Reviewing Verizon’s Mixed Q2 Report And Outlook

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Verizon (NYSE:VZ), the largest U.S. carrier, published a mixed set of Q2 2015 numbers on July 21, beating market estimates on earnings although revenue fell short of consensus. On the wireless side, the company posted strong post paid subscriber growth (1.1 million net retail adds) and impressive churn figures (0.90%). However, growth in customer adds for the FiOS service – which the carrier is counting on to shore up its wireline unit – slowed sharply (-70% year-over-year). The company also slashed its full year guidance for 2015, estimating revenue growth of 3% versus its earlier guidance of 4% growth, owing to higher competition and saturation in the U.S. wireless market. Total operating revenue grew by about 2.4% to $32.2 billion, while net income attributable to the company remained almost flat at $4.231 billion. ((Verizon Delivers Double-Digit Adjusted Earnings Growth and Strong Cash Flows in Second Quarter)) Below is a brief review of the company’s earnings and a look at some of the areas that could drive future growth.

We have a price estimate of $55 for Verizon’s stock, which is about 20% ahead of the current market price.

See our complete analysis for Verizon

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Wireless Subscriber Growth Driven By Tablets

Verizon’s wireless business, which accounts for more than 95% of the company’s value by our estimates, saw reasonably strong subscriber growth, with retail postpaid net adds coming in at 1.134 million users. However, this marks a 21% decline in year-over-year adds. Tablets continued to be the primary driver of net adds, with the firm gaining 852,000 tablet connections while the more lucrative handset adds stood at 321,000. ((Verizon Communications (VZ) Q2 2015 Results – Earnings Call Transcript, Seeking Alpha, July 2015)) Postpaid churn numbers were particularly impressive at 0.90%, marking the company’s lowest churn rate in three years. The high customer retention rates indicate that the carrier’s strategy of fending off competition with its focus on network quality and consistent branding, coupled with plans such as More Everything and Edge, is working.

The take rate of the company’s Edge equipment installment plans remained solid, with the percentage of phone activations on the plan standing at 49%, compared with 39% in Q1. Verizon expects the number to come in at close to 60% in Q3. Equipment installment plans help carriers lower handset subsidies, since the customer ends up paying the full retail price of the smartphone in installments in return for not having to sign on to a wireless contract. However, average revenue per account (ARPA) for postpaid subscribers fell by about 3.8% year-over-year to about $153.73. This is likely to be due to the shift of some of the equipment related revenues out of the service revenue number for the Edge plan. However, retail postpaid ARPA plus installment billings (which is a more apt metric for year-over-year comparisons) was up 1% y-o-y.  Wireless EBITDA’s Service margins also saw strong growth, rising from 50.3% to 56.1%, possibly due to a smaller mix of lower margin handset revenues recognized under service revenues.

FiOS Helps Soften Wireline Decline, But Customer Growth Slowed Significantly 

Verizon’s fixed line revenues fell by about 2% year-over-year to about $9.43 billion, due to intense competition and saturation in the wireline market. Verizon has been banking on the FiOS service – which includes broadband, voice and video services – to stabilize its wireline operations and revenues from FiOS grew by about 10% y-o-y. However, the crucial subscriber addition numbers were disappointing. The firm added just 98,000 digital subscribers, marking a 70% year-over-year decline. Moreover, the weak FiOS adds and the high-speed internet attritions meant that overall broadband connections actually fell by about 25,000.

The weak additions are likely due to two reasons. Verizon has been selling a new offering called Custom TV under FiOS, which is essentially a scaled down pay TV bundle that provides fewer TV channels and allows customers to buy particular categories of content that they want to view, rather than buying channels in bulk. However, this hasn’t gone over too well with content providers, and ESPN is notably suing Verizon for a breach of contract. Apparently, advertisements for the service were also blocked by content providers in some large markets, reducing the company’s ability to sign on new customers. Secondly, Comcast and Time Warner Cable have been getting more aggressive with their customer acquisition programs following their failed merger earlier this year, resulting in more intense competition and weaker adds for Verizon.

 So Where’s Future Earnings Growth Going To Come From?

Tablet Additions and Higher Data Consumption: Despite the 800k+ quarterly tablet additions that Verizon has been posting in recent quarters, it notes that its tablet penetration still stands at under 10% of its customer base, allowing room for further growth. While tablets per say are not as lucrative as handset additions, they help to increase data usage (effectively moving customers to higher data tiers on shared plans), while also reducing churn numbers (accounts with more devices are less likely to deflect from the carrier).

Mobile Video And Ads: Viewers are spending a greater portion of their media consumption time on mobile devices and advertising dollars are shifting away from traditional media such as TV and newspapers, onto mobile. Mobile ad spending is expected to grow 50% this year to $28.7 billion, according to research firm eMarketer. Verizon is looking to cash in on this trend, with plans to launch its own over-the-top mobile video service later this summer. Advertising is likely to be primary revenue driver for the service, and this is likely to have been a big factor behind the carrier’s recent acquisition of AOL and its promising programmatic advertising platform.

Internet of Things: Verizon has also been investing in the Internet of Things space at both the network and platform levels, as it looks to drive incremental growth. Areas such as transportation (connected cars), healthcare, and energy industries in particular could be focus areas for the company’s IoT initiative. Revenue streams from the Internet of Things and telematics continued to grow through Q2, totalling about $165 million in the quarter and about $320 million year to date, according to the company.

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