Covering Analyst: Armando Perez Email: armando@uoregon.edu
The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG’s portfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG’s portfolio.
Verizon Communications Inc.
RECOMMENDATION: HOLD
BUSINESS OVERVIEW
Verizon Communications (VZ), formerly known as Bell Atlantic Corporation is a global provider of various telecommunications, internet and media entertainment services. They were incorporated in 1983 from a subsidiary that resulted from the breakup of the parent telecommunications company AT&T. They began doing business as Verizon Communications after merging with CTE Corporation on June 30, 2000. Through strategic mergers and
Stock Data
Price (52 weeks) $25.99 – $38.95
Symbol/Exchange VZ / NYSE
Beta .68 Shares Outstanding 2,833 M Average daily volume
(3 month average) $16.5 M
Current market cap $104,792.7 M Current Price Dividend Dividend Yield $36.99 $1.95 5.27%
Valuation (per share)
DCF Analysis $49.65 (70%) Comparables Analysis Target Price Current Price $60.93 (30%) $47.19 $36.99 Summary Financials (2010) Revenue Net Income $106,600 M $3,730 M
2
acquisitions which were complemented by organic growth, VZ has become one of the largest players in the domestic wireless and broadband industry.
Verizon seeks to improve the way people collaborate by integrating the most advanced technology into their networks and offering the latest in communication devices. Even in the recent distressed environment, VZ’s business model has allowed them to remain profitable and continue to grow revenue. VZ operates in various industries and has a diverse customer base with no single customer making up a material percent of their sales.
Verizon divides its services by network infrastructure resulting in two segments: wireless and wired. These segments are further divided into sub-segments that include related services.
Wireless Segment
$63.4 Billion in Revenue, 60% of Total 2010 Revenue
The majority of VZ wireless revenues are realized through its subsidiary Cellco Partnership which does business as Verizon Wireless. Verizon Communications owns 55% of this subsidiary while Vodafone owns the remaining 45%. Currently, Cellco is one of the largest providers of wireless communications in terms of customers and revenues in the U. S. and is the largest 3G provider. Cellco ended 2010 with over 94.1 million customers, a 5.5% increase from 89.2 million in 2009.
Products and Services:
Cellco offers an array of wireless products and services to accommodate customer type and specific needs.
Voice Services:
Wireless voice services are used with devices that are capable of receiving and sending voice airwaves. VZ offers a selection of voice service plans that are categorized by customer type and differ in terms of available minutes outside of the network. The plans require a two year agreement and can be packaged with wireless data services by adding additional charges. Customers can use the network to make calls beyond their minute allowance but are subject to additional charges.
VZ does their best to provide customers with the ability to make changes to their plans without being penalized. A few benefits include providing customers with the option to change their service plan at any time to any qualifying plan without paying switching fees and placing an early termination fee that decreases after each month that a customer remains on their contract.
Subcategories in voice plans are as follows:
Individual Plans: Aims to provide affordable wireless voice services to individual customers.
Family Plans: The plan’s minutes are shared by the number of lines on the plan, maximum of five lines. Prepaid Plans: Allows for customers to pay as they use minutes and avoid the standard two year agreement. Push to Talk: Provides a “walkie talkie” style of communication that is efficient for when there are consistent
conversations with multiple parties.
International Plans: Delivers a comparatively priced wireless solution to individuals who consistently make calls around the world.
3
Voice services have experienced high demand since the early 2000s, but demand has started to decrease due to high market penetration which has been somewhat offset by advances in technology and competitive pricing. Fierce price competition between AT&T, Sprint and T-Mobile has resulted in customer base growing faster than revenues. Growth in this service has and will continue to cannibalize wired services as more of the population disconnects their wired lines and switches to wireless. All of these factors will result in slowly decreasing revenue growth for the service.
Other Connection-Related Services
Telemetry services are another category in VZ’s wireless segment. These services are machine-to-machine (M2M) wireless interactions that do not include a voice component. They allow companies to automate the transfer of data from collecting devices to host devices. An example would be a wireless thermostat in Seattle that sends the current temperature to a display panel in New York.
VZ’s biggest customer in this segment is OnStar, a subsidiary of General Motors. VZ does not state much about these services, which makes it difficult to analyze company strategy in respect to these services. What should be noted is the large growth opportunity as a cause of the increasing demand for instant and automated information. A few examples of possible new clients are companies that need to connect with and monitor equipment, such as medical devices used to monitor patients in the medical industry, and fleet management devices that monitor company vehicles such as trucking and limousine companies.
Data Services
Verizon offers data services that can be used in addition to voice services on smart and feature phones or can be used solely with laptops, tablets and mobile hotspot devices. With Verizon’s network upgrade to 4G LTE the quality and speed of these services will greatly increase.
A list of the data services is as follows:
Internet Access on Smart and Feature Phones: Charges based on agreement allowances.
Mobile Broadband: Charges based on agreement allowances; the service is available on laptops, tablets and mobile hotspot devices.
Messaging Services: Enables Customers to share text, picture and video messages. Charges are based on agreement allowance.
Location-based services: Provides customers with maps, directions and has the option to locate other VZ customers.
Multimedia Offerings: Allows customers to view and purchase media content through VZ sources such as V CAST, charges based on purchases.
Data services are the fastest growing segment with revenues increasing by 25.6% in 2010. High demand for wireless internet access and VZ offered smart phones such as the newly acquired iPhone and the phones powered by the popular android operating system have fueled this growth. In addition to their smart phones, VZ has positioned themselves to attract customers with their network by having the largest 3G network and upgrading to a faster and more reliable 4G LTE network.
