The Best Positioned Telecom In The Industry

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Verizon (NYSE: VZ) is the second-largest telecom operator in the U.S., providing various wireline and wireless services to its customers. The company had approximately 98 million wireless customers as of Sept. 30, 2012. I suggest a long position in the stock because even though the company will face an extremely competitive wireless market in 2013 and onwards, I believe Verizon remains the best-positioned carrier in the industry, and is likely to continue gaining market share in the wireless segment.

Market leader in 4G LTE

Telecom carriers in the wireless market are in need of two things: the iPhone in their portfolio, and broadly deployed networks. Verizon has benefited from having both, whereas its main rival AT&T (NYSE: T) has been playing catch-up.

Verizon currently has 4G LTE coverage of more than 250 million people in over 450 markets, while AT&T has less coverage than that. This increased coverage was reflected in both the companies’ recently announced results, where Verizon reported record postpaid additions of 1.5 million compared to the modest additions of only 151,000 for AT&T. However this window is closing, as T-Mobile has recently announced that it will begin selling the iPhone sometime next year.

Increased wireless competition but Verizon ahead

With all four major carriers in the U.S. meeting these two conditions (iPhone in their lineup and increased coverage), the wireless market will become significantly competitive in the coming year. After the Softbank deal with Sprint (NYSE: S) and the T-mobile merger with MetroPCS, they will both put increased pressure on Verizon and AT&T.

Sprint’s deal with Softbank needs to be discussed in any conversation about Verizon and AT&T. Sprint has been losing customers for a number of years, partly due to the AT&T and Verizon duopoly in the U.S., and partly due to its Nextel Network. Both reasons have weighed on its profitability, but with the company deciding to finally shun its Nextel Network, growth in customer numbers and better service can be expected going forward. With Softbank injecting over $8 billion in capital into Sprint, it is highly likely that the funds will go into speeding up the Nextel shutdown process, which is already well on track. Sprint's network vision program, which is expected to bring operational and financial synergies in excess of $5 billion, will certainly be helped or boosted by the $8 billion capital that Softbank is throwing in the company.

However, there is still some catching up to do for the smaller rivals, as Verizon is way ahead of them. It has been adding subscribers at a staggering rate, which was evident throughout the first three quarters. As I mentioned previously, Verizon added 1.5 million postpaid subscribers in the third quarter and with the increased market area coverage, it would not be an exaggeration to expect the company to post additions in excess of 2 million in Q4 2012, especially after the launch of the new iPhone 5. In that scenario, which is very likely, we are looking at postpaid additions of over 5 million for 2012, which would make it the company’s best year for over four years.

Share Everything plan to boost ARPU and compensate for margin erosion

Moreover, while the company continues to see an impressive growth in subscribers, its new Share Everything plans are reflecting positively in its average revenue per user metric, the more common term for which is now average revenue per account. As the customers continue to get themselves on these plans and add more devices under the same plan, further growth in ARPA can be expected. These factors will eventually have a favorable impact on the company’s wireless service revenues, which have served to offset the declining revenues from wireline to a great extent.

However, there is a downside to this impressive growth in the wireless service revenues: the margin erosion caused by the subsidies paid on smartphone sales. In the third quarter, the company sold 6.8 million smartphones, 3.1 million of which were iPhones. Verizon is expected to sell a little over 9 million smartphones in the fourth quarter, which includes 6 million iPhones. Selling these many smartphones is undoubtedly going to put pressure on margins, but they will most likely remain higher than in the year ago quarter due to the company’s Share Everything plans, which have done exceptionally well since their launch.

Wireline stabilizing

Despite the falling wireline revenues, the company is well positioned to post better margins over the next few years due to some of its initiatives, which include the recent union agreement. The new agreement would provide the company with cost savings through headcount reductions. Verizon’s management has estimated that due to the initiatives taken, it can save around $200 million to $500 million through employee healthcare contribution, which will have a positive impact on wireline margins.

Moreover, the residential market, which accounts for roughly 40% of the wireline revenues, is also headed in the right direction, as the company is accelerating its efforts to transition from copper network to fiber in areas that were hit by Hurricane Sandy. The company is expected to replace around 400,000 access lines in 2013 with fiber, which will result in more cost savings, as fiber has much lower maintenance costs than copper lines.

The stock has significant upside potential, as earnings growth expectations for the company are higher than its peer group. Earnings are expected to grow over 10% in the next five years, which will give its multiples a boost. In conclusion, I maintain my positive outlook for Verizon, despite intense competitive environment in the next year.

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