Verizon Q3 Preview: Postpaid Adds, Churn In Focus As Rivals Step Up Promotional Activity

Verizon (NYSE:VZ), the largest U.S. wireless carrier, is scheduled to publish Q3 2015 earnings on October 20. ^[1] The U.S. wireless market has been contending with increasing saturation and that competition likely mounted during Q3, with the increasing promotional activity surrounding the launch of Apple‘s (NADAQ:AAPL) new iPhone 6S, as well as growing signs of subscriber stabilization at Sprint (NYSE:S), which had been a source of new subscribers for larger carriers in the past. While Verizon has largely held its ground in recent quarters by focusing on network performance and high quality customer adds, it was recently forced to slash its 2015 revenue growth guidance from 4% to 3%, owing partly to discounting and offers from rivals. In this note, we take a look at some of the key metrics that we will be watching when the company publishes earnings Tuesday.

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

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Customer Adds Could Face Pressure On Rivals’ Promotional Activity

Verizon has been posting decent levels of subscriber growth in recent quarters. During Q2, the carrier reported 321,000 handsets adds, while overall postpaid adds (including less lucrative tablet adds) came in at 1.134 million. ((Verizon Delivers Double-Digit Adjusted Earnings Growth and Strong Cash Flows in Second Quarter)) Churn figures were equally impressive at 0.90%. However, we believe that the metrics could face some pressure in Q3 for two reasons. Firstly, Sprint, the fourth largest wireless carrier, has been improving its network quality while stemming its subscriber losses. Sprint’s platform postpaid subscriber losses narrowed to just 12,000 during Q2, while its post paid churn rates rate improved by 0.49% y-o-y to 1.56%. The lower defections could potentially reduce the supply of new customers for top-tier carriers like Verizon. Secondly, there was a flurry of promotional activity in the industry towards the end of Q3, with the launch of Apple’s new iPhones. The smaller two carriers – Sprint and T-Mobile – came up with particularly innovative plans, offering the new iPhones for just a few dollars a month under trade-in schemes (related: Why The $1 A Month iPhone 6S Offer Could Be Great For Sprint). Verizon’s offers, in contrast, were perceived as being somewhat conservative. While offers from rivals are less likely to have swayed Verizon’s high-quality subscriber base or impacted churn numbers, it’s possible that it could have limited new customer additions.

ARPA Growth Could Remain Sluggish 

Average revenue per account (ARPA, also referred to as Average Revenue Per User) is among the most important valuation drivers for wireless carriers. There are a couple of trends playing on Verizon’s ARPA metric currently. Verizon has been seeing growing data usage, as more customers adopt LTE services. During Q2, 4G LTE devices as a percentage of postpaid customers grew to 73.3% from about 54.5% last year, while smartphone penetration grew to 81%, up from 75% a year ago. Verizon has noted that overall traffic on its LTE network has also nearly doubled in the past year. However, despite the higher data consumption, Verizon hasn’t been able to improve its ARPA meaningfully due to discounting. During Q2, retail postpaid ARPA plus installment billings was up by just 1% y-o-y. That said, we believe that Verizon should be able to improve the metric in the long-term, given its focus on network quality and its drive to add more tablets and connected devices to each account.

Uptake Of Equipment Installment Plans

Like the rest of the U.S. wireless industry, Verizon has moved in favor of equipment installment plans. These plans help carriers lower upfront handset subsidies, as customers pay the full retail price of the smartphone in installments, in return for not having to sign on to a wireless contract. During Q2, the take rate for the company’s Edge equipment installment plans remained solid, with the percentage of phone activations on the plan standing at 49%, compared to levels of about 39% in Q1. The number could rise further, considering that the carrier said that it would be doing away with its mobile device subsidies for all new users beginning in mid-August. The higher mix of installment plans could have some transitional effects on Verizon’s operational metrics. While it should effectively reduce ARPA for postpaid subscribers, due to the shift of some of the equipment related revenues out of service revenues, it could help wireless margins due to a smaller mix of low-margin handset revenues recognized under service revenues.

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1. Verizon Investor Relations [↩]