4
Wireless Devices
Verizon carries an extensive line of devices that can run one or more wireless services. Devices that are purchased with a two year activation agreement carry discount prices to attract new customers and retain current customers. Current customers have the option to upgrade their devices and receive a discounted price after a certain point of carrying the set agreement but are required to extend the agreement.
All devices come with a free one year manufacturer warranty and the option, at an additional charge, to fully cover devices with insurance through the third party Asurion’s Wireless Phone Protection. The plan covers all the following: If the phone is lost, stolen, accidentally damaged or malfunctioning after the manufacturer’s warranty expires.
A list of wireless devices is as follows:
Smart phones: Phones that run or have the ability to run third party software and applications, require an agreement of the unlimited data plan.
Featured phones: Phones that have limited operating systems and features, commonly regarded as “easy to use” require a data plan agreement from one of the various data package.
Tablets: Newly introduced personal computers which require a data plan agreement from one of the various data packages.
Netbooks: lightweight and portable laptops, capable of accessing wireless internet anywhere without additional equipment required and agreement of unlimited data plan.
Internet Access Devices: Portable modems capable of connecting up to five devices to internet access. Requires an agreement of an unlimited data plan.
The selection and inclusion of highly demanded devices is crucial to attract and retain customers. VZ has realized this and acted by adding the iPhone and iPad to their selection as well as offering an extensive line of the popular Android powered phones. Another reason why these additions are particularly important is that smart phones are the current driver for device revenues. VZ stated that smart phones provide lower margins than that of feature phones but from a long term perspective, the loss in device margin is more than offset by the additional revenue generated from the larger data package required on smart phones as appose to feature phones. The large increase in smart phone revenues as a percentage of total device revenues in 2010 resulted in a lower overall net margin.
Wired Segment
$41.2 Billion in Revenue, 39% of total Revenue
Verizon’s wired segment operates through various subsidiaries that provide global services. They are one of the largest domestic global wired telecommunications providers. Wired services include any service that is delivered through a physically linked network. The segment’s services and offerings are categorized into four targeted customer types: Mass Market, Global Wholesale, Global Enterprise and Other.
Mass Markets - $16.2 Billion in Revenue, 40% Wired Revenue
These services target domestic consumers and include local and long distance telephone lines, broadband internet and FiOS TV. Services are typically bundled to provide customers with savings and convenience. All services are billed on a monthly post-pay arrangement.
5
Video Services: Verizon offers fiber-optic (FiOS) TV to over 15.6 million homes across 11 states. FiOS TV includes widgets that allow users to access local weather, traffic, community information and popular social media sites such as Facebook and Twitter. It also allows internet browsing with compatible television sets. VZ has partnered with DirecTV to deliver video services in bundled packages outside of the FiOS network. Data Services: Offerings include high speed internet and FiOS broadband with a variety of speeds available.
VZ’s FiOS broadband is currently the fastest broadband available in the United States with downstream speeds at 150 Mbps and upstream at 35 Mbps. To put these speeds in context VZ gave an example: “On the average broadband connection today, a full-length HD movie takes almost four and a half hours to download with 150 megabit service; that time is reduced to just four and a half minutes.”.
Voice Services: Packages include local and long distance telephone service. VZ also provides VoIP service, which uses the Internet to transmit voice communications.
The Mass Market segment should experience swift growth driven by video and data services. As VZ expands their FiOS network an even greater potential market will become available. Voice services have been on the decline due to customers switching to different technologies such as wireless and VoIP. Since VZ provides both of these alternatives; most wired customers will be switching to one of VZ’s other services. The portion of revenues lost from customers that leave VZ wired for another carrier or already have wireless and drop the wired service will be offset by the increasing demand in Video and Data services.
Global Enterprise - $15.7 Billion in Revenue, 38% of Wired Revenue
This sub-segment of services targets medium to large businesses and government agencies by providing large scale voice, data and internet solutions. VZ has constructed one of the largest global IP networks to deliver these services to over 150 countries. Services include traditional voice and data with the addition of strategic services which provide advanced services. Verizon did not provide any detail on how these services are charged.
Global Enterprise services include:
Voice services: provides traditional wired local and long distance telecommunications or the newer VoIP option.
Private IP: A strategic service that allows customers to use Verizon’s IP network for various data exchanges. This is VZ’s fastest growing global service.
Managed Services: A strategic service which monitors and manages customer’s networks.
Application Hosting: A strategic service that offers hosting of software application which similar to cloud computing.
Customer Service management: A strategic service that improves clients “customer service” through training and restructuring.
6
During the past few years this segment has been growing slowly due to the stagnant global economy. VZ expects revenues to grow at a faster rate as the global economy regains momentum. In preparation for the global economy rebound, VZ started a multi-year reorganization in this segment to become more competitive in the global market. VZ stated that by reorganizing they plan on expanding their geographical market, improve the customer experience and improve the quality of their services. The purchase of Terremark World Wide is a step in the reorganizing by enhancing VZ’s application hosting.
Global Wholesale - $8.4 Billion in Revenue, 20% of Wired Revenue
VZ offers most of their wired mass market services at wholesale prices to other carriers who can resale the service to their own customers. VZ states that a large percentage of the revenues from this segment come from a few large telecommunication providers. In addition to the mass market services VZ also offers strategic services to their wholesale customers.
