In my two previous articles on Seeking Alpha, I defended Verizon Communications Inc. (VZ) and then, argued further upside. However, I recently made the decision to exit VZ. The reason: value, and a decision to reduce exposure to the telecommunications segment. Let me walk you through my thesis on why the value proposition at VZ is little more than the dividend at this price.
Let's look at VZ from a sum-of-the-parts perspective (using a back of the envelope analysis for now, as more details will be available in the forthcoming 10-K):
· The Wireline business did $8.5 billion of EBITDA in 2012, down from the $9.4 billion in 2011 and $9.3 billion in 2010. Wireline was impacted by various one-time charges associated with Hurricane Sandy. Getting to a clean EBITDA number, according to the 4Q earnings release, EBITDA margin was 22.1%. Ex-charges, Wireline did $8.8 billion of EBITDA. Considering the moderate (to diminishing) growth prospects for wireline, let's assign a 5.5x EBITDA multiple to this business (consistent with peers), valuing it at $48.4 billion.
· The Wireless business did $29.7 billion of EBITDA in 2012, a solid jump from the $26.5 billion in 2011. VZ owns 55% of Wireless, so the "net" to VZ is $16.4 billion. Let's assign a 7.5x multiple (higher than peers, to reflect the market leader position) to the Wireless franchise, which values the VZ ownership of the business at $114.5 billion.
· Based upon the current valuation, the enterprise is worth $162.9 billion. At 12/31, the company had $52.0 billion of debt, of which roughly 20% was attributable to Wireless. Adjusting out the Wireless debt, the enterprise, less debt, is worth $115.5 billion. Splitting the cash ($3.1 billion in cash and $470 mm of short-term investments) in half between Wireline and Wireless, the enterprise is worth $118.3 billion. At $118.3 billion, the stock is worth $41.33 against the 2.8 mm shares outstanding. At $41.33, the company is valued at 14.7x 2013 estimates and 13.0x 2014 estimates, right in-line with a high quality electric utility (to which I could argue that VZ is cheap or expensive, depending on my mood, so almost 15.0x feels right against the current year forward).
The current analysis doesn't take into account the prospects for growth in the business (although I could argue that I am assigning peak multiples on the business), which includes the continued strong performance of Wireless and the impact of the summer AWS spectrum acquisition on forward EBITDA and Cash Flow. There are other risks that I am not baking in either, including competition, risks to ARPU growth and legacy obligations of the enterprise (pension).
The bottom line is that at the current price, my enthusiasm for belief that there is upside to the stock is diminished as a value play (which is somewhat of a change relative to the summer, when I was a bit more aggressive around valuation in my assumptions). The dividend is still attractive, and I do believe there is core growth at VZ that could support a higher valuation over time. But for now, it is clear why the market discounted VZ once the stock moved higher than the $43.00-$44.00/share context, and based upon the current price, unless you are simply looking for dividend income, there are other, more interesting opportunities out there.