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Verizon trades at a fairly low cash flow multiple and high dividend yield given their strong competitive position in the concentrated US mobile market. Now that they own all of Verizon Wireless, is the market underestimating potential earnings growth and giving them too low a multiple?

 

VZW has built a reputation for having the largest and fastest national network, edging out AT&T according to many observers. Sprint and T-Mobile are further behind and have to compete on price instead of quality.

http://bgr.com/2014/03/05/verizon-vs-att-coverage-map/

 

Between VZW and FiOS, it looks like earnings growth over the next few years should be over 10%, possibly approaching 15%.

 

http://www.cedmagazine.com/news/2014/01/verizon-well-nab-share-by-revving-fios-data-speeds

 

As a boring $196B blue chip it may not keep up with a bull market. But if the market is turning more bearish, VZ and T would be natural defensive plays.

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^^Even after you add the pension plan to EV? IIRC, there's about 40B in pension liabilities for each.

 

VZ's pension plan is only underfunded by around $4B and falling, but the healthcare plan is underfunded by $25B. Apparently there's no mechanism which forces them to contribute more to healthcare, so they can just pay as they go.

 

http://blogs.wsj.com/cfo/2013/07/18/verizon-pension-gets-boost-from-rising-rates/

http://www.icyte.com/system/snapshots/fs1/5/7/f/6/57f6b8b63d11e7193bac893db2d1b18e16255ad5/index.html

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this could be a value trap - pending industry changes due to Tmobile/Softbank, tailwind from smartphone upgrades is near ending, etc

 

What's new about the T-Mobile and Sprint approach? Sprint has more financial muscle now but they are still offering worse service for less price, the same strategy that has failed shareholders over the last 10 years. It's not disruptive.

 

http://media.ycharts.com/charts/6ecaea6b502bb0ae81bd8584b2b2a295.png

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As the smartphone upgrade cycle lengthens it will be bad news for Apple and Samsung but not that bad for Verizon and AT&T. Because of the subsidy model, their profits aren't particularly tied to upgrades. I don't see why that would prevent VZ and T from continuing to adjust their pricing to optimize profitable market share relative to S and TMUS.

 

Tablet growth (and maybe automotive and wearable growth in the future) also makes up for slowing smartphone device growth.

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tailwind from smartphone upgrades is near ending, etc

 

 

nah...they make their money from subscriptions, not phone upgrades. A slow down in phone upgrades will probably benefit them as they'd have to spend less subsidizing phones. People sticking with Verizon and not upgrading their phone for 3-4 years is great for Verizon.

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tailwind from smartphone upgrades is near ending, etc

 

 

nah...they make their money from subscriptions, not phone upgrades. A slow down in phone upgrades will probably benefit them as they'd have to spend less subsidizing phones. People sticking with Verizon and not upgrading their phone for 3-4 years is great for Verizon.

As the smartphone upgrade cycle lengthens it will be bad news for Apple and Samsung but not that bad for Verizon and AT&T. Because of the subsidy model, their profits aren't particularly tied to upgrades. I don't see why that would prevent VZ and T from continuing to adjust their pricing to optimize profitable market share relative to S and TMUS.

 

Tablet growth (and maybe automotive and wearable growth in the future) also makes up for slowing smartphone device growth.

 

Smartphone plans have higher ARPU than regular plans. They have been offsetting declines in voice and text usages in the last several years. Once the number of smartphone subscribers stabilizes, you lose this benefit. This is an industry wide trend and hurts all carriers. Prior to 2013, the four carriers have a cozy oligopolistic relationship. They largely do not compete on prices. Tmobile broke rank this year and started offering cheaper/unbundle plans. In Japan, in order to reach scale, Softbank has increased its market share by aggressively lowering prices. It was able to do this by extreme cost control and squeezing its suppliers (goodbye European/US telecom equipment providers, hello Chinese providers). Softbank wants to replicate this model with Sprint and hopefully T Mobile. 

