Author’s note: This is a long article because there are so many facets to the Verizon business. Overall, however, the info is pretty simple and has easily explained projected numbers.
In the gangster movie Casino, Ace Rothstein describes Nicky Santoro’s method of strong arming the bookies. He says: “I mean, what were they going to do, muscle Nicky? Nicky was the muscle.”
I compare that to Verizon in the communications industry. Who’s going to threaten Verizon? Verizon IS the threat.
For you conservative investors out there, VZ is a very safe place to park your cash. Verizon has had a pretty steady share price for the last 7 years. From January 2004 to today, it has hovered between 27-37. This is a good sign for conservative investors who are looking for low beta stocks, Verizon is a great investment if one is primarily concerned about preservation of capital. The company offers a dividend which is currently at a 5.4% yield.
Verizon has invested a lot in its wireless and wireline networks in the US and internationally. It invested $17 billion on infrastructure in 2009. In 2010, $19 billion was invested.
Infonetics Research co-founder Michael Howard says AT&T is more conservative with its network investments and took longer to upgrade from copper wires to fiber-optic cables and other cutting-edge gear.
Recon Analytics analyst Roger Entner said: “Verizon planned its network with greater foresight than anyone else. They have a very well-built network, and they don’t cut corners.”
Verizon is also spending a lot on patents for 4G licenses. 4G networks are more than 5 times faster than 3G. Verizon’s 4G networks are already available in 40 cities. AT&T is just getting started building their 4G networks and should have them ready later this year. It seems like AT&T is always playing “catchup” to Verizon’s prompt integration of the newest technology.
I see parallels between the battle of AT&T and Verizon and that of MySpace and Facebook. MySpace was acquired by News Corp. in 2005 and their focus was to maximize income from it. Facebook’s focus has always been to expand their userbase and make it more user friendly – immediately raking in the dough wasn’t on its mind. Now Facebook has blown way past MySpace to the point where hardly anyone uses MySpace anymore. Facebook has been appraised at $50 billion.
From this analogy, Verizon could easily surpass AT&T in market cap within the next five years.
To figure out Verizon’s value, it’s important to project its future revenues, net income, and cash flow. It’s also important to know that Vodafone (VOD) has a non-controlling interest in Verizon Wireless of 45%. This means that 45% of VZ net income is attributed to VOD. If one doesn’t remember this, VZ valuations can be misleading.
Verizon revenues mainly consist of wireless and wireline segments. Let’s start with the wireless segment.
Wireless segment revenues: For 2010: $63,407M For 2009 $60,325M
Verizon Wireless revenue comes from subscriptions to its large network for cell phones, tablets, netbooks, and MiFi hotspots, and cloud computing. The vast majority of Verizon Wireless revenue is from cell phone subscribers. According to the Nielsen Company, by the end of 2011 50% of cell phone users in the US will use smart phones. Right now, 26% of Verizon’s wireless customers use smart phones. In Q4 2010, more than 75% of new Verizon postpaid wireless subscriptions were for smartphones. For AT&T, 80% of new users got a smart phone in Q4 2010, a larger percentage than Verizon because of the iPhone. But guess what? AT&T’s iPhone advantage has now been rendered null and void.
Impact of the Verizon iPhone
Piper Jaffray analyst Gene Munster said at the beginning of January that Verizon will likely sell 2.5 million CDMA iPhones total during the handheld’s first release wave, and 9 million iPhones across 2011. He also cautioned that those sales may not translate to as big an influx of new subscribers as possible because 6.5 million of those total sales would be existing AT&T iPhone users switching to Verizon. Munster also advised that his estimates might be “conservative.” Even before January’s impressive preorders, other groups were predicting higher numbers than Munster. Research group iSuppli estimated 12.5 million iPhone sales for Verizon in 2011, a number echoed by Kaufman Bros. analyst Shaw Wu following the official announcement of the CDMA iPhone in mid-January.
I predict Verizon will claim 11 million iPhone users by December 31, 2011. This includes 7 million who will have left AT&T to go to Verizon, 3 million will already be Verizon customers, and 1 million will be new Verizon customers switching from a carrier other than AT&T.
The plans and costs are very similar between AT&T and Verizon. Now that Verizon also offers the iPhone there’s little reason to go with AT&T. The connection is much better with Verizon. The only advantage with getting the iPhone with AT&T is that you can surf the net while you talk. I think this advantage is overrated. I have owned an iPhone for over 2 years, and I have never used it for surfing the web while talking on it. I may surf the web on my computer while talking, but never on the phone, that would be difficult. One should focus on their conversation anyways besides surfing the web.
