Everyone Is Making Smartphones Now

Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The "SprintPhone" is here, and it is "Vital" you check it out. Sprint Nextel (NYSE: S) just announced that it is going to make its own smartphone and sell it for $100. ZTE, the low cost Chinese manufacturer, is going to make the device. The Sprint Vital will have a 5 inch HD screen, a 13 megapixel camera, will run Google's (NASDAQ: GOOG) Android Jelly Bean OS, and will have a dual core 1.5 GHz processor with 1 GB of RAM and 8 GB of internal storage. Not bad for a phone with a $100 price tag.

Sprint has said it wants to make this phone to be more like Google intended and less like what third party manufacturers have made Android to be. They are going to intervene less in the overall feel of the OS but they will have some Sprint-based preloaded software on the device. Is this a good idea for Sprint or is it a half-baked attempt like HP's Palm?

Leverage

One of the biggest costs telecoms in the US have to deal with is the phone subsidies they pay to get customers to upgrade their device. The iPhone costs telecom companies $600-$700, but the end consumer will pay anywhere from nothing to $200 for the phone (with a two year contract). With Sprint offering its own phone it could give the company more leverage over smartphone manufacturers like HTC, Apple, and Samsung.

PC Magazine said, "the Sprint Vital smartphone gets you a big screen and a solid camera for a good price, but everything else is just average." They gave the phone 3.5 out of 5 stars and said that it was a good phone but wasn't that interesting other than it was big and had good specs.

Regardless, Sprint can still push this phone aggressively in its stores and use that leverage to potentially reduce the subsidies that they have to pay. They can also sell the phone at cost without the premium they pay to Samsung or Apple, the premium being the profit both those manufacturers make.

This will boost their margins and significantly help out their bottom line, huge news for Sprint because its operating margin (TTM) is 1.87%, which is way lower than the 16.14% average for the telecom industry. If Sprint can boost their margins to even half of the industry average it justifies its recent rally and explains why Softbank and Dish want to buy Sprint.

Other telecoms

Verizon Communications (NYSE: VZ) and AT&T (NYSE: T) have long wanted to reduce the subsidies they pay for smartphones. When Verizon or AT&T have a good quarter, that usually means they sold more smartphones than expected. Smartphone customers bring in 90% more revenue than feature phone customers so telecoms have a huge incentive to get that Samsung S4 or iPhone into your hand.

But the caveat to that good quarter is that their profit margins take a huge hit as they shell out ~$400 for each phone they sell. If they branched out with their own phone good quarters could actually mean they made more money for their bottom line.

Google's benefit

Google seems like the ideal OS for branching out, just look at the Sprint Vital or Amazon's Kindle for proof of that. With Android, OEM's (original equipment manufacturers) have a lot of control over what they do to the device and what the customer will be able to do with the software.

Even if Apple or Samsung gets hurt by self branded phones Google will benefit. They offer the Android OS for free as long as the phone has close integration with Google Maps and Google search engine. Google reaps huge gains as they continue to dominate the rapidly growing locational services market. Nokia and Google have moved the locational services market to an advertisement based service, which is Google's bread and butter. 

According to Pyramid Research (read the footnotes) the locational services market was $2.8 billion in 2010 and will hit $10.3 billion in 2015. This is why Google just offered $1.1 billion to buy Waze, another company that offers locational services. Google wants to capture as much of this market as it can but the purchase of Waze may raise antitrust concerns.

Acquisitions  

Sprint is currently in the process of either being bought out by Softbank (which recently raised its buyout offer to $21.6 billion) or Dish, and its stock has run up to match roughly the price of the Softbank offer but is still $4 billion short of the $25.5 billion offered by Dish. The Sprint Vital may increase interest in owning Sprint by either of these companies and could be a small part of why Softbank raised its offer (other than the Dish offer).

If you buy shares of Sprint you are betting on Sprint's board treating Dish's higher offer seriously (which they haven't done) and a bidding war ensuing between the two companies. There is a small chance of a bidding war, but I wouldn't take more than a speculative stake in Sprint until its future is decided on. Dish could offer a higher offer and force Sprints board to reconsider, or Softbank's offer could be accepted and the shares are dead money for a while as its stock has already run up enormously.  

Final thoughts

The best way to play this is with Google and the other telecom companies. If AT&T or Verizon decide to offer their own devices, that could push up their margins just like Sprint can. Verizon pays out a 4.1% dividend and AT&T pays 5.1%; if they can boost their profit margin that will translate to a bigger bottom line, which will enable them to pay out larger dividends, rewarding long term investors. Verizon and AT&T have already alluded to cutting down on subsidies, and this is one great way to do so.

Google is another way to play this because if those self-branded devices are running on Android, it will take a larger share of the smartphone market. It doesn't matter if the phone is made from HTC, Samsung, LG, or Sprint: as long as it runs Google's Android OS Google reaps the rewards and sees both top and bottom line growth as it captures more advertising revenue from the rapidly growing Google Maps and from its continued domination of the search market.

If the choice is between one Android phone or other, then you are dominating the market. Bullish on Google and the dividend prospects of Verizon and AT&T.

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Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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