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^^Even after you add the pension plan to EV? IIRC, there's about 40B in pension liabilities for each.

 

VZ's pension plan is only underfunded by around $4B and falling, but the healthcare plan is underfunded by $25B. Apparently there's no mechanism which forces them to contribute more to healthcare, so they can just pay as they go.

 

http://blogs.wsj.com/cfo/2013/07/18/verizon-pension-gets-boost-from-rising-rates/

http://www.icyte.com/system/snapshots/fs1/5/7/f/6/57f6b8b63d11e7193bac893db2d1b18e16255ad5/index.html

 

Very interesting....I may have to look at it along with AT&T again. That being said though, even if they are not forced to contribute more, shouldn't it still be considered a liability? Unless you mean that they are not required to meet that obligation?

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^^Even after you add the pension plan to EV? IIRC, there's about 40B in pension liabilities for each.

 

VZ's pension plan is only underfunded by around $4B and falling, but the healthcare plan is underfunded by $25B. Apparently there's no mechanism which forces them to contribute more to healthcare, so they can just pay as they go.

 

http://blogs.wsj.com/cfo/2013/07/18/verizon-pension-gets-boost-from-rising-rates/

http://www.icyte.com/system/snapshots/fs1/5/7/f/6/57f6b8b63d11e7193bac893db2d1b18e16255ad5/index.html

 

Very interesting....I may have to look at it along with AT&T again. That being said though, even if they are not forced to contribute more, shouldn't it still be considered a liability? Unless you mean that they are not required to meet that obligation?

 

Yes underfunded healthcare is a liability, but it's a relatively good liability with a low implied interest rate (like insurance float). An underfunded pension has a higher implied interest rate since it requires cash contributions up front.

 

On the other hand the liability is a pretty rough estimate. It is sensitive to interest rate / discount rate, and also the assumed rate of healthcare cost growth.

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  • 3 months later...

Has anyone looked into the capex spending by AT&T, VZ, Sprint and T-Mobile? VZ is leading the pack by far and the aggregate amount is increasing each year. What’s more interesting is that the capex% to revenue for VZ is decreasing… the same can’t be said for the other competitors. This seems like a runaway effect. Constantly boost tech capabilities and take more market share because of better networks. Sprint and T-Mobile have to spend even greater amounts of their cash flow just to stay in the same position. I just don't see how the marginal players survive another upgrade cycle... VZ will have the lion share of the profits of the industry.

 

This looks like a solid duopoly in the making with AT&T, but I’m on the fence about their pension and healthcare liabilities.

 

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Capex was also higher over the past few years due to the roll out of FIOS in the wireline division.  Now that the roll out is effectively complete they have indicated that capex should remain flat to down slightly in total.  I think it's supposed to be around $16-$17bn in 2014 which is the same as last year and down from $17+ before that.  This is one where FCF is higher than earnings.

 

I think the one thing to watch out for though is the spend on spectrum.  They are participating in the auction later this year and while they have plenty of spectrum right now, they will ultimately need more and that could be a multi-billion $ purchase.

 

Alternatively, they admit they have been talking with Ergen at Dish to acquire some of his excess spectrum although I'm not sure how contiguous that is and what the cost to implement it might be.

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  • 4 months later...

http://www.verizon.com/about/investors/citi-2015-global-internet-media-telecommunications-conference/

 

Some quotes that I found relevant:

 

"Well, there's really two aspects of that. First from the network side, this reminds me of the days of voice and then the days of SMS and now the days

of data where if you look at the top-line price, it looks like things are going down but the costs are going down equally so you can maintain some

profitability.Just as the example, when we went from 3G to 4G, our efficiency of the network went up by 8 times. So you can take a pretty significant price cut

and your costs are dropping at the same level. "

 

" people like to take a very complicated industry and say, well, it's like the number of cell sites is what is going to

be the thing that makes somebody competitive over the long term. As an engineer, I wish things were that simple. They are not.

