Why Verizon Will Win The Wireless Spectrum Arms Race

Dec.20.11 | About: Verizon Communications (VZ)

With smartphones, tablets and laptops proliferating like weeds all over the landscape, telecommunications companies are in a virtual arms race to claim airwave spectrum. Verizon (NYSE:VZ) is pursuing an especially aggressive strategy for dominating the airwaves with two recent plays for spectrum space. If approved by the FCC, the deals can bring 275+ million new potential customers for Verizon wireless, and make the company an even more dominant player in the telecom sector.

Verizon is spending nearly $3.6 billion to obtain wireless spectrum from SpectrumCo, a consortium up of major cable companies that include Comcast and Time Warner along with Bright House Networks. The purchase gives Verizon access to 259 potential new wireless customers.

Verizon is also waiting for approval for its agreement to buy radio spectrum licenses from Cox Communications. If approved, Verizon would acquire licenses for spectrum in Boston, New Orleans, Jacksonville (FL), Phoenix, San Diego and Las Vegas. The company would gain access to 28 million potential customers for its investment of $315 million.

Both deals are subject to FCC approval. Currently, the only way to get more spectrum is to acquire existing licenses from other broadcasters and telecom companies, most whom are reluctant to let go of the precious licenses which are akin to airwave gold. If the FCC approves the deals, Verizon will gain huge additional swaths of spectrum space to support video and other data services provided to wireless customers.

The acquisitions will put Verizon out ahead of its main competitors AT&T (NYSE:T) and Sprint Nextel Corp. (NYSE:S) in the spectrum war especially with the recent announcement that AT&T is dropping its bid to acquire T-Mobile.

If Verizon succeeds in its two spectrum deals, the company literally muscles out the competition by making a sizeable chunk of scarce spectrum space unavailable.

The deal with SpectrumCo has even deeper implications than just adding bandwidth. The consortium companies have also agreed to a resale plan of each others’ products and services.

Verizon will be able to offer Comcast (NASDAQ:CMCSA) and Time Warner (TWC) cable services in areas where it does not have FiOS in place. And Comcast and Time Warner will most likely be selling rebranded wireless Verizon wireless services. The arrangement takes direct aim at AT&T, because the deal puts AT&T customers squarely in Verizon’s scope.

The deal with Cox has similar reciprocal resale benefits, enabling Verizon and Cox to sell each other’s products and services.

Verizon Wireless is also part of a joint technological venture with cable companies to innovate advanced technology that will facilitate better integration with wireless and wireline products and services. Going forward, this could stop the bleeding from landline cancellations and appeal to customers who want to simplify their telecom services usage and billing

The new spectrum will accelerate Verizon’s current roll out of 4G network in its services markets, adding another powerful marketing tool to the company’s arsenal.

Both deals hold the promise a tremendous growth from new customers down the road for Verizon. On the other hand, the short-term outlook will no doubt be clouded by the huge capital expenditures invested in future earnings growth. Verizon’s cash flow and balance sheets will reflect the capital outlay and borrowing necessary to pursue the license purchases.

Currently, Verizon trades at about 15.5 P/E. On December 1, the company declared a quarterly dividend of 50 cents, unchanged from last quarter. With a 5.2 percent dividend yield, the stock remains an attractive equity for income investors. The dividend has been consistent and raised regularly since 1984.

An aggregate analyst recommendation of 2.5 puts the stock right in the middle of the buy/sell continuum, making it fairly neutral at this point especially since it is selling close to its 52-week high. Though the long term future looks bright, the spectrum acquisitions cost could impinge on Verizon’s balance sheet for 2012. Verizon’s current PEG ratio of 1.47 is likely to spike scaring away investors unaware of the potential magnitude for future earnings growth.

Value and income-minded investors should wait for market pullbacks to start building, or add to existing VZ positions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.