Verizon (NYSE:VZ) posted an yet another set of strong Q2 2012 results on July 19th. The largest wireless carrier in the U.S. reported a healthy 3.7% y-o-y growth in revenues, bolstered by a strong 18.5% growth in wireless data revenues. More importantly, however, the carrier was able to grow its operating income by more than 15% by managing its subsidies and other expenses well. Despite a saturated wireless market, Verizon was able to add 888,000 postpaid connections in the quarter, substantially higher than the 501,000 net adds posted last quarter. 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.
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ARPU rises on growing smartphone penetration
A saturated wireless market caused postpaid net additions to slow down. Postpaid net additions for the quarter came in at 888,000, a more than 29% drop over the same period last year. However, this was still substantially higher than the 501,000 net postpaid adds posted last quarter, probably bolstered by the first full quarter of sales of the new iPad. Tablets bring in a lot less revenue per user but are more profitable due to the lower subsidies on offer.
With the wireless industry getting more saturated, the focus has shifted from acquiring new subscribers to converting more of their existing base to smartphones. Verizon said that about 73% of all retail postpaid phone sales this quarter were smartphones with 40% of those upgrading being first time smartphone buyers. This helped increase its smartphone penetration within the postpaid subscriber base to 50%, up from 47% at the end of the first quarter 2012. Increasing smartphone penetration helped drive postpaid ARPUs, as smartphone users are usually heavy data users as well. Verizon’s data revenues soared more than 18% and postpaid ARPU grew 3.7% over the same period last year.
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. However, Verizon has been able to manage its expenses well, driving operational efficiency through initiatives such as the $36 upgrade fee and the sale of tablets such as the new iPad at unsubsidized rates. (See Verizon Introduces Smartphone Upgrade Fee; Looking For iPhone Subsidy Relief) Wireless EBITDA margins saw a sequential rise of 270 basis points to a record high 49% this quarter.
Share Everything Plans
A slowdown in subscriber growth has caused Verizon to explore new growth areas in other non-smartphone connected devices such as M2M, telematics, tablets and e-readers. The carrier recently acquired Hughes Telematics to further its connected device ambitions. (See Verizon Picks Up Hughes Telematics For Connected Devices Push) The recent launch of multi-device data share plans called the Share Everything plans was also done to get users to add more of these connected devices to the carrier’s wireless network. While this might decrease the average revenue per device seeing as these connected data-only devices consume much less data, as users connect more devices to the wireless network, Verizon will be able to draw more revenues from each individual subscriber. Moreover, since their data consumption is low, it will help shore up the service margins for Verizon.
The focus on margins is also evident from the fact that Verizon has prohibited its unlimited plan users from availing smartphone subsidies in case they want to continue using their plans. (see Verizon’s Share Everything Plans Could Kill The Last Unlimited Plans) This, we believe, is a step in the right direction since it will help Verizon more efficiently manage network resources that are not exactly unlimited in nature and monetize every bit of data transferred through its pipes. The limited nature of spectrum is evident from the spectrum crunch that the industry is currently facing, and we believe that Verizon is likely to get its cable spectrum purchase approved by the FCC and will be able to use it to augment its LTE buildout. (see Verizon Likely To Receive FCC Approval For Cable Spectrum Purchase)
LTE adoption rises steadily
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 2.5 million 4G LTE smartphones this quarter, which is about 16% more than it did in the first quarter. This increased LTE adoption at the end of Q2 to 12% of its postpaid subscriber base, up from about 9% last quarter. While LTE adoption has so far been sluggish, we expect the launch of the iPhone 5 later this year will be the tipping point with Verizon’s leading LTE coverage providing it with a good marketing ploy to drive LTE adoption rates further.
Increased adoption of 4G will reduce dependence on Verizon’s 3G networks, which are under great strain due to heavy data usage by smartphone users. Also, LTE as a network technology not only supports higher speeds but is also more efficient than the current 3G networks at handling data, improving margins by reducing maintenance and handling costs. Further, higher LTE speeds will see subscribers increasingly use data-intensive applications on their smartphones. This will drive data revenues, thereby increasing ARPU levels for Verizon over the coming years.