong: I love the iPhone, and I've made a ton of money owning Apple shares for the last few years. But the reality is that the Android has come close enough to Apple's iOS mobile operating system that there is now no functional difference between the two. If Sprint/Softbank starts taking significant market share over the next two years -- which is about how long it will take, as people need to roll off their two-year contracts -- consumers will face the choice of buying a $200 Android vs. a $700 iPhone.
The end of subsidies means the end of Apple's margin structure. In order to remain competitive, the iPhone premium will need to shrink substantially. In three years, the iPhone at retail will probably sell for $300 to $400 at best. I could argue against this as an abstract investor -- but as a consumer living it in the store, the trend seems inevitable.
So here is the trade: long the new Sprint, and possibly short Verizon and AT&T. I say "possibly" because you are fighting a huge dividend payout, so you may be better off "avoiding" rather than shorting.
Secondarily, go long Google and short or at least avoid Apple. I do think the iPhone margin pressure will drive the stock down but, similar to my thoughts on Verizon and AT&T, I am still cautious here: Apple's computer business still has momentum, and the company may get additional growth in the television business with new products. Also, Apple shares are not overvalued; they are at a market multiple. For these reasons, Apple may be better to avoid than to short.
I have been long Apple for years, and at one time thought it had the chance to be the first company with $1 trillion in market capitalization. But, with Steve Jobs gone and the world changing in its most important market, the top may now be in.