Verizon: An Overpriced Telecom To Avoid

| About: Verizon Communications (VZ)

Verizon (NYSE:VZ) is the nation's second biggest wireless carrier with 94.2 million subscribers. Only AT&T (NYSE:T) has more at 105.2 million. Sprint Nextel (NYSE:S) lags behind at 56 million subscribers. Verizon shareholders have enjoyed an unending string of success. Unlike Sprint's shareholders, they don't hear talk about a buyout. Verizon is seeing record-high margins that are supported by strong revenues. But there are reasons to be bearish on Verizon. Based on valuation, the stock does not look attractive. Analyst downgrades, and more importantly, network issues could also negatively impact the stock in the coming weeks and months.

The second quarterly report this week stated that Verizon's wireless segment posted accelerated growth in consumer revenues. Verizon recorded 56 cents in earnings per share (EPS) in third quarter 2012, an increase of 14.3% compared with third quarter 2011 earnings of 49 cents per share. Verizon has a price-to-earnings ratio of 41.38, more attractive than AT&T's at 47.08. Its adjusted third quarter 2012 earnings (non-GAAP) of 64 cents per share exclude 8 cents per share for charges related to patent litigation settlements. Comparable adjusted third-quarter 2011 earnings of 56 cents per share excluded 7 cents per share for a non-operational charge related to valuation of pension plans.

In the third quarter, Verizon delivered double-digit earnings growth and strong cash flow. According to Lowell McAdam, its CEO, Verizon remains on track to meet its financial objectives of the year. Its wireless division achieved record profitability in a quarter in which it reported the highest number of retail postpaid gross and net ads in four years.

Based on the strength of Verizon's fiber optic network, it reported the highest growth in U.S. consumer wire line revenues in 10 years. Strategic growth in its Enterprise business helped offset weaker revenue caused by global economic challenges. According to McAdam, Verizon is confident that it has the right plans in place to meet its challenges and improve its long-term profitability in both consumer and enterprise.

Earlier in the week, Verizon announced that it will launch its 4G LTE service next week, surpassing its previously announced goal of providing its blazingly fast, mobile broadband services in 400 markets by the end of the year. The company held celebrations with customers and others to mark the milestone. A report stated more than 245 million people throughout the U.S. will have access to the Verizon Wireless LTE with the new and expanded market. Nearly 11 million customers were on the network at the end of the second quarter, and more than 35% of Verizon's data traffic is carried out on it.

Despite the record of Verizon's success, I think Verizon is far from perfect. On September 13th, Christopher King, a Stifel Nicolaus analyst, cut his rating to hold Verizon, trimming estimates for the company. He argued Verizon could be used as a near-term source of funds for investors as the QE3/risk-on-trade becomes more prevalent. He put 2012 profits at $2.45 a share, down from his former prediction of $2.51. For 2013, his new forecast is $2.78, down from $2.81.

Verizon touts its 4G LTE as the nation's largest and most reliable, but it looks like something fragile that could fail at the drop of a hat. For example, many Verizon users over the past few months have been unable to use their mobile devices to connect to the web. The outage appears to affect Verizon's 4G network. Any smartphone, tablet, or mobile hotspot user could be affected. The outage means that the data connections are not reliable and cut out.

Recently, Clearwire joined the RCA, The Competitive Carriers Association, and raised concern over the market power of Verizon and AT&T. In comments filed last month with the Federal Communications Commission, RCA urged the agency to take action to improve competition in the wireless business, saying the dominance of Verizon and AT&T was getting worse. Verizon, which wants the FCC to approve its acquisition a of radio spectrum license from Comcast (NASDAQ:CMCSA), disagreed with RCA.

T-Mobile also opposes Verizon's ambition to buy spectrum from a joint venture made up of Bright House Networks, Time Warner Cable, and Comcast. To prevent the FCC from approving Verizon's application, it challenged Verizon's claim that it is the most efficient user of radio spectrum.

Sprint still has a lot of stake in the wireless business. The beleaguered carrier has success selling iPhone on its network. It is not clear whether it was successful in luring customers away from Verizon and AT&T. But it has a unique selling point - unlike Verizon, it has unlimited data plans for its line of smartphones.

In order to deliver high-speed internet access from its 4G LTE network, Verizon is challenging Charter (NASDAQ:CHTR), AT&T and other broadband providers with a new Home Fusion Wireless service that will rely on large antennas attached to homes to deliver high speed internet access. The move will sharpen Verizon's competition with others, fanning the flames of a rivalry that is already fierce.

I think Verizon's current share price around $44 is too high. While Sprint's price-to-sales ratio is at 0.49, it is trading around $6. Verizon's price-to-sales ratio at 1.12 is not attractive. The price-to-earnings ratio of Verizon is 41.38, which is in line with the industry average at 41.20.

Sprint has the cheapest share price among the three wireless giants. However, it has just sold 70% of its shares to Japan's Softbank. Verizon and AT&T are expensive, but they are the leaders in the wireless sector and are financially stable based on their revenue.

I still think investors should shy away from Verizon for the time being. Those who cannot be talked out of speculating should consider other alternatives in the telecom sector.

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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