Verizon Communications (VZ) continues to lead the wireless communications industry. Verizon Wireless's new postpaid subscriber volumes were higher in H1 2013 versus H1 2012, even though the company has more postpaid contract customers than AT&T (T), Sprint (S) and T-Mobile US (TMUS). Part of the reason why Verizon Wireless is currently the king of the US wireless market is because it has the largest 4G-LTE network. Verizon Wireless has extended its 4G-LTE footprint to 510 U.S. Markets as of Q2 2013 and is expecting to complete its network rollout in the middle of 2013. AT&T Wireless and Sprint previously bet heavily on different 4G network systems (HSPA+ for AT&T and WiMax for Sprint) and have been trying to catch up to Verizon Wireless while T-Mobile USA implemented its 4G-LTE network in 2013. While Verizon's share price is within 7% of its fair intrinsic value, it still offers a 4.5% dividend and a cash-cow wireless business.
Source: Verizon Wireless
Verizon Wireless continues to be the star-performer and workhorse for Verizon shareholders. Verizon Wireless grew its Q2 2013 revenues by 7.5% versus Q2 2012 levels and this was slightly better than the 7.4% year-over-year growth achieved in Q2 2012, though it was lower than the 13% achieved in Q4 2011. Retail service revenues grew by 7.8%, aided by increased smartphone penetration and positive reception for its Share Everything data plan. Verizon Wireless is leading the way in retaining customers with its enviable 0.93% contract customer churn rate and its 1.27% total retail customer churn rate (versus 1.02% contract customer churn and 1.36% for AT&T Wireless). Verizon activated 3.7M new Android smartphone and 3.8M new iPhones, half of which were iPhone 5. New iPhone activations increased from 2.7M in the prior year period. 42% of all new smartphone sales were to first-time smartphone customers, versus 44% in Q3 2012 and 40% in Q2 2012. However, Verizon Wireless should not ease up due to the following reasons: because
- AT&T is spending $21B to narrow the gap in 4G-LTE coverage and recently spent $18M/annually for naming rights to the Dallas Cowboys professional football team's new stadium
- Sprint shut down its obsolete Nextel 2G iDEN network
- Sprint's new majority-owner SoftBank has the resources to enable it to better compete against the AT&T-Verizon wireless duopoly
- T-Mobile US acquired MetroPCS and implemented its 4G-LTE network
Verizon Wireless has made a strong push towards converting its customers from low-end mobile phones into higher end smartphones. In Q1 2010, its proportion of smartphone customers to total customers was 18.6% but it has steadily increased in each succeeding quarter and reached 64.4% in Q4 2012. Verizon Wireless's smartphone sales as a percentage of total phone sales increased from 35.6% in Q1 2010 to 86.5% in Q4 2012. I concluded that the division is maturing as its 2012 CapEx declined by 1% relative to 2011 levels and Verizon's management projected flat CapEx growth as it is completing its 4G-LTE network build-out in the middle of 2013.
Source: Verizon's Last 14 Earnings Releases
Verizon's Wireline businesses were reliable cash-cows in the 1980s and 1990s and Verizon Wireless is steadily transforming from its phase of breakneck growth into a maturing cash-cow. Although Sprint has nearly doubled its CapEx from $2.2B in 2009 to $5.7B in the last twelve months, it has a long way to go before it catches up with Verizon Wireless's CapEx ($9.2B). It was surprising that Verizon Wireless has been able to continue increasing its net customer additions and that people would be willing to pay $30/month and up more for Verizon Wireless's 4G-LTE network versus its competition, especially since Sprint is steadily building out its 4G-LTE network and has been improving its customer service experience.
