The quote above sums up our investment thesis for Verizon (VZ). We received shares in Verizon as part of Verizon’s deal to buy the rest of Verizon Wireless from Vodafone (VOD), one of our existing holdings. We had to decide whether to sell our shares, keep them, or possibly add to them. After thoroughly researching Verizon, we have decided to add to our holdings.
Our reasoning is fairly simple: Verizon along with the other major telecom companies operate as a de facto monopoly in the US telecommunications market.
First, let’s talk about the state of the telecom market in the US. It’s awful. Plain and simple. The US pays some of the highest prices for the lowest speeds in the world when it comes to mobile and broadband access. Compared to the rest of the world we rank from 15th to well past 30th when it comes to mobile and broadband access.
We also hold the inglorious distinction of paying the most for the least amount of service. According to a 2013 report by the New America Foundation, the best US deal for high speed broadband internet access is almost three times as expensive (per Mbps) as the average international plan. The best deal for mobile data in the US is about twice as expensive (per GB) as the average international plan.
It’s pretty clear no matter how you torture the numbers that the US service is terrible. (Even the chief apologists for the telecom industry can’t massage the numbers enough to get us any higher than about 10th in the rankings.) The question is why. Is it because the US telecom market is an anti-competitive oligopoly ruled by a few firms (Verizon, AT&T, Comcast, and Time Warner)? Or is it because, as the telecoms and their hired spokesman claim, the population in the US is so geographically dispersed and therefore not comparable to other developed nations?
The US Telecom Market is an Oligopoly
We can answer that question very easily by looking at the financial accounts of the US telecoms. We will concentrate on Verizon specifically, but I assure you that the others are similar, compared to foreign telecom companies.
The first claim we should test is whether or not the geographic dispersion of the US population plays a significant role. If the claim is true, then we should see Verizon with higher capital expenditures (meaning Verizon has to install more fiber lines, switching equipment, cell towers, etc.) than comparable developed market telecom companies.
Below is the data (via Morningstar) we used for comparison. The companies are Orange (France), British Telecom (BT), Deutsche Telekom (ticker:DTEGY, Germany, also owns part of T-Mobile in the US), Telecom Italia (Italy), Vodafone (ticker:VOD, England), SK Telecom (ticker:SKM, South Korea), KT Corp (South Korea), and NTT DoCoMo (ticker:DCM, Japan). We looked at the average capital expenditures over the last five years as a percent of revenue.
Verizon under-spent European telecom companies by almost a full percent (82 basis points).
While that may not sound like much, remember it is a percentage of revenue. Verizon earned over $120B in revenue in its latest fiscal year, so .82% of $120B is $988M. Imagine if Verizon had been spending an extra billion dollars each year for the past five years on more equipment. That’s an awful lot of 4G cell towers and fiber optic cable that they could have laid. Clearly, Verizon is not spending extra money building infrastructure because the US has some sort of particular geographic problem compared to other developed nations.
The final nail in the coffin of the special geography argument is below. It’s a population density map of the US. The US does not have a spread-out population; everyone lives along the coasts, the Great Lakes, or major waterways.
Below is a population density map of Europe.
Europe’s density looks similar; most people live along the coasts and major waterways. People cluster around the same geographic features no matter their country because that is how human civilization works.
The next question we looked at is pricing. Are prices in the US higher due to the telecom oligopoly or some other reason? Again, we compared Verizon to the same group of international companies, but this time by looking at the companies’ operating profit margins.
Here we see the truth. Verizon’s operating profit margin is almost four percentage points greater than comparable foreign companies. That means Verizon is earning almost $4B ($3.978B) per year in profit more than it might earn in a more competitive market. Part of this increased profit, around $1B, is due to lower capital expenditures. The rest is due to the higher prices Verizon is able to charge.
We can also see this in how the communications market in the US behaves. In almost all developed markets, average revenue per user is being driven down by competition. But in the US, we see the opposite. As the chart below shows, over the past four years Verizon’s ARPU numbers have been heading up.
Verizon Average Revenue per User (ARPU)*
*Figures are revenue per year. Data uses total customers for wireless and total connections for wireline computed by averaging current year and previous year user figures.
In the rest of the developed world, the opposite is happening. The chart below shows ARPU for several major European mobile markets. It also includes the US market, which shows slightly declining ARPU. This is likely due to exchange-rate fluctuations (the chart is presented in Euros rather than dollars) and decreases in price by second and third-tier carriers rather than Verizon or AT&T.
The financial accounts of Verizon demonstrate that it has superior economics compared to international peers due to the oligopolistic nature of the US telecom market.
The important question now isn’t whether or not the large US telecom earns monopoly-level profits; the question is how long can that continue.
The Obama administration has a horrible record when it comes to regulating and policing corporate America. It has basically been open season on anti-competitive and illegal behavior by corporations under Obama (although he is simply continuing the same behavior as Reagan, both Bushes, and Clinton). The problems have been decades in the making and are likely to be decades in the fixing.
The chief regulator for the telecom industry is the Federal Communications Commission (FCC). The head of the FCC, appointed by Obama, is Tom Wheeler, a former telecom industry lobbyist. It is absolutely insane to think an industry lobbyist will be able to effectively regulate.
To show just how effective Verizon (and other telecoms) are at keeping markets uncompetitive and extracting revenues from users, I’ll leave you with this story.
In the case of New Jersey, Verizon was allowed to tack on special surcharges to customer bills starting in 1993, bringing in $15B, in exchange for the promise of providing FiOS (fiber optic cable) service to the entire state by 2010. That hasn’t happened. Instead, only about two-thirds of the state has FiOS available. Verizon is now actively lobbying to back out of the deal (without returning any money!).
Disclosure: Long Verizon, AT&T, Comcast, Vodafone