- Verizon's stock has been the worst-performing among its competitors, but price increases have helped drive wireless service revenue growth.
- The company has struggled to increase customer growth, losing customers to competitors like T-Mobile and cable companies.
- Verizon's recently cleared C-band spectrum will help it compete in wireless and Fixed Wireless Access offerings.
- We believe that the dividend is not at risk. Capex is coming down to the BAU levels. Verizon possibly has more room to deleverage.
- Shares are trading at a decade-low, with 7x forward P/E and 8% yield. Maintain BUY.
Struggling to Increase Customer Growth, But Pricing Actions Come to Rescue
Verizon (NYSE:VZ) has been the worst-performing stock among the big three. Since last year, Verizon is down 18%, AT&T (T) has fallen 8%, while T-Mobile (TMUS) remains flat. Verizon is now trading at a decade-low, and the dividend yield is approaching 8%.
So, what are the reasons? In 2Q23, the company reported 8,000 postpaid phone net adds, far below its competitors such as T-Mobile (760,000) and AT&T (326,000). Worse, on the consumer side, Verizon lost 136,000 customers during the quarter. This marks the fifth consumer postpaid phone net loss out of the last six quarters.
This was caused by pricing actions taken by Verizon and intense competition, especially from T-Mobile and cable companies. Big cable companies, such as Charter (CHTR) and Comcast (CMCSA) under Spectrum and Xfinity, add roughly 650,000 and 350,000 per quarter, respectively, as they have been aggressive in their pricing strategies. Further, Verizon’s postpaid phone churn rate was the highest among the big three.
Verizon’s management said this on the 2Q22 earnings call, citing "competitive offerings" to have impacted gross adds:
First, churn increased by 10 basis points compared to the same period last year. Higher involuntary churn contributed roughly half of the increase due to the expiration of state consumer protection policies and less stimulus funding. This was coupled with an 11% decline in phone gross adds from the prior year, driven by the competitive offerings in the marketplace.
And in the following quarter, the management attributed the net loss to the pricing actions it took:
As expected, the pricing actions we took around administrative fees and metered plans led to an increase in disconnects. With certain price-ups being phased in throughout the third quarter, we would anticipate some disconnect pressure to carry over into Q4.
Yet, partly because of those price increases, Verizon grew its wireless service revenue. It rose 3.8% (Y/Y) in 2Q23. Additionally, consumer postpaid ARPA increased 6% (Y/Y), as the company said that the recently launched myPlan drove “a significantly higher premium mix,” with about 70% of those customers taking the Unlimited Plus option.
The industry is still highly competitive, but players have gradually increased their prices and encouraged their subscribers to upgrade to premium plans. Figure 6 shows how AT&T’s ARPU has increased in the last few quarters. In addition, T-Mobile launched the Go5G and Go5G Plus plans, which are pricier than Magenta. When asked about a price increase in its high-speed internet offering, T-Mobile’s management did not rule out such a possibility. Indeed, after such a massive 5G buildout that required billions of dollars, those investments must economically make sense.
For instance, when asked whether price increases have become the industry norm, AT&T’s management answered:
Why wouldn't they? In your average life, prices go up. And this is about as critical a service as anything right now given how we all live. And so why wouldn't prices go up. Especially, we are providing more bandwidth each and every year. So, it's not like the consumer is not getting a great deal because we are giving them more each year and we should be able to price up for that.
Furthermore, Verizon raised its legacy Unlimited postpaid plan by $3 and $5 for those on the Basic postpaid plan, on top of the $10 increase on the wireless home internet offering. Looking forward, the company anticipates a significant portion of its growth will be driven by price increases. As the management said:
We've, historically, last couple of quarters, relied extensively on price to get to our service revenue number. We know, Tony and I talk a lot about it, we want to get to a more balanced 80-20 approach to price and quantity. So, we are going to grow our quantity number on phone net adds in an equal way.
Got A Much-Needed Help From the Recently Cleared C-band Spectrum
But how can Verizon drive its customer growth? Indeed, postpaid phone net losses have been narrowing on the consumer side, but it was not enough, especially as the company expects to get 35% of the 5 to 6 million of “normalized” postpaid phone net add per year. That is about 2 million net adds per year.