 

"You really have to look at the technologies that are available, the spectrum that you have, the geographies that you cover. We built our network

on CDMA, which didn't require the density of cell sites. Now the technology is such that you go in with these distributed antenna systems, which

can go in very quickly, very inexpensively, and can fill in that under the large umbrella sites.

So it's actually a lot cheaper for us to have the network that we've got than it is the ones who have these large towers, these lattice and monopole

macro sites that are out there. So the technology has moved our direction and the spectrum that we have -- if we had all AWS or all PCS you would

have to have factors of 2 or more cell sites than we have.Our network spectrum portfolio is based around 700 and 850 with AWS and PCS deployed just for capacity. So I would argue that our network architecture allows us to have the lowest cost structure out there and the technology going forward will allow us to keep that lowest cost structure.

"

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http://www.verizon.com/about/investors/citi-2015-global-internet-media-telecommunications-conference/

 

Some quotes that I found relevant:

 

"Well, there's really two aspects of that. First from the network side, this reminds me of the days of voice and then the days of SMS and now the days

of data where if you look at the top-line price, it looks like things are going down but the costs are going down equally so you can maintain some

profitability.Just as the example, when we went from 3G to 4G, our efficiency of the network went up by 8 times. So you can take a pretty significant price cut

and your costs are dropping at the same level. "

 

" people like to take a very complicated industry and say, well, it's like the number of cell sites is what is going to

be the thing that makes somebody competitive over the long term. As an engineer, I wish things were that simple. They are not.

 

"You really have to look at the technologies that are available, the spectrum that you have, the geographies that you cover. We built our network

on CDMA, which didn't require the density of cell sites. Now the technology is such that you go in with these distributed antenna systems, which

can go in very quickly, very inexpensively, and can fill in that under the large umbrella sites.

So it's actually a lot cheaper for us to have the network that we've got than it is the ones who have these large towers, these lattice and monopole

macro sites that are out there. So the technology has moved our direction and the spectrum that we have -- if we had all AWS or all PCS you would

have to have factors of 2 or more cell sites than we have.Our network spectrum portfolio is based around 700 and 850 with AWS and PCS deployed just for capacity. So I would argue that our network architecture allows us to have the lowest cost structure out there and the technology going forward will allow us to keep that lowest cost structure.

"

 

I think they may take some short term pain with the recent price wars from TMUS and Sprint as well as the spectrum spend - but in the long run both of these will ultimately be beneficial for VZ and T.

 

TMUS and S are basically running headfirst into a wall as they make the bet that they can grow the subscriber base fast enough to make the network profitable before they run out of cash.  Without the ability to merge though, what other option do they have?  They are between a rock and a hard place.  And ironically, in order to support all those new customers and have a competitive network they will need to buy more spectrum - which neither of them have the financial capacity to do (without killing shareholders).

 

I like VZ over the long term because it's a duopoly in a recession proof, rapidly growing, mandatory industry where the little players make enough noise to keep out severe gov't regulation but don't have the financial wherewithal to be real competitors. 

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very good discussion the last few days on this thread. congrats!

 

dwy000, why do you believe that the smaller two players don't have the wherewithal to be real competitors? i understand why they are financially disadvantaged. but in a high fixed cost, low variable cost business with high barriers to exit and high sunk costs. but i don't understand why they cannot make the business unattractive for everyone else.

 

case studies in france and japan are worrisome when it comes to price-aggressive entrants.

 

appreciate your thoughts...

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I am playing it by owning both Softbank (which owns Sprint) and Verizon.  Between the 2 of them, it's about a 12% position.  If Softbank wins, the stock could be up 50%.  In that case I don't think Verizon is necessarily going to crash, it might just be down 10-15% (okay just one of many possibilities but this is sort of my mid-point for this case), but then you get a 5% dividend so that mitigates the decline.  If Softbank fails with Sprint, well with it's Alibaba stake, Japanese telecoms and other investments I might still be okay and I should do well on Verizon.  It is possible I suppose that the entire industry just gets crunched but given that it's an oligopoly I am willing to take that risk.