Some of the carriers that purchase from VZ compete directly with them in the wired segment. The wholesale of services is required by the telecommunications act of 1996 and is regulated by the FCC. The act requires that established telecommunication providers offer their services at wholesale rates, almost cost base, to new entrants. The Global Wholesale segment has been decreasing in revenues due to lower voice minutes used on wired lines. This trend is expected to continue as more people drop their wired lines for more advanced and affordable technologies. Other - $.9 Billion in Revenue, 2% of Wired Revenue
Revenues for other services are derived from the following: Operator services
Payphones
1-800-COLLECT calls Prepaid phone cards
This segment’s revenue has been decreasing and is expected to continue the decline as customers switch to more advanced technologies.
Wireless Network
The quality of any carrier’s network is dependent on the size of the network and the technology that they choose to deploy. There are currently two types of major wireless technologies that are commonly used domestically, CDMA and GSM. I will briefly explain both technologies.
CDMA
Code Division Multiple Access (CDMA) was developed by Qualcomm in the United States, and is currently the dominant network standard in North America. Verizon, Sprint, MetroPCS and US Cellular are the top domestic carriers that use CDMA technology for their wireless networks. This technology is mostly used in the United States and some parts of Asia. It is currently making progress in other parts of the world, but global coverage is limited compared to the GSM technology. While domestic coverage is superior to GSM, due to its lack of global penetration, CDMA enabled phones lack in global roaming ability. A superior feature of CDMA enabled phones is the capability of receiving frequency signals from multiple towers at the same time which increases clarity in voice, faster data transfer and reduces dropped calls while moving. EVDO technology allows CDMA networks to deliver data at 3G for a maximum download speed of about 2000kb per second. EVDO technology is an addition to CDMA and requires phones to be EVDO compatible.
7
GSM
Global System for Mobile (GSM) communications was developed in 1987 by the GSM Association, an international organization dedicated to developing this standard worldwide. AT&T and T-Mobile both use GSM technology as their wireless network platform. Being an international standard, it reaches over a billion users worldwide which makes it better suited for international roaming. The GSM network is also well established in North America, but not to the same degree as CDMA. GSM networks have the ability to incorporate EDGE technology which allows data delivery at 3G that can provide download speeds of up to 384kb per second which is less than EVDO. This technology requires an EDGE-ready cell phone. Now I will discuss Verizon’s current wireless network position compared to that of AT&T and what its plans are for future network development.
VZ’s primary network technology is CDMA which is among the largest networks in the United States with coverage in the top 100 populated metropolitan areas. Their network covers a population of over 292 million, of which over 94 million are current customers of VZ. They continually explore opportunities to expand and improve their network through strategic acquisitions and obsolete of additional spectrum licenses. Even though GSM is the global standard in wireless telecommunications, VZ has been able to provide a superior domestic network by using CDMA technology. The lack of compatibility between GSM and CDMA enabled phones becomes a problem for customers that travel globally, for these cases VZ provides various CDMA phones that are GSM compatible.
As described in the CDMA section, Verizon’s CDMA network is capable of using multiple towers to deliver frequency signals to a single phone which reduces dropped calls and increases call clarity both of which are common complaints by customers of AT&T. VZ has installed 3G EVDO technology in all of their towers to deliver the widest 3G coverage of any domestic carrier. To further improve the reliability of their network, every cell tower switch has a backup on standby and power generators that are tested frequently to mitigate tower down times due to failed switches or power outage. These network standards have been recognized by consumers and have ultimately resulted in VZ being known for having “the most reliable network”.
To stay on the frontlines of technology and quality, VZ has begun to incorporate 4G capable LTE technology into their towers. LTE is the latest wireless technology that is becoming the new international standard in the wireless industry. The compatibility of VZ’s phones will be improved as many domestic and global carriers have committed to the technology. Verizon started to incorporate the technology in 2010 and as of now over 38 metropolitan areas have 4G available. The full upgrade is expected to be completed by 2013.
LTE was developed from a GSM platform but performance is substantially better than both GSM and CDMA. It’s rated to be able to reach top speeds of over 100Mb per second and is projected to be capable of speeds of over 1Gb per second as it is improved. It is also more efficient at directing wireless traffic which not only improves quality of voice and data speeds but allows more devices to use any particular tower by relieving congestion.
A test conducted by Computerworld.com in New York City compared the speed of Verizon’s 4G service to their 3G and Sprint’s Wimax 4G. Verizon’s 4G was, on average, about ten times faster than its 3G service and about 3 times faster than Sprint’s 3G service. It should be expected that performance results will differ from area to area but this should be an indicator of what is expected to come from VZ’s LTE upgrade.
Wired Network
Verizon has been expanding their current FiOS network which is a fiber based technology. Fiber allows for the fast speed of any other type of physical infrastructure. It can deliver various types of data at the same time to provide consumers with various types of services. Due to its compatibility and possible speeds of delivery, VZ was the first to provide an NFL and MLB game in 3D.
8
The network provides the fastest speeds in the nation with a downstream top speed of 150Mb per second and 35 Mb upstream per second. The network currently reaches 15.6 million homes and is being expanded to reach a much larger customer base. Fiber cables are the future of technology by offering the fastest speeds, however it is also the most expensive infrastructure in terms of wired to deploy. The expansion of the network will require a large amount of capital expenditures.
Collaborations
Verizon has formed various partnerships and collaborations to develop new services and improve current offerings. I will outline the most notable of these partnerships and collaborations.
Application Developers
Many of the smart phones that Verizon offers have the ability to run third party applications. In order to encourage the development of more attractive applications VZ makes available the technical interface standards
used to connect phones to their network to make development of applications easier.
Verizon is also making the interface standards of their 4G LTE network available to give
designers a head start on developing compatible applications. The availability of applications is extremely important to Verizon as they add value to smart phones. A clear example is the
iPhone and how popular it became not only because of its design but because of the numerous and “cool” applications available for it.
