Verizon Reports Strong Q1 Earnings Amid Sluggish Subscriber Adds

Verizon (NYSE:VZ) announced a mixed set of Q1 2015 results Tuesday, as healthy wireless subscriber growth in the prior twelve month period helped overall operating revenues increase by 3.8% year-over-year (y-o-y) to about $32 billion. The wireline business reported a 2% slump in total operating revenues, although consumer revenues grew by 4% y-o-y on strong FiOS Internet and Video subscriber adds. The company’s consolidated EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) rose by 5.8% y-o-y to $11.9 billion and its adjusted EBITDA margins also expanded by 60 basis points to 37.4%. ^[1]

Although the company managed to improve its top line as well as bottom line in a highly competitive environment, its subscriber gains in the quarter were not so impressive. The largest wireless carrier in the U.S. added 565,000 retail postpaid connections during the quarter, including 820,000 tablet connections and 247,000 net smartphones adds. However, its net postpaid phone additions were negative 138,000, as the carrier witnessed a decline of 385,000 basic phones. In addition, Verizon’s prepaid subscriber base declined by 188,000 in the quarter. By the end of March 2015, Verizon’s postpaid and prepaid subscriber base stood at 102.6 million and 5.95 million, respectively. In wireline, Verizon added 133,000 net new FiOS Internet connections and 90,000 net new FiOS Video connections in Q1, taking its total subscriber base to 6.75 million and 5.74 million, respectively.

Verizon’s retail postpaid churn, at 1.03%, improved both sequentially and y-o-y in the quarter as the carrier effectively managed competition from AT&T (NYSE:T), Sprint (NYSE:S) and T-Mobile. This was marginally better than Verizon’s postpaid churn of 1.04% in full year 2014. The carrier also generated strong cash flows, which enabled it to invest $3.7 billion in capital expenditures (CapEx) and return over $2.2 billion to shareholders in the form of dividends. Verizon estimates its CapEx to be in the range of $17.5-18 billion in 2015.

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

See our complete analysis for Verizon

Data Usage Soars In “More Everything” Accounts

Verizon added 565,000 postpaid connections in the seasonally low-volume first quarter. This quarter is generally low-volume in terms of new user adds and phone upgrades because the previous quarter (Q4) witnesses a lot of device sales on account of holiday season promotions and new device launches. Verizon added over 2 million postpaid connections in Q4 2014 after having added about 3.5 million postpaid connections in the first nine months of the year. At the end of March 2015, its total subscriber base stood at 108.5 million connections.

The rapid increase in subscriber adds last year can be attributed to the carrier’s innovative plan offerings, especially its “More Everything” data plans. These plans offer higher data offerings and incentivize customers to share their plans with family and friends by making the addition of members cheaper. The popularity of “More Everything” plans can be gauged from 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 the previous quarter.

In addition, the average data usage per account within “More Everything” accounts increased by 54% y-o-y in Q1 2015. This directly helped the carrier increase revenues as well as profitability because LTE networks are much more efficient than older 3G and 2G networks, and help realize higher data usage at lower cost.

Wireless ARPA Falls

Verizon benefits from offering discounts under its “More Everything” plans as subscribers are incentivized to add more mobile devices to their shared data plans, which encourages them to shift to higher data tiers. However, Verizon’s gains from such discounts were offset by the fact that it offered to increase subscribers’ data usage by providing them at least 50% more data at the same cost in November last year. For instance, Verizon increased the data usage limit of its $80 plan from 6 GB to 10 GB, and of its $100 plan from 10 GB to 15 GB.

Owing to higher discount offerings in monthly service plans as well as higher uptake of the carrier’s no subsidy “Edge” plan, its retail postpaid average revenue per account (ARPA) declined over 2.2% y-o-y to slightly above $156 at the end of March 2015. However, an important implication of giving more data to users was that average data usage per user increased dramatically. This is arguably the most important metric for carriers in the U.S. currently, considering there is very little scope for subscriber additions, and data use will likely provide the basis of all future top line growth. ((ref:1))

“Edge” Adoption Helps Protect Wireless Margins

Verizon introduced the Edge plan in 2013 to aid customers in upgrading their handsets without waiting extended periods of time or having to pay a high upfront cost. The Edge scheme created a win-win situation for both users and the carrier. While subscribers benefit from faster smartphone upgrades as well as discounts on their monthly service plans, the carrier benefits from reduced handset subsidies as the customer ends up paying the full retail price of the smartphone (in installments).

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 2014. This rose to 39% in the first quarter this year and management stated that it was currently reported to be near 50%. Since the customer ends up paying the total cost of the handset, there is a lower burden on the carrier in terms of handset subsidies to be paid. The reduced handset subsidies help improve carrier margins, which was evident last quarter with Verizon’s EBITDA margins on total wireless revenue remaining flat at 44.8% despite lower service revenues and higher promotional activity.

Going forward, we expect margins to improve as adoption of the Edge plan further increases from its current 50% levels. However, aggressive discount offerings and price/tariff reductions from rivals could push Verizon into a price war, which is likely to offset most of the Edge plan margin gains.

FiOS Drives Wireline Consumer Sales

Verizon’s wireline revenues have remained under pressure over the last six years owing to growing competition in a largely saturated market. This trend was witnessed in 2014 as well, with overall wireline revenues remaining flat at around $38.4 billion. In Q1 2015, overall wireline revenues declined 2% y-o-y to $9.47 billion on lower Enterprise and Wholesale sales.

The Consumer business, which provides broadband and video services (including FiOS), reported an increase of 4% in sales in the first quarter y-o-y to about $4 billion. FiOS now represents about 78% of total consumer revenue and it recorded double-digit revenue growth in the quarter (10.2%), driven by strong customer additions, innovative pricing actions as well as growing adoption of its recently introduced high-speed Quantum service (Internet speeds of 50-500 Mbps). By the end of March 2015, about 62% of the carrier’s Internet subscribers had subscribed to the Quantum service, up from 51% at the end of Q1 2014 and 59% at the end of Q4 2014.

On the cost side, the company’s Wireline EBITDA margins reported a y-o-y improvement in the quarter to come in at 22.7%. We expect the wireline business to improve its sales and expand margins going forward, as the company expands its FiOS offerings and works towards streamlining the business.

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1. Q1 2015 Earnings Transcript, Seeking Alpha, April 21 2015 [↩]