 

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I am playing it by owning both Softbank (which owns Sprint) and Verizon.  Between the 2 of them, it's about a 12% position.  If Softbank wins, the stock could be up 50%.  In that case I don't think Verizon is necessarily going to crash, it might just be down 10-15% (okay just one of many possibilities but this is sort of my mid-point for this case), but then you get a 5% dividend so that mitigates the decline.  If Softbank fails with Sprint, well with it's Alibaba stake, Japanese telecoms and other investments I might still be okay and I should do well on Verizon.  It is possible I suppose that the entire industry just gets crunched but given that it's an oligopoly I am willing to take that risk.

 

I like this approach.

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very good discussion the last few days on this thread. congrats!

 

dwy000, why do you believe that the smaller two players don't have the wherewithal to be real competitors? i understand why they are financially disadvantaged. but in a high fixed cost, low variable cost business with high barriers to exit and high sunk costs. but i don't understand why they cannot make the business unattractive for everyone else.

 

case studies in france and japan are worrisome when it comes to price-aggressive entrants.

 

appreciate your thoughts...

 

I'm far from an expert on the detailed technology but you can play out the game theory logically.

 

S has always had the biggest issues.  They spent way too much money on Nextel which was a completely different technology and then spent years running two networks while transferring all the Nextel customers over to the S network. They have a good amount of spectrum but it will be very expensive to build it out.  And they have an overpaying customer base for the quality of the network.  They have been bleeding customers for quite a while now because they couldn't lower their prices to compete and still be cash flow positive (and cover all the costs of that network transition/upgrade).  As long as nobody did anything stupid on pricing though the customer loss was fairly low.  But they were still running towards a wall and were probably counting on the merger with T-Mobile as an end game. 

 

T-Mobile was the lowly number 4 with a terrible network (focused on core cities but go outside of those and you're in trouble).  So they competed on price.  As you point out, this is a high, high fixed cost business and you need huge volume to make it pay off.  Neither TMUS or S have enough volume to justify the increasing network and fixed costs.  They probably would have if they merged but now that's off the table.  So (in my mind) T-Mobile said to themselves, the only way to make this work is to sacrifice profitability and hope I can attract enough customers, fast enough that I hit the required volumes before I run out of cash.  And then once they've got critical mass they can stop being suicidal on pricing, raise prices up to VZ and T levels and everyone is happy.  So that's what Leger has done - crazy promotions and a price war, hoping to gain enough new customers.  But the price war is also expensive and ironically, the more it works for them the bigger bill they'll have down the road when they have to buy spectrum to support all this new volume (and given the prices in the auction going on they'll struggle to afford it).

 

When T-Mobile went rogue and started a price war it left S in a bind.  With high prices, expensive upgrades to fund and the merger off the table they can either continue to watch customers bleed away and cash flow dissipate until they need to file bankruptcy - or they can play the T-Mobile game and hope like crazy they can attract enough new customers to make it work, even at the lower price points.  Hence their recent "cut your bill in half" promo.  Look what happened to S stock when they announced that.  It's just suicidal.

 

VZ is slightly better off than T because T and TMUS use the same technology (GSM) so you can switch without changing phones.  VZ is a different, more efficient technology (CDMA) so you need to get a new phone (usually) when you switch to a competitor.

 

Bottom line, in my view it's a race to the bottom for S and TMUS.  One of them will not be able to compete financially anymore (which will cost them the ability to attract any new customers) and either close up shop or the regulators will finally permit the merger.  In the meantime it will be painful for VZ and T due to the price wars (which long term are in nobody's best interest) but if they can work through those they are well positioned to come out even stronger as the bottom 2 can't afford to compete and upgrade.

 

Sorry for the long winded response.  More just an outpouring of my random thinking in the whole process.  I didn't even get into the whole idea of quadruple play and the cable side that will make T and VZ even harder to compete with.

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