Cell Phone Payment System
During 2010, Verizon formed a partnership with AT&T and T-Mobile, to create a mobile payment network that will enable their customers to pay for store items with their mobile phones through advanced field communications technology. This venture is seen as the future in payment systems and would provide shoppers with a faster checkout experience.
Indirect Sales Channels
To increase sales, Verizon formed a partnership with nationwide retailers such as Best Buy, Wal-Mart, and Target which sells VZ products and services. Most of these retailers also sell products from VZ’s competitions such as AT&T, Sprint and T-Mobile and could discontinue selling VZ products at any time. These relationships are vital to Verizon; as the termination of any partnership would lead to a material reduction in revenues.
Customer Service
In any industry, customer service is a key differentiator, especially in a service based industry where customer interaction is frequent. Verizon views this business component to be just as important as their physical network. To deliver superior customer service, Verizon hires customer representatives who learned English as their first language and are available twenty four hours, seven days a week. Representatives are well trained in most aspects that relate to offerings and devices to reduce the amount of times customers are transferred. The high quality of their customer service was recognized by Consumer Reports who in 2010, gave them the highest customer satisfaction rating of any major carrier for the second year in a row
Acquisitions and Spinoffs
Verizon has expanded its network and improved its services through strategic acquisitions and spinoffs. It plans to continue acquiring companies when presented with opportunities. Several factors are taken into account when considering an acquisition: the company must have growth opportunities or enhanced service structure and full integration must be feasible and swift. I will briefly discuss several of Verizon’s recent acquisitions and spinoffs. Terremark Worldwide, Inc – April 11, 2011
On January 27, 2011, Verizon announced it had entered into an agreement with Terremark Worldwide Inc to purchase all common stock. The deal closed on April 11, 2010 after government approval. Headquartered in Miami,
9
Terremark is a widely recognized Infrastructure-as-a-Service leader with a proven track record of delivering cloud-based resources with the highest levels of security and availability in the industry. They operate thirteen data centers in the U.S., Europe and Latin America where they combine secure cloud computing, collocation, a more advanced webhosting option, and web hosting management services into one single package. Its extensive cloud platform provides some of the world's largest companies and U.S. government agencies with on-demand access to secure and reliable computing resources. The acquisition enhances VZ’s Global Enterprise offerings, specifically cloud computing. The agreement was for VZ to acquire all of Terremark common stock for $19 a share in cash, approximately $1.4 billion.
Alltel – January 9, 2009
The acquisition of Alltel expanded Verizon’s network and increased its customer base by 12.9 million, which was about an 18% increase. Verizon paid over 5.9 billion in cash and took on debt which resulted in 22.2 billion net of cash acquired. The integration of the company took a number of months but was fully integrated by the end of the year. Through the integration, VZ was able to offer Alltel customers new and advanced services, specifically 3G, which provided an additional revenue stream to that of what was being realized before the acquisition. VZ stated that the network integration went smooth and that all prior Alltel customers were able to use their current devices.
This acquisition expanded VZ’s potential market and will continue to provide new opportunities as its wireless network is improved. VZ also plans to deploy its FiOS network in selected markets that were gained from the purchase. The FiOS network should provide an additional source of revenue though its services specifically broadband and FiOS TV.
Spinco – July 1, 2010
VZ completed the spin-off of a large portion of their wired network that operated as a subsidiary, Spinco. The subsidiary generated revenues of about $4 billion in 2009 and was created with the sole purpose of the spin-off transaction. The spin-off was a complex stock exchange where VZ created the subsidiary, Spinco, and delivered it to shareholders. Spinco was then spined-off to Frontier who paid VZ shareholders with their common stock. For every
4.17 Spinco shares, stockholders received one common share of Frontier. The spin off resulted in an $8.6 billion stock gain for VZ shareholders.
This spin-off illuminates VZ’s goal of reducing their exposure to the wired industry which is presently declining. VZ strategically selected the weaker performing portion of their wired segment for the transaction but retained its hold in highly populated metropolitan areas.
Spectrum and License
In order for any wireless communications provider to be able to provide their services they must obtain a license for a certain frequency band in a set geographical area. The obtainment of these licenses is crucial to the success of any wireless provider as it establishes the market it can operate in. In the following section I will briefly overview radio waves and frequency license regulation in the U.S. and then touch on VZ’s position in respect to frequency licenses. In order for radio waves to avoid interfering with each other the FCC was delegated as the government authority to determine which frequency ranges can be used by different types of radio technology. Any individual or entity that wants to transmit airwaves is required to purchase a license from the FCC for an approved frequency band. Certain frequency bands have multiple licenses in different geographical areas since most radio waves can only travel relatively short distances. To accommodate the need of wider networks by national transmitters; the FCC provides licenses to frequency bands across expanded geographical areas. The FCC distributes licenses though online multi-round auctions. Due to the auctions complexity, they can last anywhere from weeks to months. All licenses are
10
subject_to_renewals.
Verizon has established national coverage as a result of purchases of key licenses which cover large geographical areas. Their licenses include various frequencies, two of which are particularly important and will be briefly discussed. The license in various 1800-1900 MHz spectrums have allowed them to deliver their national coverage that is rated one of the best. These spectrum licenses have enabled VZ to not only deliver great voice coverage but also the largest coverage of 3G in the nation.
