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Wireless operations and data delivery are vital to the future of telecom companies. In recent quarters, Verizon (NYSE:VZ) has gained on its chief rival AT&T (NYSE:T). The near term prospects for Verizon are dependent upon the company continuing to deliver results that outdistance expectations while reflecting strength in capturing and retaining wireless customers plus data traffic. This article examines those trends.

Recent Results

Verizon reported financial results for the first quarter of 2012 that showed earnings of $0.59 per diluted share, which is one penny more than consensus analyst estimates. Revenue of $28.24 billion was 4.6% above than the same period one year earlier. Net income of $3.9 billion was 19.6% higher than one year ago.

Free cash flow in the quarter was a substantial $2.4 billion, compared to $700 million in the first quarter of 2011. Ongoing operational expense reductions should create a further rise in cash flow throughout 2012.

Trends

In the first quarter of 2012, wireless service revenue increased 7.7% and wireless data revenue rose 21.1%. The combination of solid revenue growth and the company's operating expense reductions provided Verizon with an industry leading wireless service margin EBITDA of 46.3%. This figure should receive a boost from management's intention to curtail operating expenses by $2 billion in 2012. To improve utilization of the company's assets, Verizon has completed its exit of public payphones and phone card sales plus some contracts for international connections.

The retail post-paid churn rate at Verizon was only 0.96% for the first quarter. This measure is the percentage of subscribers that ceased using services. Verizon's churn rate is an industry best. No other company is below 1%.

Retail post-paid average revenue per user increased 3.6% in the first quarter of 2012. This is a 10 basis points rise during the quarter and 140 basis points greater than the figure from the first quarter of last year. An additional 501,000 new retail post-paid subscribers were attained in the initial 2012 quarter.

The number of Verizon Wireless customers using smartphones is 47% at the end of the quarter. This still lags the 50% smartphone penetration of AT&T, but Verizon is gaining in this important metric. The Verizon figure increased 300 basis points during the period.

Smartphone use if critical because it is the avenue for capturing revenue from high margin wireless data usage. The launch of the iPhone 4S in the fourth quarter of 2011 boosted sales to 4.3 million units during the period. This declined to 3.2 million iPhone activations during the first quarter of 2012.

Continued buildout of the 4G LTE network is aimed at enhancing smartphone use by delivering higher data speed. Verizon is ahead of its goal for the network by already covering 200 million people. The company expects to complete the extension of 4G LTE service by mid-2013. Meanwhile, AT&T has experienced a much slower buildout of its 4G network.

The wireline segment at Verizon has continued to feel the undertow of systemic industry wide decline. Wireline revenue fell 2% in the first quarter of 2012 compared to the same quarter of 2011. Wireline EBITDA margin declined 100 basis points year-over-year to 22.6%. Switched access lines fell 17.7%, which is a much higher loss than a traditional wireline carrier like CenturyLink (NYSE:CTL). However, limiting wireline losses is more important to CenturyLink as it unfolds a longer-term strategy of delivering enterprise data services. Although Verizon management has plans to ultimately build its enterprise services, the company is basically in a contest with AT&T for the wireless consumer market during at least the next several years.

Verizon added 193,000 customers to its broadband fiber network during the first quarter of 2012. This compares to 89,000 high-speed internet connections added by CenturyLink in the same period. Of course, CenturyLink is less than one-fourth the size of Verizon. Moreover, the CenturyLink strategy varies from Verizon by using acquisitions to bolster wireline revenue. By contrast, Verizon fell short of offsetting wireline customer losses with broadband services. Nevertheless, the company did add 180,000 fiber video customers and an impressive 414,000 digital voice subscribers.

New Developments

On April 18, Verizon announced that it would sell its 700 MHz A and B spectrum licenses in an open-sale process. These licenses cover many major cities and a few smaller markets throughout the United States. Verizon acquired them in a 2008 FCC auction. Verizon's objective is acquisition of additional Advanced Wireless Services spectrum licenses to use in conjunction with its 700 MHz upper C band for capacity on the 4G LTE network.

Consequently, selling the A and B spectrum licenses is contingent upon the pending purchase of AWS licenses from a consortium of cable companies. The transactions are expected to close by the middle of 2012 following current review by the FCC and the Department of Justice. Regulatory approval is expected because it utilizes the presently dormant AWS spectrum and does not eliminate any actual competitor. Verizon's voluntary sale of the A and B spectrums strengthens the case.

Financial Strength

Verizon lowered its debt by $3.5 billion in the first quarter of 2012 by using part of its dividend distribution from the Verizon Wireless joint venture. This caused the ratio of debt to total capitalization to reach 36.9% - a favorable decline from 39.1% at the beginning of the quarter. Adjusted EBITDA is 13.5 times interest expense, which is an increase from 12.5 for the entire year of 2011.

With free cash flow rising to $2.4 billion for the first quarter, Verizon delivers a secure dividend that gives shareholders a yield of over 5% based upon stock price in the middle of the second quarter. In fact, dividend increase are reasonably anticipated - probably at least 3% higher in 2013.

Risks

Verizon is allocating the majority of capital spending to buildout of the 4G LTE network. Limited investment in enterprise services and high costs for the company's fiber network mean that broadband is unlikely to offset a weak wireline segment. Accelerating gains in wireless subscribers - and particularly users of smartphones - on the 4G LTE network is vital to Verizon's success.

Any economic weakness that deters recent advances by the Verizon Wireless segment presents a significant challenge. Under such conditions, many consumers could opt for lower cost reduced service options. Wireless telecom is highly competitive.

Analysis

The fundamental conditions for Verizon are relatively sound, but this is primarily already reflected in the stock price for the near term. The ratio of price to earnings of about 15 is slightly ahead of the average of 14 for the five largest U.S. telecom companies.

Although Verizon's growth rate has surpassed its peers, the net margin leaves little room for any large setback. Therefore, purchasers of the stock must exercise patience. Current owners are well advised to maintain their holdings. Fortunately, Verizon's dividend rewards the patient investor. This presents an opportunity to look deeper into the company's prospects beyond 2012.

Although year-over-year wireline losses are alarming, many analysts have overlooked stability in this area over the past six months. In addition, strong sales of connections to the fiber network are unjustly disregarded because they failed to substantially offset losses of switched access lines.

The strong operating margin in the wireless segment is a testament to Verizon's strength. It also supports management's decision to focus on this area. That is driving the rise in wireless customers and low churn rate.

I believe that Verizon is winning the wireless market share race with AT&T. Meanwhile, Sprint and T-Mobile continue to lag in perceived network quality.

Verizon has a competitive advantage over AT&T in the pace of developing a 4G network. Completion of the 4G LTE buildout should inspire higher use of smartphones for accessing the faster service. Expanding the smartphone base naturally leads to higher data revenues. The reasonable expectation going into 2013 is that Verizon's advantage in average revenue per user will deliver strong earnings, accelerating cash flow, and a higher stock price.

Source: 4G Buildout Will Shoot Verizon Higher By 2013