Verizon Vs. AT&T: Which Has A Better Operating Strategy For The Future?

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Includes: T, VZ
by: Brian Nichols
Summary

VZ has chosen to focus on its wireless business entirely, specifically in the U.S.

AT&T has chosen to expand internationally and maintain big investments in U-verse.

Which approach will be most rewarding to shareholders long term, and why?

Verizon (NYSE:VZ) and AT&T (NYSE:T) are number one and two respectively in the U.S. wireless market. However, these diversified telecom companies are each operating their own strategy for the future, and one strategy appears far superior to the other.

Verizon's Strategy

Verizon's strategy for the future couldn't be more evident; divest wireline assets and place big bets on wireless. It all started when Verizon paid a whopping $130 billion to take full control of Verizon Wireless, thereby acquiring Vodafone's 45% stake of Wireless. By doing so, Verizon was expected to see a 10% boost to its EPS, and would gain full control to make all strategic decisions related to its mobile network.

During 2014, Verizon's Wireless business grew 8.2% year over year and accounted for nearly 70% of the company's total revenue. It also accounted for most of Verizon's operating income. However, with Verizon raising its debt from $50 billion to over $113 billion during the last 16 months, mostly stemming from the Wireless acquisition, Verizon has since made the choice to divest wireline and other nonessential assets.

Most recently, Verizon sold $5 billion worth of cell towers to American Tower (NYSE:AMT) for $5.06 billion. Then, it sold voice and FiOS assets to Frontier (NASDAQ:FTR) for $10.5 billion. The general assumption is that Verizon made this move to pay a $10.4 billion debt to the FCC for spectrum it won in Auction 97. Once more, selling tower and wireline assets to pay for spectrum is just another example of Verizon emphasizing its Wireless business over everything else.

AT&T's Strategy

AT&T's direction is almost completely opposite of Verizon. While Verizon is narrowing down its business, AT&T is expanding in a million different directions. Granted, its Wireless business isn't growing quite as fast as Verizon's competing business, however, AT&T is quickly growing its Wireline business behind U-verse. This includes broadening its TV presence with DIRECTV (NYSE:DTV) and expanding internationally in Latin America and Mexico.

Specifically, U-verse is growing north of 20% annually and accounts for more than 10% of the company's total revenue. While Verizon divests its competing FiOS business, AT&T is investing in U-verse to increase its broadband speeds from a peak of 300 megabits per second to one gigabit per second, just like Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Fiber.

AT&T's acquisition of DIRECTV not only gives it a leading satellite business in the U.S., but also in Latin America. Then, with the acquisitions of Iusacell and Nextel Mexico, AT&T increases its network size from 300 million to 400 million by entering Mexico. Importantly, AT&T moved into two countries, increased the size of its network by roughly 100 million users - all positives for AT&T's Wireless business - and did so while spending half as much as Verizon spent to acquire full ownership of its Wireless business. Meanwhile, Verizon insists that it's not moving into Mexico, as CEO Fran Shammo told the WSJ that Verizon is not interested in America Movil's (NYSE:AMX) assets. In other words, Verizon is not looking to moving into Mexico or Latin America, or at least that's the message management is trying to convey.

Which Strategy Is The Best?

The unfortunate reality for Verizon is that much has changed within the wireless space since it agreed to pay $130 billion for full ownership of its Wireless business. The industry itself has entered a full blown price war, and while Verizon managed to successfully maintain premium prices for a while, it too has increased data allowances, and just recently for the first time cut data plan prices by $10 per month. Verizon management had always insisted that it would not buy customers, but given its new prices and a $100 credit to switching customers, I'd say that Verizon has been forced to join the game of buying subscribers.

That said, AT&T is subject to the same macro, competitive issues as Verizon in the wireless space. The U.S. wireless industry is mature, and growth is no longer measured by new subscribers, but rather activations, hoping that subscribers will add multiple lines with tablets, smartphones, and other devices that consume data. Furthermore, data is another growth market within the wireless space, as global mobile data traffic is expected to increase nearly tenfold between 2014 and 2019 as the Internet of Things takes shape, according to Cisco. Unfortunately, by constantly cutting data prices and increasing data allowances, both Verizon and AT&T are limiting their revenue potential from the growth in data over the next five years.

However, what makes AT&T different is the growth opportunities that exist in Mexico and with U-verse. Mexico's current wireless leader, America Movil, must decrease its market share from 70% to below 50%, and so far, AT&T has been most aggressive in entering the region. That opens a new revenue opportunity for AT&T, also allowing it to become a cross-border service provider. In regards to U-verse, one gigabit per second broadband speeds will likely become the future standard of Internet and TV, and AT&T has the resources available and presence to dominate the massive market as these speeds are implemented throughout the U.S.

Nonetheless, AT&T has a clear growth plan ahead in both wireless, via international expansion, and in wireline, via U-verse. Meanwhile, I don't see those same growth opportunities for Verizon, and its recent sale of towers and wireline assets serve as proof that Verizon has very few available operating options. With the wireless service price wars in full swing, and CAPEX budgets still high, Verizon's free cash flow loss of 36% last year might very well become its new standard. As of now, Verizon's dividend payments account for well over half of its annual free cash flow, which puts the company in a very vulnerable situation. First off, investments and acquisitions of spectrum are necessary, but with $113 billion in debt, Verizon can't very well issue more debt, and since Verizon has increased its shares outstanding by nearly 47% over the last five years, it can't very well dilute shares further with offerings to raise capital. This means that future acquisitions and big unexpected expenses will come via divestments of valuable assets like FiOS, as Verizon puts all its eggs into one wireless basket.

Granted, AT&T has many of the same problems as Verizon, but what I find encouraging is that AT&T's shares outstanding have declined 12% over the last five years, and it has $30 billion less debt on its balance sheet. This gives AT&T more options, and with it expanding into other markets and growing its U-verse business, I see far more growth opportunities ahead for AT&T. Nonetheless, these two companies are headed in two completely different directions, and one of the biggest reasons I think AT&T is headed in the right direction is because of how drastically the wireless industry has changed since Verizon agreed to pay $130 billion for full control of its wireless operations. In my opinion, Verizon made a big mistake by acquiring all of Wireless that has hindered its future, whereas AT&T continues to make the best moves to find growth opportunities, which will likely reward shareholders most in future years.

Disclosure: The author is long T. 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.