The most recent acquired 700 MHz licenses also provided national coverage but provided an additional benefit. They are the lowest spectrum available to wireless carriers making them very sought after. The benefit of low MHz is that the radio waves are physically longer than higher-frequency radio waves which results in them traveling farther and are better able to penetrate walls and other impediments that a radio wave must go though. VZ has a dominant national position in this spectrum; AT&T only has licenses at this spectrum level in a few large cities. VZ plans to use this spectrum with the new LTE physical infrastructure to deliver an even better performance than any other carrier.
AT&T and T-Mobile Acquisition
On March 20, 2011, AT&T and T-Mobile announced that they entered into a purchase agreement under which AT&T will acquire T-Mobile USA from Deutsche Telekom in a cash-and-stock transaction estimated to be valued at approximately $39 billion. The acquisition is subject to FCC review and approval. I will discuss how the approval of the acquisition would change the wireless telecommunications industry landscape specifically from the perspective of VZ and AT&T.
Currently AT&T is the second largest provider and T-Mobile is third largest in terms of customer base. Both carriers have had constant issues with overwhelmed networks due to the increasing traffic of wireless data. The number of customer complaints has been steadily increasing and both carriers have responded with upgrades but are not able to keep up with the increase in data traffic. The acquisition would alleviate both carriers of this problem by combining their spectrum licenses and physical networks which are both GSM.
As outlined earlier, acquiring licenses from the FCC is time consuming and requires carriers to wait until the FCC offers additional relevant licenses which can take years. After acquiring a spectrum license carriers need to apply for permits from state or county regulators to build towers, both of which require an extensive amount of time. AT&T’s decision to acquire T-Mobile would allow them to avoid this hassle by combining their physical infrastructure and spectrum licenses. Combining the licenses would greatly expand AT&T’s potential market and improve their wireless quality both in terms of data and voice.
If the acquisition were to be approved, VZ would face two major business environment changes. First, it would no longer be faced by the intense price pressure that T-Mobile applies to the industry. There are other smaller carriers that offer lower prices than the major carriers, but their operations are regional. T-Mobile is the only carrier out of the big four that effectively applies price pressure to the rest of the carriers. Second, though it is not clear the level of improvement AT&T’s network quality would realize it would certainly be much better than without the acquisition. VZ could potentially lose their reputation of being the most reliable network if AT&T’s quality and coverage were to match or exceed that of VZ.
There has been no indication by the FCC on what the possible outcome of the proposed acquisition will be but it should be noted that the top four industry participants, VZ, AT&T, T-Mobile and Sprint have over ninety percent of the wireless market share.
11
MANAGEMENT AND EMPLOYEE RELATIONS
The success of Verizon is directly related to its management team which is composed of highly experienced individuals. I will give a brief description of the top officers.
Ivan Seidenberg, Chairman of the Board and Chief Executive Officer -
Seidenberg has led Verizon since its inception in 2000, transforming the company into a premium network by building infrastructure to provide nationwide wireless, deploying high-speed fiber broadband direct to homes, and expanding its global internet backbone network around the world. Under his leadership, Verizon has stayed on the frontline of technology innovation with its industry-leading FiOS fiber-optic network and its planned deployment of LTE 4G wireless technologies. Verizon's leadership in network innovation has earned the company numerous awards, including being named to Fortune’s 2010 “World’s Most Admired Companies” list as No.1 in the telecommunications sector.
Since his beginning as a cable splicer's assistant at New York Telephone, Seidenberg’s telecommunications career has spanned more than 40 years. A New York City native, he earned a bachelor's degree in mathematics from Lehman College, part of the City University of New York, and a master's degree in business administration and marketing from Pace University.
Lowell C. McAdam, President and Chief Operating Officer
His responsibilities include management of the subsidiaries: Verizon Wireless and Verizon Telecom and Business and Verizon Services Operations. He is also responsible for the technology management and CIO functions.
Before becoming president and COO in October 2010, McAdam held key executive positions at Verizon since its inception in 2000 and helped build the company into the industry’s leading wireless provider, with the nation's largest, most reliable wireless voice and 3G networks. He earned a bachelor's degree in engineering from Cornell University and a master's degree in business administration from the University of San Diego. He also spent six years in the U.S. Navy's Engineer Corps and is a licensed professional engineer.
PORTFOLIO HISTORY
Currently the group holds VZ in the Tall Firs and Svigals’ Portfolios.
Tall Firs currently holds 500 shares. The shares were purchased on October 14, 2005 for $30.55 a share. Svigals currently holds 135 shares. Shares were purchased on two separate occasions, November 28, 2006 for
a price of $34.24 a share and on August 17, 2010 for $30.13 a share.
RECENT NEWS
Verizon to spin out rural business to frontier – May 1, 2010, MarketWatchers
The spin-off reflects part of a long-term strategy by VZ to mimic its rivals in the cable industry by concentrating its operations in more lucrative metropolitan markets. The spin-off is the second large drop of a portion of their wired segment. In 2007, the company sold off other portions of their rural phone business in New England. The deal gave Verizon extra cash to pay down debt or fund its FiOS network expansion strategy.
12
Verizon Profits more than triples as iPhone helps win customers – April 21, 2011, Bloomberg
VZ reported earnings that more than tripled as the carrier attracted new customers after introducing the iPhone. Net income rose to $1.44 billion, 51 cents a share which beat analysts’ estimates of 50 cents. Verizon also added 906,000 new wireless contract customers in the quarter while their FiOS network added 207,000 Web subscribers and 192,000 video users in the quarter. Sales from the wireline business fell 2.2 percent to $10.1 billion.
