Verizon (NYSE:VZ) posted yet an another set of strong Q1 2013 results on April 18th. The largest wireless carrier in the U.S. reported a healthy 4% y-o-y growth in revenues, bolstered by a strong adoption of smartphones and its recently launched Share Everything data plans. More importantly, however, the carrier was able to grow its operating income by almost 20% as wireless EBITDA margins improved to a record high on effective management of subsidies and other expenses. Despite a saturated wireless market, Verizon was able to add 677,000 net postpaid connections in the quarter, up 35% over the same period last year. Meanwhile, LTE adoption continued to rise as Verizon leveraged its LTE coverage lead over AT&T (NYSE:T) and Sprint (NYSE:S) to good effect.
We are in the process of updating our price estimate for Verizon’s stock based on the recent earnings.
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ARPU rises on growing smartphone penetration
The U.S. wireless market has become increasingly saturated with wireless connections having exceeded the population in mid-2011. This has made acquiring new subscribers, especially those that pay for the higher-margin data plans, very tough for the wireless carriers. Despite this, Verizon has banked on its better 4G LTE coverage to do well on the postpaid front in the recent quarters. Last year, Verizon racked up as many as 5.1 million postpaid net adds in 2012 versus AT&T’s 1.4 million for the full year. While AT&T is yet to announce earnings, the trend seems to be continuing this year as well with Verizon adding 35% more postpaid connections in Q1 over the year-ago quarter.
In addition to acquiring new postpaid subscribers, Verizon also managed to convert more of its existing base to the higher ARPU-yielding smartphones. Verizon said that more than 85% of all retail postpaid phone sales this quarter were smartphones with 38% of those upgrading being first time smartphone buyers. This helped increase its smartphone penetration within the postpaid subscriber base to more than 61%, up from 58% at the end of the December quarter. Verizon’s industry leading LTE coverage saw more of the smartphone crowd switch to Verizon (almost 28% of its smartphone activations were new subscribers) than the historical average of 22-24%. Increasing smartphone penetration helped drive postpaid ARPA, as smartphone users are usually heavy data users as well. Verizon’s postpaid ARPA (average revenue per account) grew to over $150 in Q1 2013, almost 7% over the same period last year .
Smartphone sales may increase postpaid subscriber additions and bring in juicy data revenues, but they are also very expensive due to the huge subsidies that carriers provide in return for long-term contract plans. For example, a basic model of iPhone 5 costs around $650 for carriers who then subsidize it heavily to sell the handset for $199. However, Verizon has been able to manage its expenses well, driving operational efficiency through initiatives such as the $36 upgrade fee and the sale of tablets such as the new iPad at unsubsidized rates. (See Verizon Introduces Smartphone Upgrade Fee; Looking For iPhone Subsidy Relief) The carrier has also recently increased the minimum upgrade eligibility from 20 months to 24 in a bid to increase the upgrade cycle and mitigate the margin impact. Wireless EBITDA margins in Q1 saw a y-o-y rise of over 400 basis points to a record high 50.4% this quarter.
Share Everything Plans
A saturated wireless market has caused Verizon to explore new growth areas in other non-smartphone connected devices such as M2M, telematics, tablets and e-readers. The carrier recently acquired Hughes Telematics to further its connected device ambitions. (See Verizon Picks Up Hughes Telematics For Connected Devices Push) The recent launch of multi-device data share plans called the Share Everything plans was also done to get users to add more of these connected devices to the carrier’s wireless network. While this might decrease the average revenue per device seeing as these connected data-only devices consume much less data, as users connect more devices to the wireless network, Verizon will be able to draw more revenues from each individual subscriber. Moreover, since their data consumption is low, it will help shore up the service margins for Verizon.
The focus on margins is also evident from the fact that Verizon has prohibited its unlimited plan users from availing smartphone subsidies in case they want to continue using their plans. (see Verizon’s Share Everything Plans Could Kill The Last Unlimited Plans) This, we believe, is a step in the right direction since it will help Verizon more efficiently manage network resources that are not exactly unlimited in nature and monetize every bit of data transferred through its pipes. Despite the hue and cry over the supposedly complicated nature of pricing that the shared data plans have, 30 % of Verizon’s postpaid base, or almost 28 million subscribers have already switched to one of these plans.
LTE adoption rises steadily
Verizon also saw LTE adoption rates increase this quarter with both LTE smartphones as well as LTE Internet devices seeing a good uptick in volumes. The company sold about 5 million 4G LTE smartphones this quarter, which is more than twice as many as it did in the same period last year. This increased LTE adoption at the end of Q1 to 28% of its postpaid subscriber base, up from about 23% last quarter. LTE adoption seems to have picked up well with the launch of iPhone 5 and other LTE-capable smartphones such as the Galaxy S III, and Verizon will be looking to market its industry-leading LTE coverage better and drive LTE adoption rates further up.
Increased adoption of 4G will reduce dependence on Verizon’s 3G networks, which are under great strain due to heavy data usage by smartphone users. Also, LTE as a network technology not only supports higher speeds but is also more efficient than the current 3G networks at handling data, thereby improving margins by reducing maintenance and handling costs. It is therefore a good sign that almost 54% of Verizon’s data traffic is on its 4G LTE network already. As more people switch to 4G LTE-compatible smartphones, the higher LTE speeds will see subscribers increasingly use data-intensive applications on their smartphones. This will drive data revenues, thereby increasing ARPU levels for Verizon over the coming years.