Telecommunications giant AT&T reported its earnings rose 5.5 percent during the third quarter, but profits fell short of analyst predictions. Ironically, the chief cause of both the rise in revenues and the disappointing profits was the same: The company’s strong sales of Apple’s iPhone 3G.

According to the company’s report, 2.4 million people activated an iPhone 3G during the third quarter, and 40 percent of those were new AT&T wireless subscribers.

“I am particularly pleased with the customer response to the iPhone 3G,” said Randall Stephenson, AT&T chairman and chief executive officer. “The new customers we’re winning are high-value, with attractive revenue and churn profiles. We’re expanding the market as users adopt more data and media-rich services and access a wide array of applications. These achievements are positive for the future of our business.”

The news, however, was disappointing to Wall Street — in midday trading, AT&T was down about five percent.

The iPhone Effect

Before the release of AT&T’s earnings statement, analysts had predicted the company would earn 71 cents per share. AT&T fell well short of that target, reporting earnings of just 55 cents per share.

A significant portion of the shortfall (roughly 10 cents per share) was attributed to AT&T’s decision to subsidize the cost of the iPhone 3G. The company underwrites approximately $375 of the cost of each handset, enabling consumers to purchase the iPhone 3G for just $199 or $299, depending on the configuration they select.

When it rolled out its exclusive iPhone 3G to the public in July, AT&T had predicted that over the course of the coming year, handset subsidies would cost the company 10 to 12 cents per share. But thanks to the more than two million activations, AT&T hit the low end of its cost estimate in just three months.

Nonetheless, AT&T believes the significant subsidy is a useful investment, since iPhone wireless customers are particularly heavy users of data services and are willing to pay higher service fees.

Analyst Charles Golvin of Forrester Research thinks AT&T has established a viable business model. “These subsidies are a one-time cost,” Golvin said, “that will be significantly eclipsed in the long run by the increased average revenue per user iPhone users deliver, enhanced by their much lower likelihood to churn.”

And in fact, AT&T’s wireless division had an excellent quarter, with revenues rising 15 percent, from $10.9 billion a year ago to $12.6 billion this year. Confirming AT&T’s assessment of iPhone 3G users as data-gulping consumers, the company’s wireless-data revenue rose a remarkable 50.5 percent to $2.7 billion.

Distant Storm Clouds

As Wednesday’s launch of the Android-driven T-Mobile G1 amply demonstrates, the market for smartphones will only get increasingly competitive in the months to come. It is certainly no accident that T-mobile is marketing the HTC-built handset for $10 less than the lowest-priced iPhone 3G. But Golvin says AT&T doesn’t have to worry in the short term.

“The decreased cost of software and maintenance attributable to Android won’t be realized for OEMs for several years,” Golvin said. “In the near term, OEMs actually have increased costs associated with adding a new platform, and they will continue to maintain much of their current costs as they continue to support existing platforms.”

Golvin suggested that until the market for Android devices matures, AT&T can bank on the fact that Apple is a premium brand, and can charge higher margins as a result. “AT&T benefits from that brand,” he said, “in the form of higher-value customers with high loyalty.”-News Factor Network

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