INDUSTRY
Industry Wired
Wired telecommunications industry participants exchange local, long, and international calls through wireline networks composed of landlines, microwaves and satellite linkups. Currently the industry is declining due to competitively priced substitutes. The industry generates 141.4 billion in annual revenue with a profit of 8.3 billion. Revenue is projected to decline by an annual rate of 7.4% over five years to 2016. New and more lucrative technologies such as voice over internet protocol (VoIP) and wireless telecommunications are stripping revenues away from this industry by offering competitive pricing. These substitutes have become particularly appealing to residential customers which represent 44% of the industries revenues.
Many of the industry participants are also players in other related industries such as wireless, VoIP and internet service providers. These diverse companies are currently selling portions of their wired business segments in response to the industry’s decline. Revenues are projected to decline to 94 billion by 2016, for any industry participant to remain profitable over this time period they will have to identify which portion of their wired segment will produce adequate voice traffic such as highly populated urban area and maintain them in their business portfolio.
Verizon communications is the second largest participant in the industry with market share of 23.4%, AT&T is the largest with 30.5% market share. VZ is very aware of the decline in the industry and have taken various steps to reduce the impact to their wired segment on the overall business. They have segmented their wired business component to: Verizon Telecom and Verizon Business. Verizon Telecom provides wireline services while Verizon Business provides IP based telephony services (VoIP) to medium and large businesses as well as various levels of government. This separation has allowed VZ to focus more resources to the rapidly growing VoIP segment and monitor the purely wired segment. VZ recently spined-off a large portion of their wired lines in rural areas to Frontier Communications
Wireless
Industry participants operate switching and transmission facilities to provide direct communications via airwaves. Participant’s services include: cellular mobile phone services, broadband personal communication services (PCS) and wireless public safety services. It is important to note that wireless communications also includes wireless internet service providers while wired Internet service providers are included in the Internet Service industry. Unlike wired, wireless has been growing for the past five years at an average annual rate of 4.6% reaching 193.6 billion in revenues in 2010. Decrease in pricing and advances in wireless technology have been the catalyst for the growth in the industry. These trends are expected to continue driving the industry to grow at an estimated 3.2% annual rate to 239.7 billion in revenue by 2016. IBISWorld estimates that a substantial percent of the population that can operate a cellular phone owns one; this will result in a slower growth rate than has been realized in the past.
To keep growth rates strong, industry participants will have to create appealing wireless packages and plans complemented with a reliable and expanded network. Carriers that develop wireless packages that best suit customers needs will establish and retain a dominant market position. With the increasing demand in wireless data traffic and growing customer expectations, a large and reliable network will be crucial to retaining and attracting new customers. Verizon is the industry leader in market share with 33.2%, AT&T is second with 28.6% and Sprint is third with 17.2%. To keep its dominant position, VZ has responded to the industry trends by developing various wireless plans
13
and segmenting them by customer type. The wireless plans often include a package of wireless voice and data services. Even though VZ tries to avoid competing in respect to price by differentiating its self through its network, customer service, selection of wireless products and other value adding business components, they still must price their wireless plans competitively. VZ has also built one of the largest domestic wireless networks and continually makes improvements to the reliability and scale. This is evident in their current transition to an LTE network which will provide superior service to that of their current CDMA structure.
Internet Services
Companies in this industry provide internet services through wired networks. The industry grew at an annual rate of 7.3% reaching 43.1 billion in revenue and 4 billion in profit by 2010. Faster technologies such as broadband internet and bundled services will fuel future growth that is estimated at 5.7% over the next five years.
The high demand for fast internet connectivity has attracted new participants to the industry increasing competition. To stay relevant, companies will need to provide bundled services and consistently improve their networks to deliver faster internet speeds.
Verizon is the third largest participant with market share of 12.6%, Comcast is the second largest with 20.3% and AT&T is the largest with 34.2%. VZ is aiming to gain market share by providing superior technology with the deployment of their FiOS network. FiOS Internet can be ordered with speeds of up to 150 Mbps downstream and 35 Mbps upstream, which is currently the fastest mass-market broadband service in the United States. They have also strategically bundled services in triple-play and double-play packages that include a combination of wired phone, FiOS TV and internet services.
S.W.O.T.ANALYSIS Strengths
Largest 3G coverage domestically
Offers key wireless products such as the iPhone, iPod and android powered phones Hold a reputation for being “the most reliable network”
Have strong customer service which was recognized by Consumer reports with an award
Control most of the 700 MHz spectrum which is the most effective spectrum currently available to wireless carriers
Their CDMA network allows for multi-tower reception which provides higher quality in wireless services Weaknesses
Currently behind Sprint and T-Mobile in 4G coverage
Required to provide wired services to other carriers at close to cost prices
14
Under constant price pressure from other carriers, specifically T-Mobile Hold a large amount of wired lines which are expected to keep losing revenue Opportunities
Upgrading to LTE technology will position them as a top 4G provider
VoIP and wireless could recapture customers that are dropping their wired voice services Expansion of FiOS network will provide a larger potential market
Acquisition of Terremark will improve their product offerings in the Global Enterprise segment More industries incorporating automated data systems will lead to higher demand for M2M services Threats
Approval of AT&T and T-Mobile could improve AT&T’s network to the same level or past that of Verizon’s Time Warners possible expansion and improvement of their FiOS network could result in VZ losing the
fastest broadband speed
The decline in the renewal of a spectrum license could reduce their wireless market
PORTER’S 5FORCES ANALYSIS Supplier Power
New innovative wireless products are a driver for any carrier’s wireless revenues as they retain and attract new customers. As was clear with the iPhone, a material degree of customers would be willing to switch from one carrier to another due to key product offerings. Suppliers on the other hand have four carriers that are potential buyers, VZ being the largest. I would rate supplier power as medium as suppliers heavily rely on carriers for device sales and vice versa.
