- Published: 29 July 2016 29 July 2016
Takeaways: The strike contributed but fundamental problems remain. They have been cutting capex since 2007 and they no longer have a major edge in quality. VZ is and will be a very profitable company, but maybe not worth $200B. Wireless data growth is way down (< 40%) as I've been forecasting for several years. 5G Highband will start rolling for fixed wireless in 2018, but probably slowly. It will not add to earnings until well into next decade. The CFO forecasts very slow revenue growth. McAdam thinks best quality, video and IoT growth, and large content revenue will solve these problems. I raise doubts.
Here's the longer version.
"FCF in the quarter was not sufficient to fund the dividend ($2.3bn)," notes Brett Feldman of Goldman Sachs. Craig Moffett calculates, “Verizon and AT&T’s real leverage ratio [3.5x EBIDTA] is well outside of what is typically considered investment grade.” Each pay about $10B in dividends each year.
I'm sure Brett and Craig would agree with me that both companies will continue to be extremely profitable; the question is whether those profits are enough to justify $200B in market cap despite $200B in liabilities. There is little or no growth in telecom. Verizon CFO Shammo projects Verizon growth in 2017 at about the rate of national economic growth.
This is not a sell call. I look at longer term factors and leave market timing to Craig, Brett, John Hodulik, Simon Flannery etc.
Verizon has significantly cut capex, from 18.7% of revenue in 2007 to 15.5% in 2016. Just to keep up with 16% inflation, the $17.5B 2007 capex would have to be over $20B in 2016. It will be ~$17.5. Shammo implied the low capex will continue. "We remain on track to return to our pre-Vodafone credit rating profile by the 2018 to 2019 timeframe," he promises. Bringing capex back would reduce cash flow and make a credit upgrade highly unlikely.
McAdam confirmed they will have (very modest) revenue deployments of highband 5G in 2018, probably the first in the world. This will only be fixed wireless. "We believe that 4G will be the base layer of our Wireless network for years to come." 5G won't have a major place until 2022-2024. Wireless data growth per subscriber is dramatically slowing to under 40%. 44% data growth includes some new smartphone users.
Verizon's primary business strategy is to charge more because they have a much better network. Network quality is the first of McAdam's three tiers. The second is video and IoT; the third is making money off content. All have issues.
- Verizon still has a better wireless network, but the differences are too small to matter to most people. They had a big lead around 2010, when they built the world's first large LTE network. Since then, AT&T has almost caught up. T-Mobile is faster in the latest New York City tests. Many people don't want to pay more for a slightly better network. DOCSIS is catching up to FiOS; my connection is 200/20 and cablecos are going to a gig downstream. Cable upstream will continue to lag, however.
- Lowell is fooling himself when he says, "This dedication to network quality has created the best Wireless network in the world. Compared to more than a dozen networks around the world, Verizon's network sucks. From the Philippines to Germany, LTE speeds from 100 to 300 megabits are common. Verizon is mostly 6-20 megabits. Their ~50,000-60,000 cell sites are about half as many as Telefonica in Spain and a third as many as China Mobile, adjusted for population. They've also cut capital spending ~15% since 2007. They haven't been using carrier aggregation for the much higher speeds of other telcos.
- The pr from their likely world's first highband 5G will be important, but 5G will lose money until well into the next decade. Cash flow will be seriously negative during construction and until the network is loaded at scale.
On video and IoT:
- Verizon lost $billions in the 1990's when they cut deals with Hollywood producers for an ADSL network dedicated to video downloads. They never built it. A few years later, Verizon went again to cut movie deals for their apartment building DSL, announced they were going ahead, and canceled the project when they discovered how much Hollywood was demanding. FiOS video works fine, except for the awful set top, but probably is still losing money after a decade.
- They've bought AOL & Yahoo for about $5B each. Both had lost $billions on their video programs. Verizon is highly unlikely to turn that around enough to move the profit needle very far on a $115B company.
- IoT will be huge but it's not clear the telcos will make a lot of money from it. 80% of wireless data today goes over Wi-Fi, not LTE networks. They are nearly ubiquitous indoors and ready to spread outdoors. They are generally free and more than enough for the vast bulk of IoT needs. Except for moving vehicles, centralized networks (electric meter reading) and a few specialized applications, why would people pay the telcos a lot of money for something they can do for free?
On making lots of money from content:
- Verizon hasn't proven they can beat Google & Facebook on this.
- Verizon and most other telcos have failed dismally when they went into the content business.
- Most online content businesses, except Facebook and Google, are too small to be a growth engine for a company Verizon's size.
On the Yahoo deal, Om asked why Verizon thinks they can do a better job selling ads than Yahoo could itself. I answered:
1- They think Tim Armstrong is an ad sales genius.
2- They think net neutrality will fail and they can slow down Facebook & Google
3- They have research that most web video users are young and think no one else knows that.
4- $5B is so little for VZ ($111B/year) substance doesn't matter,
5- They are deluding themselves, like when Lowell said VZ has the best wireless network in the world when dozens are better today. I think #5
We have spoken to you before about our three-tier strategy. First, sustaining quality and performance leadership in all of our networks; second, in building new ecosystems around our broadband, video, and Internet of Things global platforms; and finally, monetizing our investments in networks and platform through applications and content. I'm very pleased with the progress that we are making across all of these fronts.
For us, delivering the promise of the digital world begins with network leadership, which has been the cornerstone of our brand since we formed Verizon in 2000. Our 4G LTE network consistently leads all external studies for quality and reliability across the country, even with the explosive growth of data usage.
Over the last 16 years we have grown from approximately 25 million customers using Wireless almost exclusively for voice services to more than 110 million customers using Wireless for mostly data services. In the second quarter alone network usage increased 44% over the prior year. We believe that 4G will be the base layer of our Wireless network for years to come.