There's A Price War In Telecom Services

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Includes: S, T, TMUS, VZ
by: Brian M. Nelson, CFA

Summary

The telecom services group is in a price war, and we want no part of it.

The investment prospects of the group have waned due to a number of factors.

Let's address Verizon's recent warning and highlight our concerns with respect to a few entities in the space.

The telecom services industry is in a pricing war, and we want no part of it.

From outlining how AT&T's (NYSE:T) best dividend growth years are behind it (see its dividend report here) and revealing Verizon's (NYSE:VZ) potentially prohibitive debt load to Sprint's (NYSE:S) cutthroat pricing behavior and T-Mobile's (NASDAQ:TMUS) aggressive marketing, we've been pounding the table on how the telecom services industry is a mess right now. Verizon announced in a warning December 8 that the operating environment is not getting any better, and in our view, it may not for some time:

"As (Verizon) is accelerating the upgrades of high-quality customers to 4G, total retail postpaid disconnects are trending higher both sequentially and year over year in this highly competitive and promotion-filled fourth quarter...

...The company expects that the fourth quarter impacts of its promotional offers, together with the strong customer volumes this quarter, will put short-term pressure on its wireless segment EBITDA and EBITDA service margin (non-GAAP, based on earnings before interest, taxes, depreciation and amortization) as well as its consolidated EBITDA margin (non-GAAP) and earnings per share."

Verizon will announce fourth quarter results January 22, and we don't think they will be pretty. The company is in the midst of an ultra-competitive pricing environment, and we don't like its mountain of debt on the balance sheet this far into the ongoing upswing of this economic cycle. Not only is pricing pressure expected to crimp profits, but the very real possibility of increasing disconnects is a hazardous proposition for the firm. Verizon does have a significant cash balance, which is bolstering its Dividend Cushion ratio, but we urge investors to be cautious with any company that has a mountain of debt and dividend requirements and is expected to spend $17 billion in capital this year alone. At best, Verizon will stay on our watch list.

The best dividend growth years of AT&T, one of the most-followed companies by dividend growth investors, are behind it, in our view. As with Verizon, the capital intensity of AT&T's operations are like those of few other firms in our coverage, and AT&T's Dividend Cushion ratio of 0.2 (was 0.3) picks up the company's mountain of debt obligations as well - not nearly as much as Verizon, but certainly nothing to scoff at. AT&T's best dividend growth years are behind it, and much like that of other debt-heavy firms that slashed their payouts, the company is approaching trouble. Most income investors in AT&T's stock have been lulled to sleep, opening the door for disaster.

As for Sprint and T-Mobile, we don't see much of a fundamental investment case in either. We outlined how Sprint only has a sliver of equity on top of a huge debt burden here, and T-Mobile's valuation is mostly supported by the prospect of a potential takeover. However, both talks with Sprint and France's Iliad have been scrapped, and a new suitor has yet to emerge. If we see any weakness in the US economy, it's likely T-Mobile may stay single for the duration of any downturn. Absent a takeout, there's not much investment merit in either Sprint or T-Mobile, in our view.

Quite simply, we want no part of the telecom services group at the moment. Price wars, debt-heavy balance sheets, and hefty capital requirements are far from attractive qualities, and we don't think betting on a takeover is a prudent use of capital. Things will likely get worse before they get better, and gambling is not what we do.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.