While telecoms are struggling through a capital-intensive period, Verizon (VZ) is enjoying expanding profit margins. The telecom jumped ahead of the pack in the buildout of its long-term evolution (LTE) network. It is now focused on maintaining market share as an onslaught of competition approaches. With an estimated 140 million subscribers expected to jump onto LTE networks in the U.S. by 2015 (DigiWorld), global telecoms players are moving in.
The question being kicked about by analysts is, how will the entry of Japan's Softbank (OTCPK:SFTBF) into the U.S. LTE market affect the competitive dynamics of the LTE market. By buying a 70 percent stake in Sprint Nextel (S), Softbank has fortified a weak competitor in the LTE market with cash and experience deploying LTE in Japan. It is now Sprint - in addition to number one carrier AT&T (T) - Verizon must watch in its rearview mirror.
Having executed brilliantly as the first mover in LTE networks, however, Verizon will not be easily unseated. By the end of 2011, Verizon had 3.5 million LTE subscribers, or 66 percent of the U.S. market among the major LTE operators, according to DigiWorld. Subscriber growth has been impressive in 2012. In the third quarter alone, Verizon signed up 1.5 million new subscribers, 10 times more than AT&T, which has reached about half of Verizon's U.S. LTE coverage of 260 million.
After investing heavily to blanket 80 percent of the U.S. population with LTE coverage, Verizon's return on its investment now depends on pricing and cool devices - the bells and whistles it uses to retain customers. LG (LG) and Nokia (NOK) are rolling our LTE phones. The feature-packed LG Spectrum 2 and Nokia Lumia will be sold exclusively by Verizon. Good processing power and memory, large screens, 8-megapixel cameras and near field communication (NFC) are featured on many LTE devices.
With Verizon's control of two-thirds of the U.S. LTE market, expect a surge in phone contracts in coming quarters. Of the 3.1 million iPhones Verizon sold in the third quarter, 21 percent were LTE-enabled. LTE devices represent 16 percent of subscribers, or 4.5 million devices sold.
On the iPhone 5 and other Apple (AAPL) gear, the competition will come down to price. A notable shift in pricing is taking place in the lucrative market of selling broadband access to iPad and iPhone users. Sprint will start to sell the iPad, alongside the iPhone, in the fourth quarter, but it says it will not offer its popular unlimited data plans on the new iPad Mini or fourth generation iPad. Instead, it will use pay-per-use pricing, conventionally Verizon's pricing model. Verizon, on the other hand, is expanding its unlimited 4G LTE pricing option to new models. The company activated double the number of iPhones than Sprint in the third quarter, at 3.1 million.
As the first mover, Verizon is already reaping LTE revenues and can afford to be competitive on pricing plans. Users are willing to pay up to 20 percent more for LTE service. Verizon's revenues per user are increasing, jumping 10.3 percent year-over-year. This added revenue is helping Verizon provide added value to customers.
Even if brutal price competition sets in, which is likely, Verizon has more wriggle room in its margins to engage in a price war. The cost of the build out of the LTE high speed network, forecasted by iGT to reach $40 billion by 2016, is making up most of the capital spending for network providers. For the wireless industry overall, the deployment of higher speed networks and services is squeezing margins into a historically tight range.
Having recently completed deployment in its 400th market, Verizon is emerging from a capital-intensive buildout with healthy earnings and record high margins. As LTE markets continue to add subscribers, it has enjoyed three consecutive quarters of double digit earnings growth. Earning per share of 56 cents equate to a 14.3 percent increase over the year-ago period. With capital expenditures easing up, free cash flow jumped 49.9% to $13.9 billion in the third quarter. The company is now reaping the revenues from LTE, forecasted to grow at a compound annual growth rate of 50 percent over the next five years, according to the Dell'Oro Group.
Credit Suisse analyst Stefan Anninger expects the churn in wireless sales to continue to be in favor of Verizon and AT&T and their LTE networks. Verizon beat expectations by adding 1.5 million subscribers in the third quarter, 600,000 more than forecast while Sprint lost contracts and AT&T underperformed over the same period.
Softbank's purchase of Sprint introduces two wildcards to Verizon's rosy outlook. Few will argue that Sprint will not be able to simply go head-to-head with entrenched LTE players in its current state. Softbank says it is bringing economies of scale and faster LTE technology to Sprint and the U.S. market. We will have to wait and see how that plays out, but right now, investors looking at the telecom sector should definitely consider adding Verizon to their portfolio.