Our take is that the remaining C-band spectrum that was recently cleared will help Verizon better compete with its competitors at regaining its net adds. The company stated that in C-band markets, churn was lower and premium mix was higher. Previously, the company only deployed an average 60 MHz of C-band spectrum. Now, it can fully deploy an average of 161 MHz in 406 markets. Verizon aims to cover 250 million POPs with C-band next year, although the figure remains lower than 300 million POPs mid-band coverage target by T-Mobile by the end of this year.
We are very happy with, a, the deployment of C-band, but more importantly, the customer experience that comes with it. Important metrics that I track on a weekly basis is churn in C-band versus non-C-band markets. We tend to do much better, lower churn in C-band markets. So that's a good win for us. The second is premium mix. We get almost a 10% better premium mix in C-band markets. So more revenue, less churn, makes for a very happy business case.
And a substantial portion of those spectrum licenses is in suburban and rural areas. In our view, this will enable Verizon to compete with T-Mobile in Fixed Wireless Access (FWA), given that almost 50% of T-Mobile’s subscribers are from suburban and rural areas, according to OpenSignal. Please note that Verizon has not yet extensively expanded its presence in those areas. On the contrary, T-Mobile still has not received the 2.5 GHz spectrum, mostly in rural areas, that the company purchased in Auction 108.
Also, just as we said on the last article:
On the other hand, a study, which is limited only to the mmWave service, suggests that VZ’s Ultra-Wideband FWA subs skewed towards urban. This makes sense since the mmWave band spectrum should be active in highly dense areas. Thus, its mid-band footprint expansion in rural areas could provide VZ with a competitive advantage, in our view.
Dividend Is Not At Risk
Yet, a billion-dollar question remains: Can dividends be maintained? Another argument is that there is no clear plan from Verizon to pay down its debt. In 2Q23, Verizon generated $5.6 billion free cash flow. Cumulatively, FCF was $8 billion, which implies a 47% run rate to the full year target of $17 billion. Please note that a $4.5 billion one-time payment to satellite companies is coming up.
Verizon’s management has made it clear about its priorities: 1) business investment, 2) dividends, 3) deleveraging, and 4) share buybacks. Indeed, Verizon’s balance sheet is loaded with debt. As of 1H23, net debt was $148 billion (~3x net debt to adjusted EBITDA), far higher than $109 billion in 2019 (2.3x net debt to adjusted EBITDA). But this was required for 5G network buildout and spectrum acquisition to compete with T-Mobile.
Next year, the high capex cycle will be over. Capex will be down to the BAU levels of $17 billion to $17.5 billion, which has included the new C-band deployment. Assuming a $36 billion operating cash flow, we will arrive at around $19 billion of free cash flow next year. After $11 billion in dividends, Verizon should have $8 billion a year for deleveraging, if they decide to deleverage. And not to mention the management’s target of $2-3 billion annual cost savings by 2025.
If our math is correct, Verizon can deleverage its balance sheet by a total of $40 billion in the next five years before we might see another high capex cycle for the upcoming 6G. Indeed, analysts have said that spending for 5G could increase next year to keep up with data consumption, but analysts at TD Cowen argued that this spending “will still be modestly below 2023”. Hence, we conclude that the dividend is not at risk, and Verizon should have more room to deleverage.
Verizon is trading at 6x forward EV/EBITDA and 7x forward P/E, lower than the multiples' average. The market is expecting a top-line growth of 1%, whereas the company’s historical growth rate is around 2% per year. Analysts price target stands at $41, on average, which implies a 23% upside. In our view, this presents a buying opportunity with a potential upside and an 8% yield.
Shares have been punished by the market, given that Verizon is losing customers on the consumer side. Still, the company was able to growth its wireless service revenue thanks to price increases. Additionally, we think that its recently cleared C-band spectrum will help Verizon compete with its competitors in wireless and FWA offerings. And once cable's promotional period comes to an end, some will stick, but there will be churn going on, in our view.
No, we do not think that dividend is at risk. Free cash flow should be higher next year given lower Capex requirements. True, spending for 5G could increase next year, but it is unlikely to exceed the spending in 2023, according to analysts. This should give more room for Verizon to deleverage, at least until we see another transition from 5G to 6G. Shares are now trading at a decade low. Maintain BUY. If you have any thoughts, please do not hesitate to comment below.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of VZ, CHTR either through stock ownership, options, or other derivatives. 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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