We hold LightPath Technologies (LPTH) starting at $1.40-$1.60 in January 2017 and suggest long-term ...
... And a View of Verizon
11/05/2004 12:00 am EST
There are few advisors more knowledgable about the telecom sector than Roger Conrad, editor of The Utility Forecaster and co-editor of Personal Finance. Here, he looks at the changing telecom landscape and a favorite beneficiary of these trends.
Since the Telecommunications Act of 1996 was signed into law, the vast majority of sector analysts have been relentlessly negative on the prospects for Verizon Communications (VZ NYSE). The first doomsday theory was that the long distance companies were going to eat the company's lunch, as well that of the other regional Bells, in the local phone business. Then it was the now nearly extinct breed of competitive local exchange carriers and start-up wireless service providers that were supposed to whip them.
"Verizon, of course, has outlasted its detractors from the 1990s. But rather than concentrate on the company's continuing conventional-wisdom-defying success, most analysts are still focused on its local phone business. It's steadily losing customers to wireless substitution and cable television-based phone service, and it will almost surely be further eroded in coming years by the development of Voice over Internet Protocol (VOIP) technology. Some forecast the local phone business will go the way of long distance, eventually destroying Verizon's financial health once and for all.
"To be sure, pulling for the underdog is as American as apple pie. And when a David does defeat a Goliath, it's always a great story. Similarly, many analysts love to hate regional Bells like Verizon because they so thoroughly dominate telecommunications, thanks to superior economies of scale. But simply put, despite continuing to lose local phone line connections, Verizon remains the largest and most powerful communications company by leagues. Its balance sheet is the industry's strongest, recently affirmed by an A+ rating from major credit raters, even while its rivals are being consistently cut. And VZ continues to get stronger, generating $1.3 billion in third quarter free cash flow, and cutting debt 10.7% in the first nine months of 2003.
"Most importantly--and virtually ignored by its detractors during the bashing that went on following the earnings announcement—the company is growing. In fact its growth is accelerating. Third-quarter sales growth came in at 6.7%. That's up from around 6% in the second quarter, barely three percent in the first and no growth in the fourth quarter of 2003. Sales growth is accelerating because the company is becoming less and less dependent on its traditional business of servicing and leasing local phone lines, and more reliant on its fast growing wireless and broadband business. Wireless--now 40% of sales--added a record number of new customers, pushed down overall customer turnover (or "churn") to just 1.5% (best in the industry), and raised revenue per customer by 3.1%. Operating income rose 46.4%, a clear sign that economies of scale have grown to the point of increasing profitability. And it's done this in an environment of increasingly cutthroat competition for wireless customers.
"You don't need a crystal ball to see that Verizon's wireline business will continue to lose customers. But with the company's overall revenue growth actually accelerating over the past three quarters, it's equally plain that wireless has become its most important business, and it's only going to become more important going forward. Consequently, Verizon's loss of local phone lines is less important with each successive quarter. Even in the wireline business, Verizon managed to boost revenue per customer by 4.4 percent. That's a clear sign its product bundles--which typically include broadband and long distance service--are catching on. That means more cash flow growth, which should improve further as management follows through on plans to improve its wireline infrastructure with a fiber buildout.
"Of course, this is my spin on the company. Should Verizon Wireless weaken from here or wireline sales per customer start to tail off, the loss of local phone lines would become considerably more important. At this point, however, the wireless company is routinely beating expectations the old fashioned way, by signing on new customers and keeping current ones with good service at competitive prices. With all the key metrics for this business advancing in the third quarter, there's little sign of weakness. The bottom line: If there's one telecom that looks set to come out of this industry depression stronger than ever, it's Verizon. Paying a dividend of nearly 4%, it's cheap, too, selling in the high 30s."
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