Verizon was ranked as the top major carrier in a 2010 Consumer Reports reader survey of 58,000 readers comparing cell phone services. Here are the results:
In the Tri-State area, Verizon is known to be king. It is known to work the best in packed cities all over the country like San Francisco and Chicago.
AT&T, the largest cell phone carrier in the US, was ranked the worst carrier in the country in this survey. It is known to have overextended itself in cities and hasn’t built enough towers to handle the overload of customers.
In 2010, the percentage of dropped calls on AT&T’s network had risen to 5.8 percent, compared with 2 percent for Verizon, according to a survey by Changewave Research.
On January 13, 2011, Changewave did a survey on cell phone users who are going to switch providers. “Importantly, when we compared the churn rates for the top wireless providers, we found major differences,” ChangeWave noted. “Only four percent of Verizon’s customers plan to switch wireless providers in the next 90 days. In comparison, 10 percent of Sprint/Nextel’s customers say they plan to switch, as do 15 percent of both T-Mobile’s and AT&T’s.”
At December 31, 2010 Verizon had 94.1 million customers, up from 91.2 million on Dec 31, 2009, for a gain of 2.9 million customers. That’s 3.1% of additional cell phone subscribers, and wireless revenues increased by 5.1%. Right now, 26% of Verizon wireless subscribers use smartphones. According to Nielsen, by the end of 2011 50% of cell phone users in the US will use smart phones. In 2011, I project that 80-85% of new wireless Verizon subscribers will get a smart phone now that they have the option to get an iPhone. Smart phone users spend about double what feature phone users spend. For 2011, my projection is there will be an 8% increase in wireless customers, which will add 10% to wireless revenues. Verizon’s other wireless businesses will add an extra 2% gain in revenues, for a whopping 12% gain this year. For 2012 projections, customers will still be moving to Verizon from the other networks, but most of them who were going to join already did in 2011. I project 2012 wireless revenues will increase by 7%.
The enterprise cloud industry is growing fast, it’s 15 times as big as it was six quarters ago. Companies are adopting cloud service for several reasons. A simple explanation of what makes cloud computing so popular is in this article: http://www.serverschool.com/cloud-computing/what-makes-cloud-computing-so-popular/
Verizon has big plans for cloud computing service. Security has always been an issue with companies thinking about hiring cloud services, and with a company as respected and accomplished as Verizon, companies can be confident that their information is secure. Verizon’s acquisition of Terremark was a very good move. It catapulted Verizon into becoming a major player in the cloud computing industry. Terremark has to expand ahead of its revenues. That’s why it has never shown a profit. Because of its huge debt load and inability to show a profit, Verizon was able to buy it for peanuts, or $1.4B, which is chump change for Verizon.
Terremark was founded in 1980 by Manuel Medina in Miami, Florida. . In fiscal 2010 (ended in March) Terremark boosted its data center capacity to 504,000 square feet, its customer count to 1,350, and its utilization to 29 per cent, pushing revenues up to $292.3m. However, in the past 5 fiscal years Terremark has booked 136.6m in losses on $893.7m in aggregate revenues. Terremark has had revenues increase at an average of 20% per year. With Verizon’s connections and ability to bundle services together, it will be able to market customers faster for Terremark and have its revenues increase even faster. With Verizon’s help, Terremark revenues should grow 25% in 2011 and 30% in 2012 which is $365.3M and $475M, respectively.
Verizon Business, the IP network and server hosting unit, has over 180,000 customers in 75 countries and a total of 200 data centers scattered around the globe. Verizon is keeping the management of Terremark in place, and a bunch of Verizon data centers will be immediately transferred to Terremark to operate as soon as the deal closes, within 90 days or so, because Lowell McAdam, Verizon’s president, said that building and running data centers was not Verizon’s “core competency.” Eventually, all of Verizon’s data centers may be run by Terremark.
Verizon management expects Terremark earnings to break even in 2011 and not become profitable until 2012.
Projected wireless segment revenues: 2011: $71,016M 2012: $75,987M
VERIZON’S WIRELINE SEGMENT REVENUES
Verizon’s wireline segment consists of fixed phone lines, fiber based services, and enterprise.
Wireline revenues: 2010: $41,227M 2009: $42,451M
Wireline revenues dropped by 3% from year end 2009 to year end 2010. This drop in revenues is because of a decrease in its fixed line subscriber base of 9.5% from December 31, 2009 to December 31, 2010. This decline occurred because customers are looking for cheaper solutions for their phone landlines like VOIP (voice over internet protocol) Vonage and Skype, and some just use their cell phone instead of a landline. DSL is also included in the fixed line segment and customers are ditching that for the much better FiOS internet. Every other aspect of Verizon’s wireline segment increased in revenues. Verizon sold a huge chunk of its landline business to Frontier Communications for $5.3B in mid 2010 so it could focus on its wireless service instead of trying to grow its fixed line business.
