iPhone 'jail-breaks' stall growth at OSS firm Synchronoss

Almost by definition, OSS vendors work behind the scenes with little fanfare and even less recognition. That changed for vendor Synchronoss Technologies when its service activation platform earned a key role in the iPhone activation process along with operator AT&T – garnering it plenty of attention.

But now, Synchronoss is blaming unanticipated strong user demand for unlocked or so-called “jail-broken” iPhones for a significant drop in revenues and a drag on its growth plans, the vendor said in its earnings release Tuesday. An expected impending release of a 3G-capable iPhone may also be putting a drag on activations of the current 2G version.

It was the second straight quarter that Synchronoss lowered guidance due to the iPhone, a situation Goldman Sachs blamed on “the near-term erosion in activation visibility.” In other words, despite growing iPhone sales, it’s simply impossible for Synchronoss to predict whether customers will opt to activate them on AT&T’s network or prefer to unlock them and take them elsewhere. Synchronoss declined a request for an interview.

The story demonstrates in stark terms the financial impact that the changing nature of more “open” wireless networks, devices and services could have on mobile operators and their vendor ecosystem.

First, the good news for Synchronoss: revenue for the first quarter grew $29.1 million, or 36% year-over-year. Gross profit for the quarter was $15.7 million, including the impact of fair value stock compensation expense, representing a related gross margin of 53.9%, the company said in its first quarter earnings release. The company claimed to have won more new customer deals in the quarter than ever before in its business.

But trouble loomed under the surface, largely because even though Apple’s iPhone sales have met expectations, many of those phones were not activated onto the AT&T network – Apple’s sole U.S. partner – but through unsupported processes unlocked and moved to other networks.

“The gap between the number of iPhones expected to be sold and the actual number that we are activating continues to be significant, and we expect this trend to continue,” said Synchronoss CEO Stephen Waldis in an earnings conference call. Waldis noted that Synchronoss is paid not on the number of iPhones sold, but on the number activated onto the AT&T network. Due to jailbroken iPhones, Waldis said the vendor expects iPhone activation transaction revenue to decline by $30 million in 2008.

In addition to a lower number of activations, Synchronoss in the quarter dropped the premium per-activation fee that Apple was paying versus previous quarters. Waldis said the initial higher fee helped ensure the iPhone launch got off to a strong start and that the fee drop brought Apple’s fees in line with Synchronoss’ other transaction-based pricing.

Beyond the iPhone, Synchronoss also runs other wireless phone activations on AT&T’s Web site, putting a lot of the vendor’s eggs in the AT&T basket. Overall, first quarter revenue from AT&T was about $21 million, representing 72% of total revenue. Helping to end its reliance on AT&T, Synchronoss’s Waldis detailed launch plans with previously announced customer Sprint, an expanded relationship with customer Time Warner Telecom and the vendor’s first international customer in Vodafone.

Synchronoss’ story points to two key, and somewhat conflicting trends. On the one hand, carriers are increasingly relying on Web site e-commerce channels for new phone activations, with a focus on making that initial customer activation experience as seamless, pleasant and uneventful as possible. At the same time, a large number of customers are willing to go through the at-times complex and customer-unfriendly work of unlocking or jailbreaking phones in exchange for increased freedom in how they use their phones.

But with most wireless customers today used to swapping out SIM cards to "activate" service -- the overall impact may be limited.

"I think this is a pretty significant iPhone/AT&T issue, but I do not think it has much broader issues around OSS/BSS," said Larry Goldman, senior analyst with OSS Observer. "In most of the world, people don't activate phones, they activate services assigned to SIM cards that go in the phones. It is common that people go to a store, buy a new phone and put an existing SIM in the phone without needing any further activation. There is and has been and will be a large difference between the number of phones sold and the number of subscriber activations. Service providers already know that."

In a move that could impact the future of iPhone activations, rumors this week had AT&T considering offering a $200 subsidy for users that activate the phone on the AT&T network. The goal, of course, is to keep those iPhones on the AT&T network delivering what AT&T has confirmed is an extremely healthy ARPU for the iPhone -- reaching the upper $90s per user per month versus $50 for other phones.

Such a subsidy has the potential to double AT&T’s iPhone sales, according to Bernstein Research analyst Toni Sacconaghi. “We have long held that the iPhone’s high price has been the biggest limiting factor on its sales,” Sacconaghi said in a research note, noting that a subsidized AT&T iPhone could also pave the way for a (higher-priced) unlocked iPhone sold directly by Apple.

Overall, Apple has sold 1.7 million iPhones so far and recently restated its goal of selling 10 million units in 2007. If so, Apple will have to pick up its pace; at its current rate it will barely reach 7 million iPhones sold.