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Verizon: An Attractive Long-Term Play

April 23, 2012 | About:
Verizon (VZ) has just announced its results for the first quarter of 2012 and the salient features were revenues and earnings which were slightly above expectations and the addition of significantly fewer new customers.

Profit was $1.69 billion which amounts to $0.59 per share (both up from $1.44 billion and $0.51 per share in the same quarter of the previous year. Revenue was up 4.6% to $28.2 billion. The average consensus among analysts was an EPS of $0.58 per share on total revenues of $28.17 billion. Verizon Wireless (which is a joint venture with Vodafone) added just over 500,000 customers, down 58% over the previous quarter and iPhone sales were down 26% to 3.2 million phones.

Verizon, like rivals AT&T (T) and Sprint-Nextel (S), has been spending large amounts of money building the next generation high-speed broadband mobile networks 4G LTE with the expectation of attracting new customers and boosting sales of mobile phones. It should be kept in mind the iPhone is not yet compatible with these networks and these are the largest-selling smart phones in the world. Despite this, there is some progress because the company managed to increase from 5% to 9% the number of contract customers using devices compatible with the new network and expects to continue successful penetration.

The traditional fixed-line business continues to shrink as customers switch from traditional telephones to mobile phones. Operating revenues from the fixed-line business dropped by 2% to $9.9 billion. Negotiations continued to take place with the fixed-line business employees' unions. Some 45,000 employees walked out for two weeks last August in protest against concessions that the company was seeking from them. Verizon also announced that it will expand the trial markets for the partnership that it has with Comcast (CMCSA) and Time Warner Cable (TWC) in an attempt to cross sell the services of all the participants.

And in a separate development, Verizon Wireless has made an offer to sell some of its 700 MHz spectrum if the regulators approve its proposed purchase of spectrum from a group of cable TV companies estimated at $3.9 billion. This acquisition has been resisted by some rivals as well as watchdog groups on the grounds that Verizon would wield too much power in the market. The company says that it has no use for this spectrum because it prefers to develop its 4G LTE networks on the spectrum that it is proposing to buy from the cable TV companies. Analysts estimate that the sale could fetch in the region of $4 billion.

What are the implications of these results both for Verizon and the industry as a whole? You would recall that in the previous quarter Verizon had record revenues on the back of the iPhone 4S though operating margins dropped by 10% because of the upfront subsidy payments to Apple (AAPL). For the first quarter of 2012, revenues only rose by a modest margin but EPS has improved by 16%. The company still sells a substantial number of subsidized smart phones but margins are back on track. Obviously, I think that this shows that increased fees from users are starting to offset subsidies, which of course was the rationale behind subsidies in the first place. Almost half of Verizon's customers now use smart phones and their main competitors including Sprint are expected to show similar figures. Does this mean that the market is oversaturated? The spectacular success of the new Apple iPhone suggests that this is far from being the case. The new high-speed 40 broadband networks will continue to boost user fees and I suspect that Apple will be forced to conform to the new services.

Verizon has a few strengths that provide a good platform for long-term and profitable growth. In the first place, and they provide some services that are overlooked by other telecommunication service providers. Secondly, the fragmented nature of the telecommunication industry means that they can grow their market share even if overall industry growth is moderate. There are a few weaknesses that may limit growth prospects. They are competing against better established companies such as AT&T, Sprint, and MCI. Also, the rapid changes in technology in the industry require large investments as well as the nimbleness to keep pace with development. For instance, AT&T appears to have done a better job in keeping up with the explosion in the sales of tablets and they are the only service provider to offer the Samsung Galaxy.

This is clearly a time of rapid transition in the wireless communications industry and the number of players including Verizon are spending money upfront (such as the subsidies on smart phones) in the expectation that the rapid penetration in the market as well as the increased user fees that should be available should establish them as forces to reckon with. When you combine this with the potential of the new 4G networks, I consider it entirely possible that these subsidies could be dispensed with in the course of time and the power to generate profits and cash could well shift from the device makers such as Apple and Samsung. There are early indications that we are seeing a shift in the balance of power. Without the boost of holiday season sales in the first quarter of this year, the company has done well in boosting free cash flow.

The hefty dividend that the company pays is safe for many years to come and you could see an increase if things turn out in their favor. If you have an existing investment position in Verizon, I would strongly recommend at least a hold if you are not yet tempted to make a further investment. I would watch the developments within the industry very closely because downturns in the stock price of Verizon would make for very attractive buying opportunities indeed.

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