This week, AT&T (NYSE:T) (Thursday) and Verizon (NYSE:VZ) (Tuesday) report their fourth quarter earnings. Even without following the stocks, we know by the plentiful G3 advertisements that the companies are engaged in a wireless battle. We expect these two biggies to be the US industry leaders, forging ahead as wireless technology continues to advance.
But wait! Check out company financials, stock fundamentals and management’s actions – what do we see? Certainly not the characteristics of growth companies. Take a look…
First, a bit of perspective on technology. Think of two basic areas:
- Research & Development (R&D) – When we hear “technology” this is what we think about. It’s where the new, exciting and previously unimaginable happens.
- Application – Where the practical happens, converting R&D into usable products and services
AT&T’s and Verizon’s wireless companies operate in the latter. They play the key role of combining the three wireless areas: devices (e.g., smart phones), services (e.g., phone applications) and systems (e.g., G3). They make the industry work – for now.
With the device/service/systems areas continuing to see rapid development, we naturally expect to see the wireless companies focused on ramping up their delivery. Financially, the companies’ established landline and long distance services are “cash cows” providing the funds for growth. Sounds like an ideal setup, doesn’t it?
Well, the numbers don’t bear it out. Instead, AT&T and Verizon look more like electric utilities: heavy debt, controlled capital expenditures, 75+% dividend payout policies, and political lobbying to “grow” by increasing fees, not improving services.
A good relative measure for capital expenditures is to compare them with depreciation. (Depreciation, an expense taken out of income, is a non-cash item, making cash available for reinvestment.) Typically, in a growth business, we expect to see a level of capital expended higher than depreciation. Verizon has spent a bit more, but AT&T is not even reinvesting the amount of depreciation. AT&T has been roasted this past year for cutting back spending, a criticism they answered by saying their 2009 capital expenditures exceed that of 2007. Then they said that they don’t break out wireless spending separately, but it is an important area (however, not important enough, evidently, to break out for concerned investors).
Here are the depreciation/capital expenditure comparisons:
In setting dividend policy, the root question is: Who can make better use of the money? For stable, non-growing businesses with few investment opportunities (think established electric utilities), paying out most of the income can make sense. For companies in the technology sector (and that is where AT&T and Verizon are), it doesn’t. Their high payout ratios drain resources and are reminiscent of the past, when phone companies were utilities.
AT&T’s CEO statement on this quarter’s dividend increase focuses on longevity, with no mention of growth:
Our 26th consecutive annual dividend increase underscores the Board’s continued commitment to stockholders and confidence in our strong financial position.
Verizon’s CEO statement on last quarter’s dividend increase reflects a “have your cake and eat it, too” unreality:
This increase reflects the strength of our cash flow and balance sheet. It demonstrates the Board’s commitment to return cash to our shareholders while continuing to invest in the long-term growth of our business.
The fact is, both AT&T’s and Verizon’s stocks are not benefiting from the payouts. They sell at dividend yields far above the market (i.e., prices are well below the market level compared to the dividends): AT&T = 6.6% and Verizon = 6.3%. These high yields show that the companies’ policies are at odds with what investors want – reinvestment and growth.
A final point on management and dividend payout. The times we have been through were perfect for the companies to change their dividend policies. Statements like “Given the need to invest in coming technologies…” and “with the uncertainty in both the financial markets and the economy…” would have allowed each to shift to a growth track. And I believe it would have been welcomed by shareholders.
To me, lobbying tactics are the surest sign that AT&T and Verizon are mismanaging their growth potential. Attacking “net neutrality” in order to create service classes is an unrealistic strategy. I believe it comes from the misguided goals of (1) trying to boost profit and cash flow by stabilizing capital expenditures and (2) becoming monopolistic gatekeepers who ration available services by charging for “premium” services. In the highly competitive, fast changing technology field, trying to sit back and enjoy the profits is the kiss of death.
As a result, AT&T and Verizon are setting themselves up to be losers in the long run if they don’t change their approaches. They are setting the stage for technology partners and supporters to become combatants, and that is a disastrous strategy. These developers of products, services and delivery technology can overcome obstacles to keep their growth on track. Their growth may depend on the wireless providers today, but tomorrow will be different if the wireless companies don’t keep up. AT&T and Verizon are providing plenty of incentive to others for finding new paths that skip them.
So, keep a close eye on the wireless providers. If AT&T and Verizon don’t begin to compete by ratcheting up capital expenditures, rather than ad spending, look for their future outlooks to be dim.
Disclosure: No positions