Although fixed line revenues will continue to fall, the worst is behind Verizon. The Company laid off about 16,000 workers last year in the fixed line segment. Some of those workers went to work for Frontier Communications as part of the deal.
“While it’s unlikely that our workforce reductions in 2011 will come close to what we experienced last year, our focus on continued — to reduce the Wireline cost structure will be just as vigilant.” Said Verizon CFO Francis Shammo in the Q4 2010 earnings call. Verizon will take many more cost-cutting strategies in 2011. “The company cut $1 billion in expenses in 2010 mostly due to better logistics and plans to cut another $1 billion in 2011.”
As the fixed phone line revenue declines in the next couple years, all the other service revenues will increase, especially the fiber based services – FiOS.
Total FiOS revenues which includes FiOS Internet, FiOS TV and HSI (DSL-based high-speed Internet) was $1.8B in Q4 2010, up 18.4% from fourth quarter 2009. FiOS revenues will grow an additional 20% by Q4 2011 to $2.16B. Growth will slow a bit in 2012 but customers will still flock to FiOS as it’s the best broadband service, by Q4 2012 it will have grown another 15% to $2.48B. This comes out to about $8B total revenue in 2011 and $9.2B in 2012.
Verizon FiOS is rated among the best residential internet service providers by JDpower.com, Consumerreports.org, and pcmag.com.
All the experts agree, FiOS is the best, much better than cable. With cable, like Time Warner Cable for example, you share the network with everyone in your neighborhood. So during peak hours, like from 5pm to 10pm on the weekdays and all day on the weekends, the server can get overloaded and surfing the net becomes painfully slow. This is not the case with FiOS. With FiOS, you have your own box that nobody else uses so it doesn’t get overloaded.
FiOS also uses fiber optic cables that go straight into your home. This is the fast and most efficient kind of cable. Cablevision, Cox, and Time Warner Cable all claimed in their ads that they use fiber cables, but that’s only a partial truth. They use fiber in their own network, but they use the second rate cables to connect to your home. Verizon reported all three companies to the National Advertising Division of the Better Business Bureau (NAD), and action was taken. The National Advertising Review Board (NARB) required them to stop advertising that they use fiber optic networks, and all three companies agreed to stop. Verizon on the other hand, can and does advertise that it uses fiber optic networks for faster internet speeds. People have been increasingly finicky about internet speeds and want the web to be more like “flipping through the pages of a magazine” as former Google CEO Eric Schmidt said the internet will eventually be that fast. When prospective customers hear that Verizon uses top of the line technology for their internet connection with fiber optic cables, then they’re more likely to switch over to Verizon FiOS internet. TV, on the other hand, doesn’t lag or need to load up when changing the channel, so there is no big advantage in switching to Verizon for TV. Verizon’s FiOS TV is pretty much the same as its competitors. However, the advantages and cost savings of bundling FiOS TV with FiOS internet will still move customers to switch to FiOS TV.
Verizon’s enterprise business consists of software developing and IT support for companies all over the world. Enterprise revenues totaled $4B for the quarter, up 1.3% from Q4 2009.
Projected wireline revenues:
2011: 40815M (down 1% from 2010) 2012: 41631 (up 2%)
As Verizon’s fixed line segment continues to contract in 2011 and 2012, the other segments will expand. I predict the Company will have a small decrease in wireline revenues this year but will increase in 2012.
Other revenues are the Company’s revenues that don’t fall under the wireless and wireline categories. Other revenues grows proportionately as the company grows.
Other revenues: 2010: $1.91
Projected other revenues:
2011: $1.98B 2012: $2.14B
Verizon total projected revenues: 2011: $113.80B 2012: 119.76B
% of total projected revenues going to wireless:
2011: 71.016B/113.8B = 62.4% 2012: 75.987B/119.76B = 63.4%
% of total projected revenues attributed to Vodafone (VOD):
2011: 62.4% (.45) = 28.1% 2012: 63.4% (.45) = 28.5%
PROJECTED INCOME STATEMENTS
Now that we have projected revenues, net income can be figured out by projecting what the expenses will be. Higher revenues usually require higher expenses, especially for the cost of services and sales.
