It is the holiday season and I don’t have to tell you that the best part of the season is the plethora of discounts and promotional offers available. Well, in a bid to stay true to the holiday season charm, telecom services provider Verizon (VZ, Financial) has also resorted to discounts and other offers. While this is a great news for customers, Verizon’s investors might not be particularly thrilled about these price promotions. The company recently said that the wireless margins will be hurting from the heavy discounts offered by phone contracts, even as the number of subscribers have gone up.
Some unfavorable dataÂ
As this Bloomberg article points out, the price wars have eroded the margins of top US wireless carriers as each of them is trying to fend off completion from cut-throat pricing policies adopted by other players. In the third quarter of 2014, Verizon’s shares dipped slightly after the wireless giant failed to meet Street estimate on earnings. However, it reported a double-digit revenue growth over healthy demand for broadband and wireless services. Though Verizon missed the estimate by a whisker yet it is a worrisome for investors because the margins are continuously taking a hit due to severe competitive pressure. In a bid to beef up subscriber base, the top telecom giants are embarking on extensive price-cut strategies, which is narrowing their margins.
In November, Verizon shares were downgraded by Citigroup analyst Michael Rollins after citing an increase in the spectrum prices. As per the analyst, the price being paid by the company for the spectrum auctioned by FCC was approximately 36 percent higher than estimates. Owing to this downgrade, AT&T (T, Financial) and Sprint’s (S, Financial) stock prices were also adversely affected. While I will talk on the competition in the later part of this article, the reason I brought up the downgrade news is to highlight that the stock is in fact, trading below the price level of $51 as estimated by Mr Rollins. However, it does not necessarily imply that the stock will slide further and in my opinion, $46- $47 should provide the support level for the stock price.
Considering that this pull-back has been generous, it could well be a lucrative time to enter the stock. Fundamental data is showing that Verizon’s wireless business growth and 4G device adoption is going to come in strong in the ensuing quarter. As per data, the strong demand for 4G smartphones and tablets is driving higher customer addition. Also, the percentage of customers choosing the Verizon Edge equipment plan installation is tracking at 24 percent, which is approximately double the rate in prior year period. Agreeably, the overall margins are going to be hurt but I am quite bullish on the volume growth in this segment owing to strong demand and Verizon’s innovative Edge offering.
Competition: A focus area
While announcing heavy discounts, Verizon mentioned that the reason behind doing so is to protect its subscriber base from competitors including Sprint and AT&T. Of these top three players, Sprint has been having a rougher time maintaining its bottom line growth, as was also seen in its third-quarter results. In the earnings call, Sprint’s CEO Marcelo Claure announced a loss of 500,000 post-paid phone connections during the quarter that ended Sept. 30. This number is down from a loss of 620,000 in the second quarter and 693,000 in the first quarter. In a way, Sprint has improved but still, considerable work needs to be done by the company to maintain its third position ahead of T-Mobile.
As a matter of fact, the bold offer made by Sprint to Verizon’s and AT&T’s customers to cut half-off their monthly bills if they switch, is an aggressive attempt by the company to expand its subscriber base. One important thing to note is that Sprint’s offer is only to customers with the Top 2 carriers and that is a sort of a public declaration by the company that it is not attempting to court T-Mobile’s subscribers. This somehow signals that the company is confident of successfully maintaining its 3rd position in the market.
Coming to AT&T, it is a telecom giant that serves hot competition to Verizon and makes it difficult for an investor as well to pick one of them. With a dividend yield that is to the north of 5 percent and almost similar to Verizon, AT&T is also trading at a similar forward multiple of around 12. Mr Bob Ciura takes up this issue in his article “Why Dividend Growth Investors Should Buy Verizon Instead Of AT&T Or Sprint” as he highlights metrics like revenue growth, price appreciation and Balance Sheet strength to table his point across.
While Mr Ciura has offered a clear winner on certain parameters, I would want to make an addition to the Verizon’s mighty tale. One of the reasons that Verizon scores well over AT&T is because of its robust wireless services, which is heavily propagated because of favourable demand for smartphones and tablets. In fact, AT&T’s tablet additions have lagged Verizon’s number by a wide margin and now that the latter has also entered the price wars, it should be able to maintain its jaw-dropping lead in this segment. Therefore, investors should be confident that the price wars will not hamper Verizon’s position in the market as was seeming earlier.
Takeaway
As I mentioned above, I am quite bullish on Verizon’s prospects because of its strong position in broadband and wireless segment including 4G network. The demand for 4G smartphones and tablets is expected to stay strong in coming quarters and therefore, it will be beneficial for the company. Apart from the wireless business, Verizon is also doing extremely well in the wireline business and is expected to hit its EBITDA margin target in fiscal 2014. Hence, Verizon is a smart pick in the telecom industry because of its leader status and sustainability in most business segments.
