U.S. consumers' obsession with using smartphones to find restaurants, surf the web and navigate city streets helped propel a 26 percent rise in AT&T's quarterly profit -- but at a cost for the operator.

The strain that wireless devices like smartphones and e-readers have placed on AT&T's network is such that the company announced on Thursday it will increase capital spending by about $2 billion this year, targeting improvements in its wireless service.

The increase was unveiled as AT&T posted revenue and earnings that largely matched analysts' estimates, although its addition of 2.7 million net subscribers in the fourth quarter was nearly 1 million more than expected.

Analysts did, however, point out that just 910,000 of those were the highly prized monthly bill-paying customers, compared with bigger rival Verizon Wireless' addition of 1.15 million postpaid users.

Every new AT&T customer puts more demands on its network. Consumers have complained about service problems in cities such New York and San Francisco, where there are a high proportion of data-hungry iPhone users surfing the web on the go. AT&T is the exclusive U.S. carrier for Apple Inc's wildly popular iPhone.

Given the strain on its network, AT&T's announcement yesterday that it will support Apple's iPad tablet is being viewed as a mixed blessing.

To that end, AT&T will increase capital spending by up to 10 percent from 2009 to a range of $18 billion to $19 billion. The roughly $2 billion increase includes spending on wireless network capacity and wires connecting mobile towers.

SLOW ECONOMIC RECOVERY

The spending boost comes as AT&T, along with rivals like Verizon, complained of a sluggish economy.

Looking to 2010 we're modeling a slow recovery in the economy and employment, said Rick Lindner, chief financial officer of AT&T.

But even in a weak economy consumers appear willing to buy devices like iPhone, which was activated on AT&T's network by 3.1 million customers in the quarter.

Lindner said the high-profile iPad would come with very positive economics for AT&T because it neither has to share service revenue with Apple nor subsidize the price of the device.

In contrast, AT&T's payment of hefty subsidies for the iPhone has made its profit margins slimmer than some analysts had hoped even as it brings millions of customers to its network.

AT&T said it would expand wireless margins this year to the low 40 percent range from below 39 percent in the fourth quarter, and it set a long-term goal of margins around 45 percent. Verizon already produces margins in this range.

While iPad will not hit the market for months, other similar devices are already helping AT&T.

Analysts said, in fact, that the quarter's subscriber surprise came from the number of customers that AT&T added with wireless links to devices such as Amazon.com Inc's Kindle, Sony Corp's <6758.T> Reader Daily Edition, and the Barnes & Noble Nook. In this emerging devices category, AT&T brought about 1 million users aboard.

Devices such as e-readers are seen bringing in much less monthly revenue per customer than traditional cellphones, but since they are unsubsidized they offer healthy profit margins.

I don't want to overstate the value of it, but it's a very high profit margin business, said Piper Jaffray analyst Chris Larsen. There is very little cost associated with the business -- it might be a low revenue per individual user business, but it's a high margin business.

AT&T's quarterly earnings rose in line with Wall Street expectations to $3.01 billion, or 51 cents a share, from $2.40 billion, or 41 cents a share, a year ago, when it took charges for staff cuts and investment losses.

Revenue fell nearly 1 percent to $30.9 billion, which met analyst estimates, according Thomson Reuters I/B/E/S.

For 2010, AT&T said it would deliver stable consolidated revenues and stable-to-improved consolidated operating income margins, leading to stable-to-improved earnings per share.

Its shares were up 3 cents at $25.59 cents on NYSE.

(Reporting by Paul Thomasch and Sinead Carew; Editing by Derek Caney and Steve Orlofsky)

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