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Verizon (VZ) is the second largest telecommunications provider in the US. Wireless services are the industry's growth force as the number of subscribers to fixed wireline voice service continues a downward trajectory. The US wireless market is primarily contested between Verizon and AT&T (T). Verizon maintains a strong partnership with Vodafone for wireless operations. With the marginalization of fixed wireline voice service, the future for Verizon rests with its success in delivering dominant wireless and broadband services. These are the elements examined in this article.

Wireless Services

In 2011, the number of customers served by Verizon's wireless division reached 90 million. That represents a gain in market share over the company's larger rival AT&T. This was achieved by Verizon's offering of unlimited service plans and popular data-equipped handsets. The wireless network of Verizon connected an additional 17 million customers by delivering wholesale access via third party resellers. AT&T surpassed 100 million wireless subscribers in 2011 and has several million customers using connected devices other than phones.

Churn rate for wireless services is low at both Verizon and AT&T, reflecting healthy subscriber bases. The monthly churn rate at AT&T is a little more than 1%, while Verizon had a rate of 0.9% in December 2011. This is the percentage of subscribers during the given period that cease using a company's services.

Both Verizon and AT&T have focused on revenue generation from data services with wireless handsets. Verizon s fourth quarter 2011 average data revenue per wireless user increased 19% over the year earlier amount. Data revenue comprised 42% of wireless revenue at Verizon. About 39% of post-paid revenue for the AT&T wireless segment is payment for data usage. This indicates that Verizon carries the greatest momentum in smartphone data usage.

During the fourth quarter of 2011, Verizon's wireless customers using smartphones increased from 39% to 44%. Further room exists for expansion in this area as the company gains from rising sales of Android devices and the iPhone 4GS, which launched in October 2011. Among the wireless subscribers at AT&T, 53% are using smartphones.

Verizon is the better story in the wireless market. The EBITDA service margin of Verizon's wireless division was 45% in 2011. That was the best in the industry - despite the company's subsidies for activation of smartphone purchases. As of December 2011, total post-paid revenue per monthly Verizon subscriber increased 2.5% from the prior year. Conversely, post-paid revenue per wireless user at AT&T is only increasing at a little better than 1%.

The Verizon wireless operations acquired Rural Cellular Corporation in 2008 and Alltel in January 2009. Upon maximizing expense synergies from the acquisitions, Verizon disposed of some Alltel properties in 2010. The increased subscriber base from these purchases provides avenues for Verizon to market its 4G network and smartphones with data features.

As Verizon aggressively builds its high-speed 4G LTE network, it is establishing a competitive advantage over AT&T. Smartphone penetration of the market by Verizon is adding earnings despite the hindrance to profit margin by the handset subsidies.

Although the Verizon 4G network experienced service outages in December 2011, the company attributed the disruptions to several distinct technical issues. Verizon has committed to smooth function of its 4G network in the future.

Wireline and Fiber Networks

In addition to the wireless segment, Verizon has a wireline division that supplies local and long distance voice services. The wireline group also provides internet access plus broadband video and data.

Wireline voice connections have declined in recent years across the industry. Verizon has experienced customer loss plus disposed of accounts. The company created a spin-off in 2008 of 1.4 million access lines, which were subsequently acquired by Fairpoint Communications. In 2010, Verizon disposed of 4 million mostly rural wireline accounts and 1 million broadband lines to Frontier Communications. As a consequence, Verizon strengthened its balance sheet by reducing its debt by about $3 billion.

Business wireline connections have declined due to lower US employment in recent years. However, broadband access with telecom carriers is gaining market share over higher-priced cable providers. This mix of voice and data plans provides some stability for wireline services to businesses. In addition, strengthening of the economy should stem the loss of business accounts.

Verizon still provides wireline services to approximately 94.1 million locations. The company clearly recognizes the trend for discarding wireline connectivity to substitute either wireless or IP voice services.

The strategy at Verizon entails eliminating wireline subscribers while adding wireless users and IP data connections. AT&T is also adding wireless customers and that company has committed to its AT&T Uverse® services, which attaches voice and entertainment to broadband subscriptions.

Verizon has about 8.6 million broadband wireline subscribers. But the number of customers for this service has declined in recent years. The company has upgraded the speed of its DSL network to compete with internet access by cable providers. Competitors in Verizon's markets for broadband and voice customers include cable companies Comcast (CMCSK) and Cablevision (CVC).

More importantly, faster fiber connections are popular with large enterprises. Fiber networks are also attractive to mid-size businesses as economic conditions strengthen and staff reductions cease. Even residential consumers are increasingly buying access via fiber networks.

Analysts have been critical of the cost Verizon is incurring for buildout of its fiber network. This is probably overblown because the company's capital expenditures have steadily declined in recent years. Capital spending was 20.5% of revenue in 2005 but fell to just 14.7% for 2011. Although third quarter weather related issues slowed the fiber network buildout, Verizon management has committed to maintaining capital expenditures below 15% of revenue in 2012. A greater proportion of capital is budget toward buildout of the 4G LTE network.

Verizon s revenue from fiber-based broadband services increased more than 15% in 2011. The fiber network is a strategic wireline service than should generate sufficient return on investment. Fiber services provided 61% of the company's 2011 revenue from wireline operations. The market penetration for Verizon in areas served by the fiber network is 35.5%. Verizon has targeted 16.5 million residences and businesses for services on its advanced fiber network. A majority of fiber network customers also subscribe to an ancillary television service.

Redbox Joint Venture

In the first quarter of 2012, Verizon announced a new joint venture with Redbox. This move fits with the trend of providing entertainment access in addition to communications services. The venture will provide a download option for movies from Redbox. In addition, the Verizon network will deliver national on-demand video by Redbox.

Verizon will hold 65% of the venture, which is expected to launch in the second quarter of 2012. As a national service, video delivery is intended to broadband subscribers of networks other than Verizon.

The impact on the company's capital budget is immaterial in order to participate in the joint venture. Verizon's initial capital contribution totals $26 million compared to the company's total annual capital budget of $16 billion. Partners have the option to increase or decrease their ownership based upon future capital requirements, which are forecast at $450 million.

The download option and low priced physical vending distribution by Redbox presents a compelling competitive case against Netflix (NFLX), the early dominator in streaming video. For Verizon, the venture provides customers with on-demand content distribution.

However, until additional details arise, this offering might comprise only a marginal benefit for Verizon. Wireless services are not part of the announced venture. However, if wireless becomes part of the arrangement in the future, that could generate significant potential for Verizon.

Summary

Verizon's wireless group is expected to drive company growth in the near term. Even with subsidies for smartphones added to its network, the strong operating margin provides opportunities for share price appreciation.

In addition, stability in the Verizon wireline segment is recently apparent. This is aided by subscriber increases for the company's fiber network.

Despite sound fundamentals, Verizon stock is reasonably priced. I rate it as a hold for existing investors and suggest caution with accumulating any shares. Some unknowns exist regarding alleviation of wireless network congestion, which the company is addressing by purchase of spectrum from a cable consortium. Moreover, ongoing strength in market penetration of the Verizon fiber network still has some unproven elements.

However, the above average dividend of Verizon does compensate for exercising patience. With 10-year US Treasury notes only paying around 2%, a stable stock with a high yield from dividends presents a compelling possibility for modest accumulation.

Source: Verizon: A Strong Play For Profits Now