Verizon’s Q4 Results Boosted By Subsidy Controls And LTE Growth As Competition Looms

by Trefis Team
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Verizon (NYSE:VZ) announced a strong set of Q4 2013 results on January 21st, as healthy subscriber growth and cost controls helped the company post strong bottom-line growth and alleviated competitive concerns for the time being. The largest wireless carrier in the U.S. added about 1.6 million postpaid connections during the quarter, sequentially higher by about 70% on strong smartphone sales during the holiday season. However, higher smartphone subsidies caused wireless EBITDA margins to decline by around 410 basis points over the previous quarter. The subsidy effect was more than offset by the cost-cutting measures and subsidy controls that Verizon has put in place over the past year, as wireless margins improved by about 560 basis points over the year-ago quarter. The more efficient cost structure prepares Verizon well for the coming years as new subscribers become increasingly tough to find in a saturated market and rivals such as T-Mobile and Sprint (NYSE:S) further bridge the 4G LTE coverage gap with the industry leader.

The carrier has also reduced its pension obligations by about $6 billion due to changes in actuarial assumptions and a higher than expected return on its assets. We have updated our price estimate for Verizon to $53, about 10% ahead of the current market price.

See our complete analysis for Verizon

Verizon Faces Market Share Headwinds In 2014

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 higher-margin data plans, very tough for the wireless carriers. Although Verizon’s postpaid subscriber additions received a boost from the holiday season, they were about 25% less than the same period last year. Verizon’s lead in LTE coverage has proved to be a key differentiator for the carrier in helping it bolster its postpaid market share in recent years. With rivals gradually decreasing the coverage gap, however, Verizon’s net adds seem to be slowing down slightly.

In 2012, Verizon racked up 5.1 million postpaid net adds versus AT&T’s 1.4 million for the full year. The gap decreased in 2013, with Verizon’s postpaid net adds dropping to 4.1 million and AT&T’s reaching 1.2 million by the third quarter itself. Verizon is adding data capacity to its existing LTE markets in a bid to stay ahead of rivals. However, competition in the 4G market is on the rise with rivals such as Sprint looking to deploy a much faster LTE network in the coming quarters. Sprint’s Spark strategy, which was launched recently to deploy Clearwire’s spectrum in areas with high data traffic, promises to offer 4G speeds of 50-60 Mbps to about 100 million PoPs by the end of the year. Additionally, T-Mobile’s resurgence with its aggressive ‘Uncarrier’ promotions could increase competitive pressure on Verizon in the coming quarters.

Verizon Scales Back Subsidies

Either way, it is a good sign that Verizon continues to convert more of its existing base to higher-ARPA (average revenue per account) smartphones. Verizon said that almost 89% of all retail postpaid activations this quarter were smartphones, with 23% of those upgrading being first time smartphone buyers. This helped increase its smartphone penetration within the postpaid subscriber base to more than 70% – up from 58% at the start of the year. Increasing smartphone penetration helped drive postpaid ARPA, as smartphone users are usually heavy data users as well. Verizon’s postpaid ARPA grew to over $157 in Q3 2013, about 7.1% 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 the iPhone 5S 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. In Q4, Verizon activated only 8.8 million smartphones, about 10% fewer than the year-ago quarter. As a result, Verizon’s wireless EBITDA margins in 2013 increased almost 300 basis points over the previous year.

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 almost 7.7 million 4G LTE smartphones this quarter, 20% more than what it did in the year-ago quarter. This increased LTE adoption at the end of Q3 to 44% of its postpaid subscriber base, up from about 23% a year ago and 38% the previous quarter. LTE adoption has picked up well in the past year with the launch of the new iPhone and other LTE-capable smartphones such as the Galaxy S4, and Verizon will be looking to market its industry-leading LTE coverage and drive LTE usage further in 2014.

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 two-thirds 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 ARPA levels for Verizon over the coming years.

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