Verizon Gains Subscribers, Pays Hefty Subsidy
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Verizon Communications (NYSE: VZ) reported earnings earlier this week and projected a fairly lackluster 2012. First, a look at the earnings: The company reported a loss of $0.71 per share, including a large pension-related charge. Ex-charges, the company’s per share earnings were $0.52, which fell short of the average analyst estimate of $0.53 per share. Revenue was up 7.7% to $28.39 billion narrowly beating the expected $28.39 billion. The revenue growth is encouraging, but comes at a heavy cost.
Verizon Wireless performed well, partially on the strength of Apple Inc.’s (NASDAQ: AAPL) iPhone. Verizon also took advantage of having a faster build out of its fourth generation network, which currently boasts coverage of nearly 3 times the customers as rival AT&T’s fourth generation network. Verizon owns Verizon Wireless jointly with Vodafone Group (NASDAQ: VOD). The company added 1.2 mill wireless contract subscribers, a 38% improvement over a year earlier. It also reported 4.3 million iPhone activations and 2.3 million smart phone activations for the quarter, and added $4 billion of wireless spectrum as well. Wireless revenue was up 13% to $18.3 billion and customer cancellations were down to 1.23% from 1.26% in the previous quarter.
The smart phone activations are impressive, though the phones running on Google’s Android operating system did not sell as well as expected. Verizon can pat itself on the back for bringing Apple to its network because Apple’s iPhone performed incredibly well for Verizon, with sales doubling during the quarter. The volume of iPhone sales isn’t surprising; Apple sold a staggering 37 million iPhones across all channels for the quarter.
Verizon absorbs a $400 loss per sale of smart phone, due to the current subsidy structure. The company more than recoups that money during the life of the typical contract, but it drives the company’s margin downward. Wireless operating margin narrowed from the prior year’s quarter, moving to 23.7% from 30.1%. This is an interesting change because Verizon did not offer the iPhone and had a smaller range of smart phones in the previous year.
Smart phones activations are still a lucrative proposition even with the subsidy attached. According to James Ratcliffe, an analyst at Barclays Capital, “The average smart phone customer will spend about $2,000 over the two-year contract, if the subsidy is $400, you’re still getting $1,600, and that’s very cash-flow positive.” With an ever-increasing pool of smart phone users, this becomes a very compelling cash stream. Verizon’s CFO Fran Shammo also indicated that the company is considering raising the price of devices this year, which would be a positive for the company, assuming it doesn’t lead to customer loss.
The company is poised to benefit from a steady revenue stream even with the added expenses that smart phones bring. Its landline business is waning, but on the plus side, as customers leave the landline service many are replacing it with cellular service. Another bright spot at the wireline business is the growth of FiOS. The company added 201,000 and 194,000 FiOS Internet and FiOS Video subscribers respectively. The shift in product composition in the unit has led to an increase in average revenue per user in the unit, which is up 8.5% for the quarter.
With the company’s recent decline in stock price, I think moving forward it might be a strong value play in the communications industry. The stock’s weakness due to rising cost could offer a good entry point, assuming the company manages to expand margins. In the post-earnings conference call they indicated margins would be a focus, so I would be content to be long the stock and see if they follow through, particularly since the stock currently has a 5.29% dividend yield.
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