Strong Customer Retention Drives Verizon’s Q3 Earnings

Verizon’s (NYSE:VZ) third quarter earnings beat market expectations, as the carrier benefited from improved customer retention and decent postpaid subscriber adds for its wireless business, as well as strong uptake of its FiOS services. The results are encouraging, as they come at a time when smaller rivals such as Sprint and T-Mobile have stepped up promotional activity, as they court an increasingly limited number of new customers in a mature U.S. wireless market. Below we review the performance and outlook for the carrier’s wireless business and take a look at the progress that it is making in two emerging businesses – wireless over-the-top services and advertising, and the “Internet of Things.” ^[1]

We have a price estimate of $56 for Verizon’s stock, which is 25% ahead of the current market price.

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Wireless Business Rides On Customer Loyalty

Verizon posted 430,000 postpaid phone net additions for the quarter, as net smartphone additions of 694,000 were partially offset by a net decline of feature phones. Tablet net adds, which are comparatively less lucrative, came in at about 818,000. Customer retention metrics remained particularly strong, with retail postpaid churn standing at 0.93%, marking a year-over-year improvement of 7 basis points. This indicates that Verizon’s focus on a higher quality customer base and its solid network performance and coverage are allowing it to largely insulate itself from the aggressive device and service offers that smaller rivals have been promoting in recent months.

While loyalty remains strong, Verizon may be making some concessions in terms of its service revenues. Wireless service revenues fell by about 4.1% year-over-year to $17.1 billion, although equipment revenues rose to $4.3 billion, up from $2.5 billion, as more customers chose to adopt equipment installment plans (58% take rate in Q3). With installment plans, carriers typically lower the cost of monthly service fees and make customers pay for their handsets separately in installments (or buy them outright). The service revenue plus installment billings metric (which is a more apt measure for comparing growth numbers as the company transitions to installment plans) rose by about 1.2% year-over-year. However, considering that the carrier’s retail postpaid subscriber base rose by 4.9% year-over-year, it indicates that per-account revenue metrics declined on a year-over-year basis.

Wireless margins rose by about 1.6% year-over-year to 43.2%, possibly driven by the lower churn figures (which help control customer acquisition costs) and the growing base of 4G users. The carrier said that 76% of its postpaid subscriber base was on 4G smartphones as of Q3, up from about 59% a year ago. Increased adoption of 4G should help reduce costs (4G is more efficient at handling data), while incentivizing higher data usage on tiered data plans, allowing for better wireless margins.

Bolstering Internet of Things Revenue Stream

The Internet of Things (IoT) is expected to benefit wireless carriers such as Verizon, as their networks provide connectivity for a growing number of networked devices. Verizon has been expanding its exposure to the space, with IoT revenues standing at $175 million for Q3 and about $495 million year-to-date. Although this is just a drop in the bucket for the carrier – which is on track to post consolidated revenues of roughly $130 billion this year – the IoT space could provide a valuation upside in terms of margins and growth prospects. Verizon has multiple IoT initiatives under way, targeting markets ranging from connected cars to smart city solutions to grid solutions for utility companies, and it’s possible that the connectivity market for IoT will eventually surpass the broader mobile phone services market in terms of number of connections. Margins should also be fairly high, considering the low incremental bandwidth and infrastructure requirements.

Over-the-Top Services And Advertising

Consumers are spending a greater portion of their media consumption time on mobile devices and advertising dollars are shifting away from traditional media onto mobile. Mobile ad spending is expected to grow 50% this year to $28.7 billion, according to research firm eMarketer. ^[2] Verizon is looking to cash in on this trend, recently launching its over-the-top streaming video service Go90. Adoption of the new service is being closely watched by investors, given that the carrier has dedicated considerable resources to building its streaming video and mobile advertising capabilities, via a series of acquisitions over the last two years at a cost of roughly $5 billion. Verizon has noted that the initial feedback for the service has been strong, with engagement levels increasing, despite the fact that it hasn’t been significantly promoted yet. ^[3] Advertising will be the primary revenue driver for the service, and the carrier is expected to leverage the programmatic advertising technologies it acquired with its purchase of AOL earlier this year (related: Will Verizon’s Streaming Video Service Catch On?).

Key Earnings Takeaways and Outlook:

• Total operating revenues rose 5% year-over-year to $33.2 billion
• Adjusted EPS stood at $1.04, compared to $0.89 in Q3 2014
• Year-to-date operating cash flows rose to $28.4 billion, from about $23.2 billion in Q3 2014.
• Wireless capex rose 8.4% y-o-y to $2.9 billion.
• FY’15 consolidated capex projected at $17.5 to $18.0 billion.
• 114,000 FiOS Internet and 42,000 FiOS video net additions.
• Verizon recent noted that FY’16 earnings could plateau, due to the effects of the lower priced wireless service plans, the sale of some wireline assets and its focus on emerging businesses.

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1. 3Q 2015 Quarter Earnings Conference Call Webcast, Verizon, October 2015 [↩]
2. Mobile Will Account for 72% of US Digital Ad Spend by 2019, eMarketer, March 2015 [↩]
3. Verizon Communications (VZ) Q3 2015 Results – Earnings Call Transcript, Seeking Alpha, October 2015 [↩]