Our money is on Verizon (VZ) - trading at 60% the market value as its toughest competitor AT&T (T). All of the top wireless companies (#1 Verizon, #2 AT&T, #3 Sprint - by subscribers) should benefit from rising adoption of smartphones, but service and coverage will be the differentiating factor. Managing the increased mobile data traffic has become cumbersome to say the least, which has only been exacerbated by the popularity of smartphones. The wireless market is undoubtedly becoming saturated, which will further lead to the great Spectrum-rush of 2013.
4G coverage. AT&T is focused on expanding its 4G LTE network, which is currently available in 100 markets and covers more than 150 million users in the U.S. - the wireless company plans to reach 250 million people by the end of 2013. However, the LTE expansion is just one place Verizon is setting itself apart from AT&T - toward the end of 2012 Verizon had LTE coverage in 420 markets and covered more than 250 million people. Verizon also appears to be leading the way with respect to service - per Consumer Reports which has Verizon as the number one carrier.
Subscriber growth. During Q3-2012 AT&T managed to add 650,000 wireless customers to put its total wireless subscriber base to 106 million. AT&T has a heavy reliance on the iPhone, over reliance in my opinion, where 75% of the 6.1 million smartphones the company sold last quarter were iPhones. AT&T added only 650,000 subscribers for the recent quarter, but Verizon managed to add 1.8 million - lifted by the highest addition of post-paid subscribers in four years. Verizon's total churn rate also decreased from 1.26% in Q3-2011 to 1.18% in Q3-2012 - one of the lowest in the industry.
Verizon initiatives. One of Verizon's big initiatives includes expansion into rural areas, including in-home wireless broadband services and LTE technology, not to mention its FiOS fiber-optic network and new initiatives in its wireline business. One of Verizon's little known initiatives includes its plans to join forces with Coinstar to offer online streaming services. The video streaming initiative should help diversify revenues and draw in more subscribers. The new-shared data strategy (Share Everything plans), which may also be leading AT&T, will be another long-term revenue driver for the wireless carrier. Although this will put pressure on the average revenue per user in the near-term the lifetime value per user should more than compensate in the long-term.
The great spectrum race. One of its biggest fails at catching Verizon in the spectrum race was its failure to purchase the fourth largest mobile carrier T-Mobile in 2011. While AT&T was seeing its T-Mobile deal fall to pieces, Verizon was making one of the most talked about spectrum deals of late. AT&T is now playing catch up in the spectrum game - even looking to buy up airwaves that Verizon will sell for roughly $2 billion - which is part of Verizon's plans to sell off certain assets to purchase the airwave rights from Comcast. It appears that Verizon is leading the spectrum game thanks to its cable spectrum buys from a suite of cable companies, including Comcast and Time Warner Cable. This deal should help double Verizon's capacity and provide services at a higher speed. The airwave licenses were initially bought by the cable companies in a 2006 government auction for $2.4 billion but sold to Verizon when their plans were abandoned to build a high-speed wireless network to compete with Verizon and AT&T.
The competition. Don't forget Sprint (S), which is the third largest U.S. wireless provider. It appears that Sprint, now strapped with cash thanks to a $20B investment by Softbank, is looking to buy up some spectrum assets - including the rest of Clearwire that it does not already own. The one caveat to the Clearwire (CLWR) deal is that the spectrum it runs will likely benefit Softbank more than Sprint, given the differences in spectrum types. Sprint is also light years behind Verizon or AT&T with respects to returning capital to shareholders via dividends. Sprint has posted negative earnings quarterly over the last TTM and is expected to post a negative $0.78 for 2012 - although an almost 50% improvement from 2012. Sprint's newest potential acquisition - Clearwire - is not in much better shape, also having posted negative EPS over the TTM and expected full year 2013 EPS in negative territory. Speaking of dividends - it is hard not to mention the parent company of T-Mobile, Deutsche Telekom AG (DTEGY.PK). Deutsche makes an annual dividend payment in May that currently yields over 7.5%.
Breaking down the numbers. Over the past five-year sales growth has been 1% for AT&T and 4% for Verizon. The 5-year P/E ranges for AT&T come in at 9x (low) and 17x (high) - compared to Verizon 11x and 20x (high). 5-year average P/E ratios come in at 13x for AT&T and 15.5x for Verizon, where compared with the wireless providers' forward P/E ratios, it appears that AT&T is rich, but Verizon is relatively in line. Digging deeper - we find that the expected growth for Verizon (by analysts) is well above that of AT&T, 11.5% vs. 6%, respectively. Verizon also outperforms on a liquidity basis with a current ratio that comes in at 1.0 and interest coverage of 7.4x, Verizon still outshines AT&T at 0.6 (current ratio) and 6.8x (interest coverage). The cash flow generation for Verizon is also more robust. For the TTM, Verizon managed to generate nearly $37B in free cash flow - which put its free cash flow yield at 29%, compared to AT&T's 21%.
Dividend conclusion. The dividend yield is a little better for AT&T (yielding 5.1%) compared to Verizon's 4.6% yield, but on a payout basis Verizon is in much better shape. On a FCF payout basis, AT&T paid out 25% over the TTM and Verizon only 16%. If Verizon did boost its FCF payout to 25% its dividend yield would be upwards of 7%. It appears that Verizon is looking to hold on to its cash for the time being in an effort to better position itself for strategic acquisitions to solidify itself as the spectrum and coverage leader. Once this is done, shareholders should be rewarded with not only a robust dividend yield but also share appreciation. With a leading position in 4G deployments - reaching and covering 250 million people or close to 75% of the U.S. population, we still see Verizon as the safe bet for income investors, helped in part by its 0.5 beta - promoting lower volatility than other high dividend paying stocks.
Disclosure: I am long VZ.