AT&T vs. Verizon: Battle of the Wireless Giants

With the U.S. wireless market nearing full market penetration at levels between 85-88%, investors must look deeper than net adds and total subscriber growth to find investing opportunities in the telecommunications industry. AT&T (T) and Verizon (VZ) have emerged as the two dominant players in the U.S. wireless market with companies like Sprint-Nextel (S) and T-Mobile (owned by Deustche Telekom DT) lagging behind.

Telecommunications is a capital intensive industry, thus it often lags the rebound in the IT sector. To greater sustain the ever increasing demand for bandwidth, infrastructure must be continually updated for faster speeds and higher data capacity. In the U.S. wireless industry, companies are currently updating cell towers to 3G. Taking a more long-term perspective, 4G or long term evolution (LTE) networks are becoming an increasingly plausible solution to our bandwidth needs. In the broadband internet industry, people worldwide are using the internet more often and are demanding more offerings such as online TV and videos. To remedy this, fiber optical cables can be used to replace traditional coaxial cables, providing more speed and bandwidth capacity. This article will explain how the two U.S. wireless giants, AT&T and Verizon, are preparing for the trends in the telecommunications industry. I will also compare and contrast them while providing my investment thesis on both companies.

Near-Term Favorite (2009 and 2010)

AT&T has substantial near-term potential to outperform the market as well as its telecom foe Verizon for more reasons than just the iPhone. But first, I will breakdown the Apple (AAPL) iPhone’s success for AT&T. Last quarter, AT&T added 2.1 million new subscribers, approximately 760,000 of which added the iPhone; however, overall net iPhone adds for the quarter were 1.9 million. With the success of the iPhone and an industry shift from traditional handsets to smart phones (iPhone, Blackberry, LG Vu etc.), wireless postpaid subscriber average revenue per user (ARPU) increased 3.9% y-o-y and data ARPU up 35.7%. Smart phones are mainly responsible for this growth because consumers pay more to browse the internet, email, download applications and games, and much more. However, since AT&T subsidizes the 3G iPhones, 4Q08 margins were compressed approximately 1.9%, and 1.0% for full year 2008. This has prompted AT&T to continually add more subscribers than Verizon (700,000 more last quarter), thus diluting short-term earnings (decreased 4Q08 EPS by $0.05) for long-term subscriber gains.

Furthermore, the iPhone has helped re-establish AT&T’s brand image, something Apple and Steve Jobs are successful at doing. Apart from the iPhone, AT&T also offers the another blockbuster phone, Research in Motion's (RIMM) Blackberry Bold, which appeals to the ‘crackberry’ followers and enterprise market. AT&T has the best product offerings to appeal to customers and also benefit from its 3G network - the nation’s fastest according to data compiled by leading independent wireless research firms.

AT&T has two years left on its contract for exclusivity rights to be the sole U.S. wireless provider of Apple’s iPhone. A large degree of uncertainty surrounds the idea that Apple may choose to not renew this contract, thus allowing other wireless providers like Verizon, Sprint-Nextel and T-Mobile to provide the media-savvy device. This could be an effective move for Apple, because the iPhone appeals to a younger population who tend to use the iPhone’s various media-rich features . But this young population is often tied to a family plan of a different wireless provider, thus being more reluctant to break off the family cell phone plan and sign with AT&T.

Financial Health

From a balance sheet perspective, AT&T is stronger than Verizon in the near-term. AT&T has approximately $5.6 billion in debt due over the next two years; however, in 2011 AT&T has $17.5 billion in debt due. Verizon is quite the opposite, with $21.1 billion in debt maturing in 2009, which drops to $2.8 billion in 2010 and $7.8 billion in 2011. This may be worrisome for investors, but the telecom industry is capital-intensive, requiring these companies to be more leveraged than companies in other industries. After 2009, Verizon will clear a substantial amount of debt from its books, thus solidifying AT&T as the near-term favorite until 2011 when a large portion of their debt becomes due. Also, the company has projected a 10-15% reduction in CAPEX for 2009 by cutting jobs and delaying its build out of the U-Verse infrastructure. In the short-term, the cost cuts will benefit the bottom line, but the U-Verse delay will have negative long-term effects as Verizon gains market share with FiOS.

Please check back for Part II on Friday, April 18th.

- Jake Kimble

Disclosure: The Fund the author is associated with is long T and has interests in VZ. The author’s family is long VZ.

Comments

[Geddy:]

What's not stated here is that since AT&T subsidized the phone for its customers they actually ended up losing money on the iPhone customers. Also I believe the facts are wrong...the exclusivity deal expires next year so not quite the 2yrs in this posting.

Apr 16 02:17 PM

[Jake Kimble:]

Geddy,
As author of this article, i would like to respond to your comment. The iPhone subsidization was an up front $200 hit for AT&T, however, over the next two years, these gains are realized through an extra $10 per month, for 24 months. Using the time value of money, with a discount rate of 8.28% (WACC pulled from bloomberg roughly 2 weeks ago), then yes... AT&T does take a loss of approximately $97. However, this has led to the substantial net add gains and higher ARPU.

To the exclusivity deal, if you refer to this website (www.reuters.com/articl...) Reuters states that AT&T is in talks with Apple to extend its deal into 2011. Yes I stated 2 years, for 2009 and 2010. However, the exact date in 2010 is unsure.

Apr 19 04:45 PM

[jstratt:]

Outstanding analysis! The author is to be commended.

Apr 19 07:13 PM