Verizon Earnings Preview: Postpaid Subscriber Adds, Churn In Focus

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Verizon (NYSE:VZ) is set to report its Q1 earnings on Tuesday, April 21. In the previous quarter, the carrier’s healthy wireless subscriber growth helped overall operating revenues increase by 4.3% year-over-year (y-o-y) to about $33.2 billion. The wireline business reported a marginal slump in total operating revenues, although consumer revenues grew by 4.1% y-o-y on strong FiOS Internet and Video subscriber adds. Notwithstanding postpaid subscriber gains, the company reported a net loss of $2.23 billion in the quarter compared to a profit of over $5 billion a year ago, on account of higher pension costs and liabilities related to other post-employment benefits. In terms of subscribers, the largest wireless carrier in the U.S. added about 2 million postpaid connections during the quarter, including 1.4 million tablet connections.

For the first quarter, we expect the company to report robust postpaid gross adds driven by growth in tablet connections. Verizon’s postpaid gross adds in Q1 2014 and Q4 2014 were 539,000 and 1.98 million, respectively. However, growing competition and the ongoing price war in the U.S. wireless market could continue to put pressure on Verizon’s EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) margins. We also expect the company’s churn rates to be almost flat y-o-y (1.07%) as the company’s network quality advantage and pricing cuts are offset by rising competition. [1] ((Press release, Verizon, Dec 8 2014)) [2]

We have a price estimate of $56 for Verizon’s stock, which is over 10% ahead of the current market price.

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“More Everything” Adoption, Data Usage Per User In Focus

Verizon introduced an upgraded 4G network last year to improve its network quality, retain existing users and attract new subscribers. The upgraded LTE network, XLTE, has already been launched in over 400 cities and can potentially be twice as fast as Verizon’s existing 4G network, depending on user location. [3] This helped Verizon in being ranked as the best overall network in the U.S. in the latest mobile network performance report by RootMetrics, leading all other carriers in reliability, network speed, data performance as well as call performance.

After lagging behind rivals T-Mobile (NYSE:TMUS) and AT&T (NYSE:T) in adding new subscribers for several quarters, Verizon added about 1.4 million postpaid connections during Q2 2014 and reported even better performances in the third  and fourth quarters. In full year 2014, Verizon added about 5.5 million postpaid subscribers compared to AT&T’s 3.3 million, T-Mobile’s 4 million and Sprint’s (NYSE:S) loss of about a million postpaid subscribers.

Considering that Verizon was not as aggressive with its marketing or plan pricing in 2014 as its rivals, its subscriber addition figures are reflective of the fact that customers are willing to pay a premium for better network quality. It also suggests that network quality is as important a factor in attracting customers as competitive pricing, which is likely to continue to benefit the carrier going forward.

To effectively compete in the saturated U.S. wireless market, Verizon made its first big move in February last year when it renamed its “Share Everything” data plans “More Everything”, increased the data allocation for subscribers and started offering heavy discounts. These “More Everything” plans were immensely popular, as evidenced by the fact that 61% of all postpaid accounts on Verizon’s network were using these plans by the end of 2014, up from 46% in 2013 and 57% in Q3 2014.

Verizon benefited from offering these discounts, as subscribers started adding more mobile devices to their shared data plans, which eventually encouraged many of them to shift to higher data tiers. However, this was offset by the fact that Verizon offered to increase subscribers’ data usage by providing them at least 50% more data at the same cost in November last year. This was reflected in the fact that its retail postpaid average revenue per account (ARPA) was almost flat in Q4 2014 at about $158 per month, and grew just about 4% for full year 2014 to $160. We expect ARPA to remain flat in the first quarter as well due to mixed impact of the carrier’s superior network quality, discount offerings and higher tablet user adds.

An important implication of giving more data to users was that average data usage per user increased by 50% in 2014. This is arguably the most important metric for carriers in the U.S., considering that there is little scope for subscriber additions, and data use will likely provide the basis of most future top line growth. We will keep an eye on this metric in the upcoming first quarter results. [4]

Competition To Hurt Churn

Competition has been intense in the U.S. wireless market in the past few quarters, with Sprint’s race-to-the-bottom pricing strategy and innovative low-cost offerings such as the “Cut your bill in half” event, “Double the Data” and “iPhone for Life”. T-Mobile also continued to innovate around its “Uncarrier” initiatives and AT&T cashed in on the price sensitive market sentiment with its equipment financing plans (“Next”).

Although Verizon has done well in adding new subscribers to its over 108 million strong subscriber base in this competitive environment, its churn rate is likely to be negatively impacted as price-sensitive customers switch to other less expensive service providers. The carrier has reported a retail postpaid churn of about 0.94-1.14% in the past several quarters and we expect its churn figures to remain towards the higher end of that range in the first quarter 2015.

Impact Of “Edge” Adoption On Margins

Verizon’s wireless segment EBITDA service margins declined by 100 basis points year-over-year to 48.5% in 2014, on account of rising competition, higher promotional activity and lower adoption of the company’s no-subsidy “Edge” plan. The percentage of subscribers opting for the company’s “Edge” plan declined from about 18% in Q2 2014 to about 13% in the third quarter before rising to about 25% in Q4. Management stated in January this year that adoption rates of the “Edge” plan were expected to rise to 35% in Q1 2015. While this will have a positive impact on wireless service margins, higher discounts and promotional activities to counter aggressive marketing by rivals are likely to offset such gains.

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Notes:
  1. Press Release, Verizon, Jan 6 2015 []
  2. Analysts: T-Mobile, AT&T likely to hold onto more customers in Q1 than Sprint, Verizon, Fierce Wireless, March 24 2015 []
  3. Press Release, Verizon, PRNewswire, Sept 18 2014 []
  4. Verizon Quarterly Reports []