BusinessWeek Logo
News January 31, 2008, 5:00PM EST

On the Trail of the Missing iPhones

About 1.7 million more have been sold than are being used by AT&T customers. The bad and good news for Apple

by Olga Kharif and Peter Burrows

It has been dubbed the Mystery of the Missing iPhones. On Jan. 22, Apple Inc. (AAPL) reported that it sold 3.7 million of its smartphones worldwide in 2007. But AT&T (T), the only authorized wireless service provider for the iPhone in the U.S., reported that its subscribers activated just fewer than 2 million units last year. The big question on the minds of Apple watchers is: Where have the other 1.7 million iPhones gone?

The uncertainty has helped sink Apple's stock to 132 a share, down 34% since the beginning of the year. That is far worse than the 13% drop for the tech-heavy Nasdaq index. Apple shares were already under pressure because of concerns that weakening consumer spending could affect sales of iPod music players, Mac Books, and other Apple gear. Now worries about iPhone sales have entered the mix.

One investor concern is that many of the missing iPhones may be languishing in inventory, on the shelves of Apple's distributors and suppliers. But inventory isn't the only issue. Two sources close to Apple say that far more of the iPhones the company is selling are being "unlocked" than previously expected. Those phones are adapted by customers or gray-market distributors, using unauthorized software and phone cards, to run on the wireless networks of companies with which Apple has no service agreement.

Some 800,000 to 1 million iPhones had been unlocked by the end of 2007, the sources say. The high end of that range outpaces most analysts' assumptions of 750,000 unlocked phones. Most of those phones are trickling into nations around the world where Apple has yet to sign up a local carrier—especially China. "In my travels around the world, two out of three iPhones I've seen outside of the U.S. have been unlocked," says Richard Doherty, director at consultancy Envisioneering Group.

Unlocked iPhones are bad news for Apple's earnings, at least in the short term. While the company's revenue-sharing agreement with AT&T is kept under wraps, there's no question it's lucrative. Charles R. Wolf, an analyst with Needham & Co., believes the carrier pays Apple $10 per month for every iPhone subscriber over the course of a typical two-year contract, for a total of $240. Toni Sacconaghi, an analyst at Sanford C. Bernstein (AB), thinks each subscriber is worth $300 to $400.

Do the math, and for every million iPhones that are unlocked, Apple misses out on $240 million to $400 million, which is pretty much all profit. Although Apple posted sales of $24 billion in 2007, such lost revenues could become more significant as the iPhone becomes a bigger part of Apple's overall business. Piper Jaffray (PJC) analyst Gene Munster expects Apple to pull in $4.6 billion in iPhone sales in 2008, up from $1.4 billion in 2007.

Still, unlocked phones aren't all bad for Apple. The company makes an estimated $120 in gross profit on every phone sold. What's more, in countries where the iPhone isn't yet legally available, the devices may function as part of the Apple's hype machine, revving up awareness of the brand. That, in turn, could make it easier for Apple to strike more carrier distribution deals. Analyst Ingrid Ebeling of JMP Securities says the short-term hit is well worth it. "The No.1 concern for them should be to sell iPhones," she says.

How do people get unlocked phones in the first place? Apple's unusual deal with AT&T in the U.S. creates a window of opportunity. Most phones from Nokia (NOK), Motorola (MOT), and others are sold through the wireless carriers themselves or authorized dealers, and you sign up for a service contract at the same time you buy the phone. Apple cut a different arrangement. Customers buy the iPhone from AT&T or Apple directly, for the same price of $399.

Reader Discussion

 

BW Mall - Sponsored Links