AT&T Comes First In List Of Preferred Stocks As Verizon Fails To Impress

Jul.15.14 | About: AT&T Inc. (T)

Summary

VZ's strategy to compete in network quality not sustainable for a longer period.

Subscribers will be attracted to other carriers with lower costs and flexible payment plans.

T also a better option due to cheap valuations and high dividend yield.

Verizon Communications, Inc. (NYSE:VZ) and AT&T, Inc. (NYSE:T) are the two largest telecommunication giants in the U.S. Not so long ago, both companies enjoyed premium positions in the industry, almost a duopoly, but small players, especially T-Mobile US (NASDAQ:TMUS), have started to pose a serious threat to these companies with their aggressive pricing.

I remain neutral on VZ because I believe its subscriber trends will be weak until it decides to change its premium pricing strategy. Furthermore, T is better placed in the industry with lower enterprise value-to-EBITDA ratio and debt-to-equity ratio. Also, T offers a healthy dividend yield, which is 90bps higher than VZ.

Competition
TMUS started to compete aggressively by cutting down prices, and achieved great success by attracting a large number of subscribers. Most of the TMUS success came at the cost of T, as both companies used the same technology. Eventually, T responded and started to compete by lowering prices and offering equipment installment plans. This benefited T, as it is expected to see 800,000 net postpaid adds in the recent second quarter. But the new growth comes at the cost of lower ARPU, and wireless service revenue for the company is expected to remain flat in the second quarter.

On the other hand, VZ has adopted a completely different strategy. It is focusing on leveraging its network to attract new subscribers and maintain the low churn rate. Although the company recognized the importance of equipment installment plans, it continues to see attractive opportunities in providing subsidized smartphones.

I believe the company cannot escape from the price competition. Sooner or later, it has to decide to lower prices to attract subscribers. VZ's management said that they do not want to buy customers, but I believe subscribers prefer lower prices and easy installment plans. So, I believe it is just a matter of time before VZ decides to offer relatively cheap products and services, or the net adds will continue to decline.

VZ recently reported additions of 1.4 million wireless subscribers in the second quarter of the year. T has already reported net postpaid adds of 800,000. The companies are expected to report second-quarter earnings next week, which will bring more clarity to the situation; I am expecting more promising results for T.

Network Expansion
VZ has taken several initiatives to compete on quality and provide a superior network for its subscribers. The company has launched the XLTE service by leveraging its AWS spectrum. This will reduce network congestion, which will enable subscribers to enjoy fast speeds. Currently, this service is available in 44 markets, and is expected to cover additional markets in the future.

It will also help the company sell large data buckets because of two reasons. Firstly, the demand for data continues to grow, as indicated by the CTIA annual survey. Monthly wireless data has increased by 120% in 2013 and reached 269.1b mega bytes. Secondly, 45 million of VZ's customers are still using non-LTE services and are expected to convert to LTE-equipped devices.

The company is also planning to shift its network to IP-based technology. This will allow consumer data to be stored with the network rather than their headsets. So, subscribers will become less device-centric and will move towards network loyalty. The company is also enhancing its machine-to-machine services. More and more complex services can now be controlled with wireless devices through M2M, such as healthcare, vendors, logistics, the retail sector, vehicle diagnostics, and fleet management.

Recently, VZ's network operational team investigated an issue with Netflix, Inc. (NASDAQ:NFLX). It has concluded that the problem lies with NFLX rather than VZ's network. The management issued the following statement, "There was no congestion anywhere within the Verizon network. There was, however, congestion at the interconnection link to the edge of our network (the border router) used by the transit providers chosen by Netflix to deliver video traffic to Verizon's network."

VZ is also keen to acquire new spectrum. Its participation is expected on both the spectrum auctions AWS and broadcast, as the opportunities to acquire spectrum privately are limited.

Conclusion

Companies

PEG 5-year expected

Enterprise Value/EBITDA

Dividend Yield

Debt-to-Equity

VZ

2.29

6.35x

4.30%

792.50x

T

2.40

5.56x

5.20%

88.02x

TMUS

28.21

9.48x

-

159.55x

Click to enlarge

Source: Yahoo Finance

I believe VZ's strategy to compete in network quality is not sustainable for a longer period because subscribers will be attracted to other carriers due to lower costs and flexible payment plans. I also prefer T because of its cheap valuation and high dividend yield.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.