Verizon: We Don't Know About Vestberg, But Dividend Remains Well Covered

by: Reason Investments

Summary

The CEO change means we now have no idea what strategic direction VZ will pursue.

We think the number of homes served by Verizon's fiber optic or wireless Internet connections could exceed 140 million by the 2030s.

Verizon's recent wireless market share losses should prove short lived.

Dividend investors should continue to own VZ shares, but keep an eye on Vestberg’s strategy as it comes into view.

Appointment of Hans Vestberg as CEO creates more uncertainty around VZ’s strategy, not less

The market has taken the appointment of the former Ericsson (NASDAQ:ERIC) CEO and recent Verizon (NYSE:VZ) chief technology officer as a sign the company will remain focused on the advancement of its wireless and wireline communications networks. This furthers the prevailing narrative that Verizon remains focused on the “pipes” while competitor AT&T (NYSE:T) plans to vertically integrate with acquisitions of more content and media assets.

We argue the CEO change means we now have no idea what strategic direction VZ will pursue. Under Lowell McAdam, Verizon nibbled on content with the acquisitions of Yahoo and AOL. But that was small stakes compared to the transformational deal AT&T completed with DirecTV and is aiming to do with Time Warner (NYSE:TWX). Verizon under McAdam publicly expressed little appetite for large content acquisitions, though press reports suggest they’ve held exploratory talks with plenty of content/media targets.

We simply have no way to know if Hans Vestberg will continue with McAdam’s approach. The fact that he was CEO of a telecom equipment company and in charge of VZ’s 5G rollout means zippo now that he is taking over the top job. Read his Wikipedia bio. He has a degree in business administration. He’s been a CFO and controller. He spent a generation with Ericsson working on four different continents. All we know is that he is an ambitious guy from Sweden who likes handball. He is not an engineer, despite the connotations of his current title at Verizon — he is a businessman and for investors in Verizon stock he is a wild card.

FiOS buildout nearly complete? Not a chance.

Verizon slowed the expansion of fiber to the home in the past few years after a very expensive buildout was completed across several markets in 2011. However, the number of homes passed with their FiOS network is still growing about 4% per annum and totaled nearly 15 million at the end of 2017.

We think the ultimate number of homes served with fiber optic or wireless Internet connections could be nearly 10x that amount, or more than 140 million by the early 2030s. The advent of 5G wireless networks (and eventually 6G, etc.) will create another new dynamic in communications markets — dense fiber networks. Once VZ’s 5G wireless network is fully built out by the middle to latter part of the 2020s, wireless companies increasingly will be in a position to compete with traditional wireline providers of Internet service. In its existing wireline markets, VZ will either need to connect to homes by extending fiber all the way or by using wireless spectrum. In the longer run, we expect two or (more likely) three national broadband providers. The largest wireless players (VZ, AT&T (NYSE:T), T-Mobile (NASDAQ:TMUS)/Sprint (NYSE:S)) are likely to be in the best position to consolidate the wireline industry given a preexisting nationwide footprint.

This implies that VZ’s long-run Internet service market share could range from one third to one half and serve more than 45 million households by about 2030.

Wireless market share has one way to go — UP.

That may sound crazy given that VZ has ceded roughly a percentage point of market share over the past three years as aggressive pricing by T-Mobile and Sprint has drawn away some of VZ’s lower-end subscribers. It seems even crazier when you consider that VZ’s market share (approximately 29% in 2018) has been maintained with network superiority, which will get increasingly difficult with each new generation of technology, particularly as service levels reach “good enough” for a higher percentage of users.

However, it has been clear for years that no more than two or three national facilities-based wireless networks are able to earn their cost of capital. Regardless of the marketing schemes dreamed up by T-Mobile and Sprint (separate or together), we expect three ultimate survivors that will split the market among them. In the longer run, we expect VZ’s market share to approach 33%, implying a modest runway of growth yet despite an industry that has reached a saturation point (at least with connecting humans, machines may be a different story).

Dividend investors should continue to own VZ shares, but keep an eye on Vestberg’s strategy as it comes into view

Based upon our detailed valuation model (available here at our Better Retirement Investing marketplace), we estimate that VZ is worth $44 if they are able to 1) maintain their current share of Internet subscribers as they expand their footprint, 2) improve their wireless market share over time, and 3) don’t make too many value destructive acquisitions. The company is well positioned to be one of only two or three national providers of Internet services in all forms.

Although we see limited upside to the current share price, the company’s dividend is well covered even with the capital investment needed to build out 5G and continue extending FiOS services. Our free cash flow projections exceed the current dividend by at least 25% over the next five years, creating modest room for additional dividend increases. VZ and its nearly 5% dividend yield has a place in any dividend-hungry investor’s portfolio. However, our opinion is contingent upon the new CEO adopting a strategy that maintains or enhances the company’s value. We will be carefully monitoring his words and especially his actions to see if our thesis remains justified.

Disclosure: I/we 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.