Will the next iPhone be subsidized?
A little company in New Jersey called Synchronoss had a very bad day today, and no one is quite sure why. I think it’s because the next iPhone will be subsidized.
Synchronoss sells software that allows cell phone companies and other communication service providers to activate cell phones and modems and cable boxes online. In particular, Synchronoss worked with Apple and AT&T to enable iPhone customers to activate the device at home via iTunes. This was one of many features that made the iPhone remarkable. Synchronoss deserves a lot of credit for pulling it off, and it was a huge deal for them, since AT&T accounts for more than 70% of their revenue.
Last night Synchronoss reported their Q1 earnings. This morning their stock dropped more than 40%. One line in the press release explains why:
“We have materially lowered our growth expectations for 2008 due in large part to reduced revenues associated with the iPhone.”
Synchronoss announced that they expect to make less money from the iPhone in 2008 than they did in 2007 - $30 million less.
The mystery is that while they explained some of their reasoning, they didn’t tell us anything that we didn’t already know. They made a lot of money during development and testing last year that won’t be repeated, and their fee per unit fell in Q1 - but they had already disclosed that. They only get paid when a phone is activated on AT&T’s network and more iPhones are being unlocked than expected before the launch - but we’ve known that for months, and the rate of unlocking doesn’t seem to have changed much from Q4 to Q1. They refused to say anything more, citing NDAs with Apple and AT&T, but they made it clear that they haven’t lost their contract. On the other hand, everyone knows that Apple and AT&T are about to launch a 3G version of the iPhone, and nobody expects iPhone sales in the US to be lower in 2008 than in 2007, when the thing was only available for 6 months. So what’s going on?
Thomas Weisel Partners analyst Tom Roderick was diplomatic:
“We find ourselves failing to fully grasp the altered dynamics of the company’s iPhone relationship.”
Here’s my guess: AT&T will offer the next iPhone at a discount with a two-year contract. Apple will continue to sell the phone at full price in its own stores, but unlocked. You may have heard this rumor already. What has it got to do with Synchronoss?
If AT&T decides to subsidize the iPhone, they will have to activate it in-store. Even at current prices, demand for the iPhone is so high that 20% of them are bought to be unlocked and flipped to buyers overseas. The problem is manageable so long as AT&T and Apple make a profit on each phone. But if AT&T starts subsidizing the iPhone, they can’t afford to let a customer walk out of the store without signing a contract with an early termination fee - otherwise they may as well be handing out $100 bills.
Apple would have the same problem. But they don’t want to train all of their staff how to sell AT&T service plans. Far better for Apple to sell unlocked iPhones at full price - this would allow them to capture the gray market premium for themselves while delighting the geeks and eliminating the channel conflict between Apple and AT&T retail stores.
Synchronoss makes no money from unlocked iPhones. But Synchronoss does not get paid for in-store activations either - they only manage activations online for AT&T. Since only a fraction of phones are bought online, the change would be bad news for Synchronoss, even if the total iPhone market doubled or tripled because of the subsidy. As a publicly traded company, Synchronoss would have no choice but to revise its projections downwards … but it wouldn’t be able to tell us why yet.
Just a theory. Comments welcome.
UPDATE: I was right. Silicon Alley Insider confirms and gives Skydeck the credit.