Source: Mobile Carrier Websites
Verizon Wireline is the old gray mare that is not what it used to be twenty long years ago. The good news for Verizon Wireline is that it generates steady revenue growth from its FiOS product line (digital voice, internet and video), it has increased its proportion of enterprise revenues from strategic communications services (FiOS, Terremark cloud services, security and IT solutions and strategic communications network solutions) and it has steadily reduced headcount in the division. Verizon improved its business operations reporting metrics for the division in 2011 and highlights from these initiatives are as follows:
- Wireline headcount has decreased from 118,700 in Q2 2009 to 84,700 in Q2 2013
- Strategic Communications Service revenues have increased from 40.6% of total Enterprise revenues in Q2 2009 to 57.2% in Q2 2013
- FiOS digital connections have increased from 5.36M in Q2 2009 to 14.6M in Q2 2013
- FiOS quarterly revenue increased from $1.26B in Q2 2009 to $2.73B in Q2 2013
Source: Verizon's Last 16 Earnings Releases
However, these efforts are not enough to offset the continued erosion of its legacy wireline voice services and its legacy High-Speed Internet offerings. Verizon Wireline's Q2 2009 revenue adjusted to account for spinning off its rural wireline operations spinoff to Frontier (FTR) was $10.6B but has declined to $9.7B in Q2 2013. This revenue decline has occurred in spite of its Q3 2012 acquisition of Hughes Telematics, its Q2 2011 acquisition of Terremark and the increased sales penetration of its FiOS products. Verizon is not alone in facing the decline of its traditional wireline business with strategic communications services such as its FiOS product line as AT&T and CenturyLink (CTL) (Sprint's former rural incumbent local exchange carrier operations) are pursuing the same strategies as Verizon Wireline. CenturyLink also resells Verizon Wireless services in its ILEC footprint. We think that Frontier's management and investors should be seething that Verizon spun-off its weakest wireline operations to Frontier in 2010 while giving the Verizon Wireless resale deal to CenturyLink. Frontier ended up inking a wireless resale deal with AT&T.
Source: Verizon's 2010-2012 Annual Reports and My Estimates
The bad news is that Verizon Wireline posted scant operating income of $74M (0.8% operating margin). Another piece of bad news is that its closest competitor AT&T generates much stronger performance in its wireline operations than Verizon and the same scenario applies to Verizon Wireless's reseller partner CenturyLink versus Verizon Wireline. At least Verizon Wireline accounted for only 22% of Verizon Communications' adjusted business segment EBITDA and its contribution to VZ's operation is getting smaller and smaller, which mitigates the negative impact that this declining business has on VZ's results.
Corporate and Administrative
Verizon increased its per share dividend distributions by 2.9% and this represented the seventh straight year it increased dividends. Verizon incurred a $7.2B pension charge in Q4 2012 after it accrued a $5.944B charge in H2 2011. Verizon's stakeholders hope that the company won't be announcing any retirement benefit charges this year considering that interest rates has bounced back from all-time lows. It reduced its outstanding debt by $2.26B and paid $3.15B in special dividend distributions to Vodafone (VOD) for its 45% minority interest in Vodafone. Verizon's management announced that it would be acquiring Vodafone's 45% interest in Verizon Wireless. Verizon announced that the deal would provide an immediate 10% benefit to its EPS once the deal closes. Verizon would pay $130B+ to acquire Vodafone's interest in Verizon Wireless, which consists of the following consideration:
- $58.9B in cash
- $60.2B in Verizon Communications' shares subject to a collar arrangement with a floor price of $47.00 and a cap price of $51.00 that will determine the maximum and minimum number of shares to be issued upon closing of the transaction.
- Verizon will issue $5.0B in notes payable to Vodafone
- Verizon would sell its 23.1% minority stake in Vodafone Omnitel N.V. to Vodafone for $3.5B
- Verizon will assume $2.5B worth of Vodafone's debt
Source: Verizon's 1999-2012 Annual Reports and My Estimates
In conclusion, I expect Verizon to maintain its leadership in the wireless communications market for the near term. I cannot argue with yield hungry investors who are interested in the company, as it sports a 4.5% dividend yield and the financial strength to cover its dividend payments with free cash flows. However, Verizon Wireless needs to keep its eyes peeled on AT&T and Sprint because these companies have been transitioning its 4G network resources from HSPA+ (AT&T) and WiMax (Sprint) to 4G-LTE and will be able to chip away at Verizon Wireless's network advantages. Although Verizon Wireless will to continue generating solid revenue growth and strong EBITDA growth, it will still face continued weakness in its Verizon Wireline division. Verizon's share price reached $54.31 in April and this was the highest it had traded since December 2000 ($53.24). Since then, it has generated a negative total return of 10% and we believe that investors should begin to accumulate Verizon shares if the price reaches $40/share or less, especially if Verizon maintains its leading position in the wireless communications industry.
Sources: My Estimates and Morningstar Direct