Barriers to Entry
There are high barriers to entry in the telecommunications industry due to high fixed cost and constantly large capital expenditures. Even with FCC regulation and requirements, which makes it easier than it otherwise would be to enter, the large fixed cost and constant expenditures keeps entry low. Most new entrants operate only regionally and struggle to deliver the same quality of service as larger carriers with expanded infrastructure.
Buyer Power
Buyer power is medium-low in the industry, if one carrier begins to charge higher prices customer must wait for their agreement to expire or pay a termination fee before switching to another carrier. In rural areas where there might only be one or two carriers that offer services or are optimal due to quality, buyer power is reduced.
15
Threat of Substitutes
The threat of substitution depends on coverage of the other carriers. In rural areas where Verizon tends to deliver better service, threat of substitution will be minimal. In metropolitan areas where even smaller carriers provide services, substitution is greatly increased. Threat of substitutions will also vary among different carriers. If only a few carriers carry key wireless products the remaining carriers will be less likely to provide substitutable products. I rate threat of substitution as moderate for the industry.
Degree of Rivalry
There is a high degree of rivalry in the industry; whenever one carrier lowers the price on their services, others immediately follow to stay competitive. Rivalry between AT&T and VZ is especially high with both airing commercials that attack their weaknesses. Rivalry is one reason that carriers spend large amount in capital expenditures, by having the superior network a carrier can over time attract more customers due to their network quality.
CATALYSTS Upside
FCC announcement that AT&T and T-Mobile acquisition will not be approved Faster implementation of the LTE network than expected
Purchases of new frequency licenses that expand their network
The announcement offering a highly demanded new innovative wireless product Downside
Higher than expected cost to implement the LTE network The approval of the AT&T and T-Mobile acquisition The failure to integrate newly acquired Terremark
COMPARABLES ANALYSIS
The purpose of a relative evaluation to determine the price a company should be trading at based on the multiples of the selected comparables. The selected comparables should therefore be similar investment opportunities in respect to risk and return. To fall in line with the principles of a relative evaluation the criteria I used for selecting companies were their exposure to similar risk factors such as industry and business specific, growth expectations, and related services.
To calculate an implied price, EV/EBITDA, EV/Gross Profit and EV/Revenue were all used. Bottom line multiples are generally better in terms of comparison since they are more indicative of cash flows which is why I weighted the bottom line multiples more than revenue. I will now go over the companies I chose as comparables.
16
AT&T, Inc. (T), 60%
AT&T provides telecommunications and internet services domestically and globally. Its dominant services currently include landline voice, wireless voice, data communication, U-Verse television, high-speed broadband and VoIP. They have over 95.5 million wireless customers, just ahead of Verizon Wireless 94.1 million, and a total of more than 210 million customers. They operate and compete in every industry with VZ. Both companies have similar business structures and operate in the same geographical areas both domestically and globally. From 2007 to 2010 AT&T had exclusive rights to carry the iPhone which gave them an advantage in product offerings. Now that VZ also offers the iPhone, that advantage has been stripped away.
I chose to rate AT&T at 60% due to the fact that they operate in the same industries with comparable market shares, offer similar products and have similar business structure. The only clear differences are brand image and physical network technology.
Comcast Corporation, (CMCSA), 30%
Comcast Corporation operates primarily in the internet service and cable and VoIP industry. The company bundles its voice, cable and internet services to provide one low monthly rate to increase customer base. It is the largest cable provider in the US, with almost 47 million subscribers. Comcast's cable systems serve 22.9 million video customers, 16.7 million high-speed internet customers and 8.4 million phone customers.
Verizon’s wired segment directly competes with Comcast’s services. They both offer bundled packages at competitive prices. Comcast’s continued improvements to their network are setting the stage for a comparable alternative to VZ’s FiOS network speeds. Though both companies are exposed to similar industry risk, Comcast is expected to grow faster than VZ in the upcoming year. Due to the difference in growth rates I gave them a weighting of 30%.
Time Warner Cable Inc. (TWC), 10%
Time Warner Provides video, data, and voice service over its broadband cable systems to residential and commercial customers in the United States. TWC has an advanced nationwide system of hybrid fiber cable. They also use double, triple and quadruple packages as a way to increase their customer base by attracting new customers with a single low rate. TWC has been successful in attracting a large number of cable internet subscribers and achieving large year-on-year revenue gains. They are currently pursuing a 4G platform that would allow them to provide wireless internet to consumers.
VZ’s advanced FiOS wireless network faces direct competition with TWC fiber network which, if improved, is capable of matching VZ’s internet speeds. TWC also provides similar packages of goods that directly compete with the packages offered by VZ. TWC is projected to grow faster than VZ, but are exposed to similar industry risk and offer comparable product leading me to weight them at 10%.
DISCOUNTED CASH FLOW ANALYSIS
Revenue
To project total revenue I separated the company sub-segments and projected each individually. I will briefly discuss projections for each segment.
Wireless – Service Revenues
Voice, data and M2M services are included in this sub segment. Growth in voice is declining due to the high market penetration of voice services. This decline is expected to be offset by growth in data and modest growth in M2M services. As a whole, service revenue will steadily decline but not as quickly as voice by itself.
17
Equipment Revenue
Equipment sales have historically matched service sales in terms of growth. This is understandable because when customer sign up for services they typically purchase equipment on which the service can be used on. I project this same trend going forward.