(dollars in millions except per share amounts)
Operating Revenues: $113,800 $119,760
Cost of services and sales: 45,520 47,904
SG&A: 34,140 35,928
Depreciation and amortization: 17,070 17,964
Total Operating Expenses: 96,730 101,796
Operating Income: 17,070 17,964
Other income/expenses 550 550
Interest expense: 2,116 1,783
Income before taxes 15,504 16,731
Income taxes 2,636 2,844
Net Income $12,868 $13,887
Minus VOD’s share: 2011: $12,868 (1-.28) = $9,265
2012: $13,887 (1-.28) = $9,999
Weighted average number
of common shares (in millions) 2,803 2,773
Earnings per common share $4.59 $5.01
Share price with a PE of 13 $43.03 $46.91
Explanation of Income Statement numbers:
From 2007-2010 Cost of services and sales has been around 40% of revenues, so I went with that percentage. The $1B in cost cutting for 2011 will even out with the increase in expenses from expansions like its 4G network and from acquisitions like Terremark.
SG&A expense has been around 28-30% of revenues, so we’ll conservatively go with 30% for 2011 and 2012.
As the company expands it gathers more assets so its depreciation and amortization expense increases. From 2006-2010, it has been around 15% of revenues, so I went with that percentage.
Other income/expenses was about 550 for 2009 and 2010, so that’s what I used going forward.
While most of Verizon’s expenses have been a consistent percentage of revenues, interest expense is different. Verizon is using much of its free cash flow to pay down its massive debt load. In 2010, the company paid off net $9.8B worth of debt, to go from $55.05B in debt as of 12/31/09 to $45.03B as of 12/31/10. This is a major step in the right direction and Verizon will continue to pay off its massive debt load. Verizon paid off 18% of its long term debt in 2010. AT&T, which also has a huge debt load, only paid off 9% of its debt in 2010. As Francis Shammo, Verizon’s CFO, said in the Q4 2010 earnings call: “reducing leverage is our top priority.” One can expect the company to continue to pay down debt with cash flow in the next two years. Although with the purchase of Terremark and more investments related to it, probably less debt will be paid off in 2011 compared to 2012. My prediction is the company will pay off 12% of long term debt this year and 20% in 2012. Interest expense is about 5% of long term debt.
Taxes: As of 2010 the Company’s effective tax rate was 17%, so I went with that for 2011 and 2012.
Number of shares: At the beginning of 2011 Verizon announced it plans to buy back 100M shares over three years. Since Verizon’s top priority is to pay down debt, it isn’t going to buyback the shares immediately. A buyback of 30 million shares for each year 2011 and 2012 is an accurate estimate.
CASH FLOW FROM OPERATIONS
Cash from operations: 2010: 33.4B 2009: 31.4B 2008: 27.6B
From net income, we can figure out projected cash from operations.
Projected cash from operations:
Cash Flows from Operating activities: 2011 2012
Net Income $12,868 $13,887
Depreciation and Amortization expense 17,070 17,964
Employee retirement benefits 4,000 4,000
Deferred income taxes 3,500 3,500
Provision for uncollectible accounts 1,544 1,666
Other, net (2,000) (2000)
Net Cash from operating activities $36,982 $39,017
Minus VOD’s share: 2011: $36,982 (1-.28) = $26,627
2012: $39017 (1-.28) = $28,092
Total dividends paid: 2011: 2803($1.95) =$5,519
2012: 2773($1.95) = $5,407
Excess Net Cash: 2011: $26,627 – $5,519 = $21,108M
2012: $28,092 – $5,407 = $22,685M
Explanation of Cash Flow numbers:
Employee retirement benefits and deferred income taxes have been pretty consistent so I just made them close to the same as 2010. Provision for uncollectible accounts has historically been 12% of net income. Other, net, is another unknown, but it seems to usually be negative from looking at past cash flow statements, so I just made it similar to 2010.
The great thing for investors about Verizon is it doesn’t sit on its cash. Many other companies like Apple and Google are sitting on tens of billions in cash that’s not doing anything. Verizon makes sure all of it is utilized for increased shareholder value. Verizon will do four things with the net cash flow from operations. In order of priority, the Company will: pay down debt, spend on investment opportunities, do share buybacks, and pay, and possibly increase, dividends. When a company generates lots of cash flow, investors often fear that it will be spent on worthless acquisitions. I have no fear that Verizon will only spend the cash on acquisitions that are a better deal than it would get from decreasing its leverage. As stated before, the Terremark deal is great for Verizon, and Verizon doesn’t skimp on investing in the most up to date networks in the industry for maximum customer satisfaction.
I believe 2011 and 2012 are the years that things are going to start falling into place for Verizon. It will slowly gain market share as its investments and vision come to fruition. It isn’t focusing on short term gains, it has always had the long term big picture in mind. That is what a long term value investor should look for in management, and VZ is also a good stock for one’s retirement portfolio.