Sell. Ticker: VZ. Sector: Technology. Industry: Telecommunications. Recommendation: Sell. Data

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1 Ticker: VZ Sector: Technology Industry: Telecommunications Recommendation: Sell Data Price: ( ) 52-wk high: wk low: Market Cap: Billion Avg. Trading Volume: M EPS (2009): 3.00 P/E: Dividend Yield: 6.57% ROA: 5.67% ROE: 8.77% Profit Margin: 3.39% Operating Margin: 18.07% Based on my research, my recommendation for our current holding of Verizon is a: Sell While Verizon is currently the largest mobile carrier in the United States, the increasing competition and recent performance is concerning. Just in the last week, Google has announced they are planning to build high-speed fiber-optic broadband networks in the U.S. to offer Internet speeds that are more than 100 times faster than what Verizon and AT&T sell today. Further, decreasing margins and revenue per customer due to intense price and network competition in the cell phone markets is hurting profitability and future prospects. Furthering the tough competition, Verizon lost money in the 4 th quarter as a result of having to lay off 16,000 employees. The poor quarter was due to the layoffs costing them $3 Billion in severance charges and having to pay higher-than-expected subsidies to put phones in the hands of customers. Verizon is constantly being overshadowed by AT&T. The elusive iphone contract is still haunting them and rumor is spreading they are going to be left out again this year. Further, while they have the most extensive 3G network and are farthest along on a 4G network, AT&T announced just this week plans to unveil its newest, arguably superior network. The result is a strong company paying a solid dividend but I feel it is overvalued and shouldn t be achieving any break through growth worthy of investment. Report by Taylor Fox

2 Company Background: Verizon Wireless was founded in 1983 as Bell Atlantic Corporation. It was one of seven baby bell companies formed by AT&T due to an antitrust judgment filed against them. The company later acquired one of the other baby bell companies after it split from AT&T. In 2000 Bell Atlantic Corporation acquired GTE for $53 billion and was renamed as Verizon Communications Inc. In 2000 the company also merged with Vodafone Group to launch Verizon Wireless. In 2005 Verizon Communications acquired MCI which significantly helped increase their long term growth strategy and long haul line capabilities. The company is currently headquarter in New York, New York and employs over 230,000 employees worldwide. Verizon Communications operates in two business segments, Wireline and Domestic Wireless. The Wireline segment provides voice, internet, broadband data, network access and long distance to consumers, other carriers, businesses and government agencies. At the year end 2008 the wireline segment for Verizon Communications was comprised of over 36 million wireline connections, 8.5 million broadband and 2 million FiOS TV customers. The Domestic Wireless segment of Verizon Communications provides wireless voice and data services as well as valued service and equipment sales. At the year end 2008 the domestic wireless segment served 91 million voice and data customers nationwide. Verizon is the global leader in wireless voice and data coverage and prides themselves on the catch phrase, America s most reliable network. Verizon saw significant growth in both of its business segments in 2009 despite the economy. The wireline segments grew in revenues by over 12% in 2008, but decreased in 2009 by 4.4%. Further, they saw a 48.7% drop in operating income in They realized 26% growth in revenue in the domestic wireless business. Verizon makes money primarily through mobile phone subscription plans for consumers and businesses. The company also provides landline phone service to residences, small businesses and large enterprises. Broadband Internet services and fiber optic TV services (FiOS) are growth areas for Verizon. 2

3 4 th Quarter Financial Performance While Verizon had a solid 2009 considering the economic conditions, the 4 th quarter wasn t as stellar as many had hoped. Revenue was down from the 3 rd quarter but up 10% from 4 th quarter Futher, for the first time in recent years, they lost money in the 4 th quarter. Losing $653,000,000 as opposed to making $1.235 billion a year ago. In the fourth quarter, Verizon recorded a loss of 23 cents in diluted earnings per share (EPS), compared with EPS of 43 cents per share in the fourth quarter Contributing to the loss was a special item of $3.0 billion in pre-tax costs related to workforce reductions. On an adjusted basis (non-gaap), fourth-quarter 2009 EPS was 54 cents, compared with 61 cents in the fourth quarter With suscriber base is increasing, it is a coming due to expensive advertising campaigns and being forced to reduce prices due to competition. having to pay higher-than-expected subsidies to put phones in the hands of customers. Verizon, already the largest cell phone carrier in the country, added 2.2 million customers to end the year with 91.2 million. However, 1 million of the new customers signed up through a reseller such as Tracfone LLC rather than directly through Verizon. Such customers generally pay much less than customers who sign contracts under the Verizon brand. 4 th Quarter Performance The Wireless segment is growing strongly at over 22% from the previous 4 th quarter in revenue. Wireless customers were up 25%. It is now the nation s largest wireless provider based on customers. The wireline segment, however, has remained relatively stagnant over the past few years. Looking to the balance sheet, a couple concerning items are observed. Primarly, it the last year, Verizon $2 billion in cash, down from 9.8 billion. This is expecially concerning considering the uncertain environment and their high dividend yield. More gloomy news includes that accounts recievable are up and accounts payable are higher as well. 3

