Acquiring Full Control Of Verizon Wireless Would Provide Much Needed Cash Flow To Verizon

| About: Verizon Communications (VZ)

A recent news report suggests that Verizon Communications Inc. (NYSE:VZ), the leading mobile phone service provider in the United States, is interested in expanding into Canada by acquiring Wind Mobile. The move comes after the Canadian government sought to boost competition with an auction of spectrum in 2008 in which Wind Mobile bought spectrum reserved for it. However, it has struggled against the three major carriers, which have a combined market share of approximately 90%. Toronto-based Wind Mobile has more than 600,000 subscribers and Verizon started to consider a bid for the company following the decision by Canadian Industry Minister Christian Paradis not to allow existing operators to bid for spectrum owned by new operators until next year. Verizon was reported to be enthused by the chance of acquiring Wind Mobile without having to bid against one of Canada's three biggest carriers. It should however be pointed out that, given the size of the Canadian market, the impact on Verizon is unlikely to be significant.

First-quarter 2013 financials

Consolidated highlights for the quarter include an EPS of $.68 per share, which is a 15.3% increase over $.59 per share in the prior year period. Total operating revenues of $29.4 billion represents an increase of 4.2% and operating income was up 19.8% to $6.2 billion. Operating margin was 21.1% compared with 18.4% in the same quarter of the previous year. EBITDA rose by 12.1% to $10.3 billion and the EBITDA margin grew by 2.4% to 35.1%. Cash flow generated by operations increased by $1.6 billion or 26.4% year-over-year while capital expenditure remained at $3.6 billion. Free cash flow increased by $1.5 billion or 64.3% compared to the same quarter of the previous year.

Verizon Wireless showed record profitability on the back of strong customer and revenue growth. Total revenues were $19.5 billion up 6.8% over the same quarter of the previous year with an 8.6% growth in service revenues as well as retail service revenues. Retail average revenue per account grew by 6.9% to $150.27 a month. Operating income margin at 32.9% and EBITDA margin at 50.4% were both at record highs. Out of 720,000 net retail connections added in the first quarter, 677,000 were retail postpaid connections. At the end of the quarter the company had 98.9 million retail connections (including 93.2 million postpaid connections) a year-over-year increase of 6.4%. Smartphone growth in the retail base grew from 58% at the end of the preceding quarter to 61% at the end of the first quarter. The company has continued to roll out the largest 4G LTE Mobile network in the United States and the service now covers almost 300 million people in 491 markets across 95% of its 3G footprint.

Consumer revenues from Wireline services increased by 4.3% to $3.6 billion while average revenue per user increased by 9.5% to $107.15. Broadband connections totaled 8.9 million at the end of the first quarter of 2013, a 1.4% year-over-year increase. Overall, net broadband customers grew by 99,000 in the first quarter, as FiOS Internet net customer additions offset the fewer subscribers for DSL-based High Speed Internet services.

The effect of buying out Vodafone in Verizon Wireless

Since 2009, Verizon has only controlled 55% of Verizon Wireless with the other 45% being held by Vodafone (NASDAQ:VOD). Now, the possibility of Verizon buying the Vodafone stake has once again come into prominence because increased cash requirements require increased cash flow. So far, Verizon has used the distribution from the joint venture, among other things, to service debt and finance common stock dividends. According to Moody's, Verizon is expected to generate positive cash flow because of the reduction in debt payments and capital expenditure though it may see significant increases in taxation as tax breaks expire. Analysts say that if Verizon could conclude the deal for $100 billion, it should be able to maintain its present credit rating of stable. However, if the deal were to cost say $130 billion, the rating would likely be downgraded. It must be emphasized that no deal has yet been announced but the deal would suit both Verizon for its cash requirements and Vodafone for its funding for other projects.

The bottom line

Verizon is presently quoting at nearly $49.00 against the mean analysts target price of $54.09 and the median analysts target price of $55, so there is some possibility of moderate capital appreciation. However, with the dividend yield in excess of 4%, which is sustainable in the foreseeable future, the stock is a compelling income investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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