Analyst Looks Into iPhone Questions

by , 9:20 AM EST, January 30th, 2007

The relationship Apple Inc. shares with Cingular/AT&T over the iPhone is designed to be win-win for both companies. Piper Jaffray analyst Gene Munster took a closer look at the relationship and the economics of the iPhone.

Although most of the information about the economics of the Apple/Cingular deal are secret, there are bits of information that help build a bigger picture. Cingular, for example, has revealed that there will be no revenue sharing between the companies over new iTunes Store users as a result of the iPhone.

For now, Cingular has an exclusive multi-year deal to distribute the iPhone. What we don't know, however, is whether or not that deal includes future iPhone models, or if it is limited to the model Steve Jobs demonstrated at Macworld Expo 2007 in January.

The price of the iPhone starts at US$500, and although it is considered high by some, is in line with the initial price of Motorola's RAZR phone. The RAZR price dropped significantly to $250 after a year, but then cannibalized sales of the higher end KRZR.

Apple will avoid the pricing issues that caused problems for Motorola by keeping the iPhone price close to where it is now and adding additional features. Eventually, it will add models geared towards more price sensitive buyers.

The iPhone isn't likely to see widespread enterprise-level adoption where companies provide employees with email devices. Instead, companies will stick with the significantly less expensive entry level BlackBerry products. Employees, however, are a perfect candidate for the iPhone since many also carry a personal cell phone and an iPod. By purchasing an iPhone, they can combine their personal devices into a single unit and reduce the electronics they carry.

Users that want to switch will have to look at some hefty costs, unless Cingular chooses to offer reduced service contract fees. Breaking a contract to switch carriers ranges between $175 and $200. Add to that an EDGE data plan and activation fee, and users could be paying over $230 before adding in the cost of the phone.

Unless Cingular subsidizes the cost of switching the service contract, new customers could be paying between $736 and $836 to start using an iPhone. Because of the costs, Mr. Munster expects that Cingular will offer contract specials at far more attractive price points. He commented "While we see this as a very high price point, we feel this is indeed a worst-case scenario and that Cingular will offer discounts on service to iPhone customers."

Mr. Munster speculates that Apple chose to avoid the faster 3G wireless standard in favor of EDGE for data transfer based on price. The cost savings comes in at about $100. By bundling Wi-Fi with the iPhone, Apple included a faster Internet option, assuming users can find a Wi-Fi hotspot to access.

"The inclusion of Wi-Fi, however, is a surprising move on Apple's part. While Wi-Fi phones are common in Europe, they are less common in the US." he said. "In the US... the carriers control the market, which leads to hand set makers including over-the-air wireless radios rather than Wi-Fi radios, which enable users to access the Internet via pre-existing Wi-Fi hotspots."

Apple's iPhone margins are estimated to be something over 30 percent, which is roughly in line with Palm's Treo. Other competing devices fall into the 30 percent range as well. For now, the iPhone does offer Apple slightly higher margins.

Looking at Cingular's 58 million subscribers, about 30 percent have iPods. Out of those 14 million iPod owners, about 60 percent, or 8.4 million, are likely candidates for an iPhone. Those numbers fit well with Apple's target of selling 10 million units in the first year. Adding in switchers and additional iPhone models, and "this addressable market grows significantly," according to Mr. Munster.

Mr. Munster is maintaining his "Outperform" rating for Apple stock with a target price of $124. Apple is currently trading in the pre-market at $86.75, up 0.81 (0.94%).