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Summary

  • Both T and VZ used different strategies and added over a million postpaid subscribers.
  • Next will add significant subscribers in the future and help maintain T’s lowest industry churn.
  • T also has a strong balance sheet and high total returns.

Telecommunication giants, Verizon Communication (NYSE:VZ) and AT&T, Inc (NYSE:T), recently reported their second quarter earnings. I continue to remain bullish on both these companies, but I prefer the latter. T's strategy of competing on pricing has helped it achieve the best ever churn and strong momentum for postpaid subscribers. Furthermore, I believe that T's equipment installment plan -Next -will continue to drive growth in the future. It also has a strong balance sheet, evident from its solvency ratios.

Subscriber Trends for Second Quarter

Wireless
Both companies have followed different approaches and both proved to be successful. VZ decided not to compete by lowering prices and used its network quality to attract subscribers. T on the other hand started to compete by reducing its rates and aggressively promoting EIP and Share Value Plans.

In the second quarter, VZ added 1.441 million postpaid customers. On the other hand, T's net post paid additions were better than the company's pre-earnings report and reached 1.026 million. In the absolute number, VZ added more postpaid subscribers, but the table below gives a true picture of the subscriber growth. T has significantly improved its subscribers trends based on a year on year analysis. It also has the lowest churn of 0.86% in the industry. Basically, T has rewarded subscribers by offering them lower prices and subscribers have responded by being loyal, hence the lower churn. Among the postpaid net additions, a major chunk for VZ comes from the activation of tablets, whereas T's net additions were driven by smartphones.

Growth In Net Postpaid Adds (yoy)

1Q'14

2Q'14

T

111.15%

86.21%

VZ

-23.75%

38.82%

Source: Company Reports

Retail prepaid net adds were better for VZ, as it increased by 191,000 whereas T lost 405,000 customers. But I believe the losses in the prepaid segment are expected to improve for T, as the company continues to heavily invest in Project VIP, which will improve its fiber footprint. The company has recently launched ultra fast fiber service in Austin and is expected to extend its services to Dallas and North Carolina.

Wireline
In the wireline segment, VZ's performance was better than T's. On a YoY basis, VZ's wireline revenues were up by 0.3%, whereas T experienced a decline of 0.9%. The growth in VZ's consumer revenues (major chunk of wireline revenues for both companies) was 1% higher than T. However, U-Verse net adds were better than FiOS for both video and broadband in the second quarter.

Verizon EDGE or AT&T Next?
Both companies offer attractive equipment installment plans with zero upgrade and activation fees. VZ's EDGE performance was lower than expected, as its take rate was only 18% in the second quarter of the year, whereas the management was expecting it to be at 30%. Most VZ subscribers prefer to stick with the old subsidized model. Moreover, the company did not market it that well, as most of the EDGE devices were sold through indirect channels.

On the other hand, nearly 3.1 million or 50% of all smart phones were activated from the T's Next platform. The company is expected to continue this momentum in the second half of the year and Next's smart phone penetration is expected to reach 66.6%. It would help the company to maintain its low churn and subscriber additions.

I believe the Next platform has been better than EDGE. T is well positioned because of two reasons. Firstly, the company has successfully diverted major a chunk of its subscriber base from the subsidized model. Secondly, T has successfully monetized its EIP receivables, which opens up future cash flows. It also reduces credit risk.

Debt
Both of these companies operate in a capital intensive industry and constantly reinvest in businesses to improve network quality. Two major events are coming up, which could be expensive and could drain free cash flows. The upcoming low bandwidth spectrum auction holds a key position because of its extensive coverage and ability to penetrate walls. The two major competitors Sprint (NYSE:S) and T-Mobile US (NYSE:TMUS) have decided to collaborate and jointly bid for the auction. They are expected to raise $10 billion together which pressurize T and VZ to at least match their bid.

Furthermore, the Bonus Depreciation Bill is also pending in the Senate and if the bill is not extended for 2014 and 2015, cash taxes will increase.

Although these companies generate hefty cash flows, they still need to raise cash through the debt market. T is well placed in terms of solvency ratio. It also has a credit rating of A3 unlike VZ, which has a rating of Baa1. So, T has access to cheaper financing to expand its operations.

Companies

Total Debt to Equity

Net debt to adjusted EBITDA

VZ

738.06x

2.4x

T

91.23x

1.71x

Source: Reuters.com and Companies Data

Valuation
I have done discounted free cash flow analysis in my previous articles for both VZ and T and calculated price targets of $51.81 and $37.47 respectively. The table below shows total returns by adding the dividend yield and potential for price appreciation. T is also cheaper than VZ in terms of enterprise value to EBITDA, as the ratio for VZ and T is 6.35x and 5.56x respectively. So in terms of valuation, T is clearly cheaper and offers an attractive total return.

Companies

Dividend Yield

Price Appreciation

Total Return

T

5.2%

5%

10.2%

VZ

4.30%

0%

4.30%

Conclusion
Although both companies have different strategies, they both were able to add over a million postpaid subscribers. However, I continued to prefer T over VZ because I think Next will add significant subscribers in the future and help maintain the lowest churn for the company. It also has a strong balance sheet and high total returns.

Source: AT&T Continues To Remain A Preferred Stock In The Telecom Space