Verizon's latest investment in its wireless business inspired some thought here about what the company might have in mind moving forward. It just may be that Verizon (NYSE:VZ) is setting up for a strategic slam dunk that could leave its cable competitors including Time Warner Cable (NYSE:TWC) and Comcast (NASDAQ:CMCSA) eating its dust. Furthermore, given the early timing of this article exposing the opportunity, readers here may have special insight into capturing alpha-rich returns that have not yet been incorporated into the VZ stock price. Verizon has not yet even discussed doing what we anticipate the company will, but whether it does now or later, I expect the stock should start to benefit near term from the possibility.
The Way it Was
Did you ever wonder why you had to dial different digits to reach Verizon Wireless than the customer support number for your Verizon wire-line, Internet and TV service? Had you considered why you had to travel to a different store front to sign up for Verizon wireless service than for the company's other services? It was because of the divide between the two businesses, much of which had to do with the ownership structure of Verizon Wireless and how Verizon got into the business in the first place. All that has completely changed now, as Verizon just implied in its release about its recent strategic move to acquire Vodafone's stake in Verizon Wireless.
The Way it Is
On September 2, 2013, Verizon agreed with Vodafone to acquire its 45% interest in Verizon Wireless for $130 billion. That is an impressive sum to pay for a minority interest in a business indeed, but well worth Verizon's investment in my opinion. The company says it will see immediate synergy from the deal, which it expects to be 10% accretive to EPS before any one-time charges. Verizon says the deal will enhance its ability to provide customers with seamless and integrated services. That's the key word here: integrated. Verizon will now be able to send one bill to all its customers, and it will find immediate savings from similar synergies. However, there's another opportunity now available to Verizon that will be extremely difficult for its cable competitors to match.
The Way it Shall Be
Imagine if Verizon bundles wireless service with its Internet and TV services, and/or with its wire-line service. This is the big win that Verizon can now fully capture because of the deal, if Verizon is ready to take a big competitive step and sacrifice a little in revenue and profit per customer for an increase in market share.
If Verizon bundles its wireless offering with its other services, I believe it will quickly steal market share away from its competitors lacking the ability to do so. That means that DirecTV (DTV), Time Warner Cable , Comcast, Cablevision (NYSE:CVC) and the rest will be at a significant disadvantage to Verizon, as they would be unable to match its offering. Only AT&T (NYSE:T) has the ability to ante up today, and I expect it would do so almost immediately out of necessity if not out of prudence. The others would be left scrambling, and potentially acquiring companies that have been left for dead, like T-Mobile US (NASDAQ:TMUS). This article suggests benefits to Verizon shares if it capitalizes on the opportunity, but I would buy T-Mobile here as well because of how the industry change would enhance its acquisition appeal. Investment banks should eventually catch wind of this opportunity and seek to advise Verizon's competitors to acquire wireless providers.
Verizon's chart shows the shares' recent decline, which coincided with the general market this summer and since the Federal Reserve said it would begin tapering asset purchases. The stock also dropped on the day after the press release was published about the Vodafone deal. I believe that was due to the hefty price Verizon paid for the stake. You'll note though, that since that initial decline, something else seems to be happening. It's hard to say for sure, but it appears that the stock is maybe starting higher here on smart money speculation. I believe that would be due to smart money anticipating what might now happen at Verizon and the bundling of wireless service with TV and Internet. A lot of other things have happened this month to move stocks including Syria, but it does appear something is afoot with VZ shares in particular.
Is the market getting wise to something? If so, it has only just begun.
Verizon and AT&T have underperformed their cable rivals over the past year, as evidenced by the following chart.
When experts speak about stocks returning to their mean price, it is suggested to be due to changes in valuation, as a stock gets out of kilter above and below the mean, inherent and true value. In this case, Verizon could also benefit by the creation of value, and so see its inherent valuation improve. You could think of this as a sort of shift of the entire mean value line higher, with the stock price forced to move around the new mean line value. Usually when this happens, a stock gains the market's interest and will rise also above that new value line. In other words, special gains should avail when companies create value, which I believe Verizon could do if it pursues the strategy described here.
Verizon currently offers these bundles of services, while AT&T offers these bundles of services. Cable providers also provide similar service bundles. However, none of the cable providers have the ability to offer wireless telephone service as part of a bundle.
When mobile phones first gained America's interest, a number of Americans had gone so far as to completely replace their landline telephone service. However, the big telecom companies proved resilient and super-competitive and stopped market share bleed by incorporating telephone service within bundles that were not much more expensive than Internet and TV service alone, and also through the provision of wireless service separately. Now, Verizon has the ability to give Americans another option; yes, eliminate your landline and bundle wireless service with TV and Internet. It's a game changer. So why hasn't it happened yet?
There's always the chance that regulators will find the strategy destructive to competition. I think that in today's market, that argument will be harder to make. This is true because the cost of wireless service is coming down, and so with cheap options available to Americans, some are likely already replacing their landline and keeping their Internet / TV bundle. This may even be the reason why Verizon may now be ready to make the move. There's also risk of cannibalization, because inevitably, some Verizon customers will save money by cutting their full scheme of Verizon services for just the new bundle, excluding wire-line service. Also, Verizon would want to keep its service bundle priced competitively in order to ensure it wins market share by giving decision makers no reason to choose otherwise.
VZ currently trades at 15.8X my estimate for EPS of $3.02 over the next 12 months. This EPS figure was simply forecast by averaging the FY 13 (Dec.) and FY 14 analyst consensus EPS estimate figures found at Yahoo Finance. That compares with a P/E of 13.3X similarly discovered for AT&T. So Verizon already trades at a premium to its peer, likely due to the higher brand appeal it's creating with its FiOS offering in my view. What I'm more concerned about is VZ's P/E-to-growth ratio, and how that might change with invention. According to Yahoo Finance data, analysts currently forecast long-term EPS growth of 9.4% for Verizon. Applying that figure to our P/E estimate, we find a PEG ratio of 1.7X. The PEG ratio is so high because of the growth expectations for VZ over the next two years, where analysts see 20% this year and 17% next year. I believe the long-term estimate should be raised higher if Verizon applies the market share gaining strategy I've outlined. The same action would likely lift my EPS estimate. Let's assume the EPS figure improves by 20% and the long-term EPS growth estimate deserves a 5 percentage point increase on the significant strategic change. The PEG ratio would then be 0.9X (P/E of 13 and LT growth of 14.4%), far more attractive. Keeping in mind that higher growth rates would be found in the nearer term, and the stock would have all the more reason to seek higher ground quickly.
Therefore, and in conclusion, for the futurists among you who see what I see as now possible for Verizon, and who are willing to make an investment on it, I say buy VZ here on the catalyst I expect will develop. If I am correct, outsized returns should find you as the stock adjusts to incorporate improved expectations and as investors price in the value of the executive team's dynamic strategic decision making skill. If I am wrong, well you will still get paid a 4.6% dividend yield while you wait, and given that the stock has already lagged peers over the last year, downside risk would seem limited. And if you agree with my thesis, you'll probably want to also acquire stakes in the independent wireless services providers like T-Mobile and MetroPCS (PCS), as they become increasingly attractive to the cable companies. I'll have more to say on the industry and subject shortly, so consider following the column.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.