I've either followed or owned Verizon (NYSE:VZ) shares for well over a decade, and as an avid follower of trends in the wireless/wireline industries, there are sure things I want to see and hear from Verizon when it reports earnings. For the most part, Verizon had a solid quarter, but there are two areas that I have a big problem with.
I first noticed in the second and third quarters of last year, when Verizon added 1.1 and 1.5 million new connections respectively, that tablet connections were driving the company's growth. At the time it wasn't a problem, as tablets were still a growing market and typically consumes far more data than smartphones - higher data consumption means more expensive data plans.
However, a lot has changed since then. In the fourth quarter of last year tablet shipments declined 3.2% year-over-year and then nearly 6% in the first quarter this year. Given the fact that iPads account for 25% of the tablet market and saw an 18% decline in shipments during the second quarter, investors can rest assured that tablet shipments will decline once more in the second quarter.
As a result, you can see why the reliance on tablets for growth could become a problem for Verizon. During its second quarter the company added 588,000 new smartphone connections, but it had over 840,000 tablet connections. In a declining market, Verizon investors can't bet on new tablet connections driving its growth long term.
The fact that Verizon is gaining so numerous new tablet connections suggest to me that it is not gaining new customers but rather add-ons to existing service plans. So while Verizon's complete adds look good for the second quarter, keep in mind that the majority comes from a declining market where losses are accelerating.
As many know, there are a lot of big changes in the high-speed broadband space. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Fiber, AT&T (NYSE:T) GigaPower and Comcast's (NASDAQ:CMCSA) (NASDAQ:CMCSK) Gigabit Pro are taking the market by storm, and Verizon's past answer to this new competition has left more questions than answers.
Before explaining, keep in mind that FiOS is one of if not Verizon's fastest growing big business. It accounts for more than 10% of its revenue and grew 10% during its last quarter. FiOS is one of the most developed broadband networks in the country, passing through 20 million premises and penetrating about 40% of that network. The necessary problem with FiOS is that it now faces increased competition from services that provide much faster download speeds at half the cost. The effect of this problem is decelerating new connection growth.
During Verizon's last quarter, it added fewer than 100,000 new connections in video and Internet services combined. This is a steep decline from the first quarter's 223,000 adds and its year ago adds of nearly 240,000. Conveniently, both Google and AT&T have stepped up their efforts to expand high-speed broadband speeds into new markets. Google and AT&T require that future customers pre-enroll in order for the construction to begin. As a result, Verizon may be feeling the effect of Google and AT&T both entering and planning to enter big markets where Verizon's FiOS has been dominant.
With all that said, the big question is what Verizon will do with FiOS? After selling FiOS services in three states to Frontier (NASDAQ:FTR), I figured that Verizon would pursue acquirers for the entire business. According to outspoken CFO Fran Shammo, FiOS divestments will not happen. A couple years ago, I would've been glad to hear such a response, but today, it creates more questions and the lack of transparency still exists.
For example, Verizon has consistently said that capital expenditures in wireline will decline and has made no effort to upgrade the top speeds of FiOS from 500 megabits per second to one gigabit per second. This would cost 10s of billions to achieve, and more than likely, Verizon is allocating its capex to complete the construction of finished areas where FiOS was promised, like sure areas in New York and other metropolitan areas. Moreover, if Verizon doesn't plan to upgrade speeds, will it decrease the price?
Notably, 500 Mbps download speeds are available in just a handful of markets from FiOS, but to get those speeds Verizon's customers must pay north of $250 per month. While this compares decently to the near $300 per month that Comcast is charging for Gigabit Pro, it hardly compares to the $120 that Google charges for Fiber internet and TV services and the advantages that come with such an increase in speeds. In most instances, Fiber's speeds will be well over 10x faster than zenith speeds that Verizon offers in most markets.
As a result, Verizon can either invest to upgrade speeds or cut prices to become more competitive. It can't really compete as is, not as Fiber and GigaPower are being rolled out throughout the country. Yet, Verizon says that it will cut capex, that it's not selling FiOS, and said last year that it won't buy customers with regard to the wireless price wars, which it later did cut prices.
The backside line: It's bad news that Verizon is keeping a business where it has shown no want to adjust accordingly to new threats. This makes me believe that FiOS' decelerating new customer growth will soon become year-over-year losses and that FiOS as a growth driver will be no more. This, combined with the majority of Verizon's wireless adds coming from a declining tablet market concerns me, especially as AT&T continues to invest in broadband and readies itself to expand into Latin America and Mexico to create new revenue growth opportunities. As I explained in a previous article, I expect AT&T to differentiate itself as the superior investment because of its growth opportunities ahead, whereas Verizon's strategy remains centered on the U.S. Based on these two takeaways from the second quarter, I'm not sure where Verizon finds future growth, and that's why I wouldn't buy the dip.
Disclosure: I am/we are long T. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose inventory is mentioned in this article.
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