Verizon (NYSE:VZ) has started the year off on a strong note with solid Q1 2012 results released Thursday. The largest wireless carrier in the U.S. reported revenues of $28.2 billion, about 4.6% higher than the same period last year and net profit that rose more than 17% over Q1 2011. It also showed a healthy growth in its retail subscriber base as well as data revenues, bolstered by growing smartphone penetration. Wireless margins also recovered from the subsidy shock of last quarter’s record holiday smartphone sales. Meanwhile, LTE adoption continued to rise as Verizon leveraged its LTE coverage lead over AT&T (NYSE:T) and Sprint (NYSE:S) to good effect.
Our $42 price estimate for Verizon stock is about 12% higher than the market price.
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ARPU rises and margins recover
Increasing smartphone penetration is helping drive postpaid ARPUs, as smartphone users are usually heavy data users as well. Verizon said that about 72% of all retail postpaid sales this quarter were smartphones. This helped increase its smartphone penetration within the postpaid subscriber base to 47%, up from 43.5% at the end of the fourth quarter 2011. As a result, Verizon’s data revenues soared more than 21% and postpaid ARPU grew 3.6% over the same period last year. Verizon also added more than 500,000 net postpaid subscribers during the quarter.
Smartphone sales may increase postpaid subscriber additions and bring in juicy data revenues but they are also very expensive due to the huge subsidies that carriers provide in return for long-term contract plans. For example, a basic model of iPhone 4S costs around $650 for carriers who then subsidize it heavily to sell the handset for $199. This had wrecked Verizon’s wireless gross margins by close to 500 basis points last quarter, as the fourth quarter last year saw record smartphone sales.
After the frenetic holiday buying seen last quarter, in part due to the debut of the iPhone 4S, we expected a seasonal slowdown in smartphone sales to help Verizon’s margins recover this quarter. True enough, Verizon’s wireless gross margins improved 440 basis points over Q4 2011. Verizon sold 3.2 million iPhones this quarter, as compared to the 4.2 million it had sold last quarter.
Verizon also saw LTE adoption rates increase this quarter with both LTE smartphones as well as LTE Internet devices seeing a good uptick in volumes. The company sold about 2.1 million 4G LTE smartphones this quarter, which is about 30% more it did in the fourth quarter. In addition, Verizon also sold more than 765,000 4G LTE Internet devices, which is again more than last quarter.
The company is currently well ahead of AT&T and Sprint in terms of LTE deployment with coverage in about 230 markets across the U.S and plans to add another 200 by the year’s end. As a result, its capital expenditures have been mounting and Verizon will be seeking to earn a return on that investment as soon as as it can. Higher LTE speeds will also see subscribers increasingly use data-intensive applications on their smartphones, thereby positively impacting data ARPU levels. Since LTE is more efficient at moving data than current 3G networks, we expect Verizon’s network maintenance costs to also reduce as LTE adoption increases.