One Phrase Not Valid for Verizon: “The More, The Better!”
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What is better than a million dollars? A billion dollars.
What is better than owning a Lamborghini? Owning a Lamborghini and a Ferrari.
What is better than a Christmas gift? Many gifts.
I think I have made my point – more is better. But, is “the more, the better” always applicable for everyone? I think not. I can’t say about others, but this phrase is surely not applicable for the top US telecom carrier Verizon (NYSE: VZ). Let me clarify the context and the reason.
Verizon has been an investor’s favorite for some time now because of its super-attractive yield. In my last piece on the telecom giant, I pointed out why I consider the stock to be superior to AT&T (NYSE: T). Though, till now, the company has been losing to AT&T in terms of yield and iPhone activations, Verizon is now positioned better to take the lead and it surely will. At present the telecom stock is offering an yield of 4.6% and this stacks up well against the 10-year treasury yield of 1.7%.
Now, with the launch of the Apple (NASDAQ: AAPL) iPhone 5 on its network, Verizon will become the consumer’s favorite to a greater degree. The company is expecting huge things from the device as the insatiable demand seemingly breaks all records. Apple has already received more than 2 million advance bookings for the iPhone within the first 24 hours of pre-orders; making it double the number of bookings the company received for the iPhone 4S last year. But, just like a coin, even this has two sides. Let’s discuss both.
The plus side
Verizon has been partnering with Apple to sell its products since early 2011 and now as Apple launches the latest iPhone on September 21, the company will be one of the three players that will carry it apart from AT&T and Sprint (NYSE: S). The company has already made announcements regarding the pricing and offers on the new iPhone as it hits the streets on 9/21.
Verizon has the largest 4G LTE network with presence in 300 markets, while AT&T has this presence only in 40 markets, and this provides the telecom giant with a huge competitive edge against its peers. The company has been building up its 4G infrastructure keeping in mind the next generation smartphones and the iPhone 5 will finally allow the telecom giant to harness the capabilities of its modern network. As more and more consumers buy the new iPhone and seek super high-speed connections, Verizon is more likely to attract customers and expand its subscriber base.
With such wide spread coverage and superior network quality, Verizon might also witness migration from other networks to its network. Apart from new users, Verizon also seeks to benefit from existing users who wish to upgrade their iPhones. The company hopes to benefit from improved ARPU and an even higher subscriber base.
The minus side
However, there is a flip side to the competitive advantage that Verizon enjoys against its peers. The stock has been yielding high and the investors have been very pleased with that. But now, as the company will launch the iPhone 5, the investors are worrying since the margins are expected to fluctuate due to the product launch. All the telecom giants – Verizon, AT&T and Sprint – pay huge subsidies to Apple for each iPhone sold and the figure goes as high as $400 to $450 per device.
So, more customers flocking to Verizon’s network will actually mean higher subsidies to pay and thus lower margins. Verizon’s high speed, which is the key to its future business success, sadly is also the key to hard hit margins. Management is also aware of the situation and recently Verizon’s CFO said that the margins for the fourth quarter will be adversely impacted, while the third quarter will more or less remain steady.
Verizon will surely not be the only company which will be hit hard by the high subsidies. However, Verizon may be affected more than AT&T or Sprint since the company also stands to benefit more from the launch of the device, thanks to its strong network. Analysts and industry experts are estimating that Apple can sell as many as 10 million iPhones in the few remaining days in Spetember after its launch and they also expect a blow of around $1 billion to the earnings of Verizon and AT&T in the third quarter only.
Concluding thoughts
The phenomenon of falling margins due to launch of a new smartphone and margin erosion due to providing smartphones is nothing new to the telecom industry. The process is well understood and accepted by the players because they also know they will be able to recover their losses through lengthy contracts. However, till the time it is able to recover its losses, Verizon will have to think of alternate methods to generate higher revenue.
Though the company will incur losses, it will have to continue selling the iPhone since that is essential for gaining market share. With the possibility of Samsung products getting banned, Apple’s bargaining power will increase even more and thus Verizon will have to accept the iPhone maker’s terms. All this will leave only one option for the telecom giant and that is to raise prices of their plans which will actually be borne by the consumers. So, “the more, the better” is not exactly the situation for the top US wireless carrier.
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