Wired – Mass Market
With the expansion of the FiOS network that is capable of increasing its internet speeds, mass market revenues are sure to grow modestly. Broadband internet will be the growth driver for this segment while VoIP and FiOS TV are projected to grow slowly.
Global Enterprise
This is one of the largest growth opportunities for VZ, I expect that a large portion of their further acquisitions will be focused on expanding and improving this segment. Even with this growth opportunity, there are other companies that have far more diverse offerings and an established position that will hinder growth in this segment. I projected growth to stay constant at about 3% into the terminal year.
Global Whole Sale
With the majority of revenue coming from wired voice carriers I project this segment to decrease until 2016 where I assume an equilibrium will be established and a small amount of growth will come from new businesses that need a secure wired line.
Other
The majority of services offered in this segment are older technologies that are quickly declining in use. I project these segments to decline to the terminal year.
Corporate:
Verizon states that this line item consists of unallocated corporate expenses, intersegment eliminations recorded, the results of interest in partially owned businesses, pension and other employee benefits related costs. These items are listed under a different line item to distinguish how they are not operationally related. Due to the lack of information provided for this item a historical average was used in projections.
Cost of Revenue
Total COGS were broken down into three categories: wireless, wired, and other. Sub-segment break down was not possible because cost was only given on a total segment basis. There was little information provided on the line item Other so a historical average was used to project into perpetuity. I will briefly explain the projections made for the wireless and wired segments.
Wireless
The cost of service revenues is expected to decrease as more people activate data plans that have higher margins than that of voice. This reduction in cost will be more than offset in the first few years by the higher cost of data ready smart phones, tablets and netbooks. This will lead to COGS increasing to 35% of wireless revenue until 2014 where it should stabilize and trend that way till 2017. As technology advances and becomes cheap, the cost of these products should fall while the percent of data revenue increases in services. These two events will lead to a decreasing COGS from 2017 to the terminal year.
Wired
As revenues from mass market increase, the cost of this segment should steadily decrease as the fixed cost to operate the network is distributed. Global enterprise cost should decline slowly as management seeks to improve cost structure of these services. Global wholesale is a very low margin segment and will be declining which should
18
decrease the cost of the total wired segment. Due to these factors I project the cost of the wired segment to decline rapidly with global whole sale, after 2015 it should level out.
SG&A
SG&A was projected out in a similar fashion as COGS, by segment. The line item Other was also projected with a historical average. I projected that both the wireless and wired SG&A expense would increase at a slower rate than revenues. The slower rate was projected based from company guidance to lower SG&A as a percent of revenue by becoming more efficient.
Tax Rate
Verizon pre-recession tax rate was about 34%; they have currently been receiving state and federal tax credits. Though it’s not certain when the tax benefits will be removed, I projected the tax rate to increase up to 34% in 2014 and remain constant to the terminal year.
Networking Capital
Networking capital was projected using pre-recession historical data. During that time period their capex was relatively comparable to what is projected and they still held a large portion of cash for operations. In my projections I accounted for the higher cash position they had before the recession.
Capital Expenditures
I projected capital expenditures to increase from historical rates to reflect the upgrade from CDMA to LTE across Verizon’s entire network. The increase would last to 2013 and drop down to historical level in 2014 after the upgrade is complete. When analyzing the DCF, it should be clear that Capex is high for the amount of revenue growth. This is not specific to VZ but is an industry trend, carriers must make constant upgrades and improvements to their networks to keep up with more voice and data traffic in a wider area. These upgrades are made to retain and attract customers but the market is already heavily penetrated which results in substantially lower revenue growth from the wireless segment.
Acquisitions
As VZ tries to expand into the global enterprise segment they will be acquiring more companies that don’t pertain to their wireless segment such as Terremark. I believe that acquisition will still play a large role in the improvement of the segment and that acquisitions will also be made as VZ expanded into wireless segment. I trended acquisitions at about 3.5% and declined it into the terminal year.
WACC Premium
The WACC derived a discount rate of 6.91%; this discount rate does not seem to accurately reflect the company’s overall risk exposure. To be more selective, a 1% premium was added to the WACC which brought it to 7.91%. The new WACC was used as the discount rate.
Beta
To determine an appropriate beta, various regressions were ran which are listed in the provided chart. A 3 year weekly beta was selected to reflect Verizon’s sensitivity since its large acquisition of Alltel. I believe this beta gives the best representation of its market sensitivity and risk associated with the company.
Calculated Betas
2 Year Weekly 0.49
3 Year Weekly 0.69
5 Year Monthly 0.65
Hamada - 2 Year Weekly 0.99
19
RECOMMENDATION
Verizon has established it’s self as a market leader in the telecommunications industry with its focus on providing a superior network. They have maintained strong revenue growth and continue to attract new customers despite operating in a highly penetrated environment. Upgrading their network to 4G LTE technology that will be delivered over the efficient 700 MHz spectrum will position them as the top provider in 4G wireless.
My Relative analysis yields a price of $60.93 while my Discounted Cash Flows model derived a price of $41.30. I decided to weight my DCF at 70% and my relative analysis at 30% which gave an implied price of $47.19. This results in an undervaluation of 27.57%, which leads me to recommend a HOLD for all portfolios.
20
21
22
APPENDIX 3–DISCOUNTED CASH FLOWS ANALYSIS ASSUMPTIONS
23
24
APPENDIX 6–HAMADA BETA
APPENDIX 7–SOURCES IBIS World Martketwire Yahoo! Finance Factset SEC.go http://www22.verizon.com/investor www.fcc.gov Consumer Reports Computer magazine Bloomberg