4 Company Analysis Strengths: Verizon s wireless business continues to grow and strenghten even during this weak economy. They have the most extensive 3G network and will be the first to deploy a 4G network in The company operates nearly 96% of its cell sites with the 3G network capabilities and continues to focus on improving and developing better high speed data transmission technology. The release of the 4G network is expected to be available in 25 to 30 markets in 2010 and cover virtually all of its current nationwide 3G footprint by the end of The recent acquisition of Alltel allowed Verizon to continue to expand its network coverage and has increased their subscriber based to almost 90 million making them the largest wireless carrier in the US. Verizon is enjoying significant growth double digit growth from its consumer broadband and video segment. Strategic partnership with Google and the Droid phone. Weakness While many agree Verizon has the largest 3G network, concerns about the quality of network are often raised. Verizon isnt allowed to carry the iphone on its network. Recent layoffs and their related severence charges indicate weakness in the business. Wireline Business Segment: Decreasing revenues continue to haunt this slowly dying business. The overall demand for wireline connections continues to decrease and Verizon continues to focus on selling off and moving out of this segment. Palm Deal not going well. The recent weakness in Palm smart phone sales can be attributed in part to concerns about how the company's latest phones are performing at Verizon Opportunities Layoffs could allow them to operate more efficiently. The 4G network launching this year could prove to be a significant differentiator between Verizon and competitors such as AT&T. Threats Verizon operates in a very competitive market that continues to hurt margins. In a report February 4 th, a team of wireless analysts at Credit Suisse downgraded Verizon Communications Inc. to a neutral rating -- citing its own analysis that suggests the iphone will remain exclusive to AT&T this year. HPSA 7.2 technology, which has theoretical speeds of 7.2 Mbit/sec. The network upgrade could give AT&T a strategic advantage over Verizon in coming months. AT&T is spending $2 billion more on network improvements in 2010, and many high-speed wireless data needs will be met with Wi-Fi connections, including 20,000 AT&T hot spots. Google s entry into the broadband market 4

5 Competition The competition is this market is feirce. We all have been obeserving the large ad campaigns by Verizon and AT&T dropping prices and comparing 3G coverage and strength. Further, as of last week, Google s entry into the broadband network is obviously not a great sign for Verizon. As previously mentioned, Verizon had a tough quarter and is lagging behind its primary competitor, AT&T. For this reason, I chose to include annual data as well. Even then, Verizon s margins are inferior to AT&T but they split the metrics regarding return. In a market that is getting increasingly competitive, they are already losing the margin race. The average Mobile Subscriber Plan Pricing for Verizon has decreased from $47.1 in 2005 to $40.7 in 2008, representing an annualized decrease of 4.7%. Besides, just cell phones, competition is heating up elsewhere as well. AT&T's U-Verse and Verizon's FiOS are fiber optic TV services, which have gained traction in some geographic areas. AT&T and Verizon are increasingly competing with cable operators such as Comcast and Time Warner over TV, Internet, and phone customers. We expect competition in this space to result in declining subscription prices for both telecom and cable operators. Further, AT&T s HPSA 7.2 technology, mentioned above was announced this week to mitigate Verizon s 4G advantage. The network upgrade could give AT&T a strategic advantage over Verizon in coming months. AT&T is spending $2 billion more on network improvements in 2010, and many high-speed wireless data needs will be met with Wi-Fi connections, including 20,000 AT&T hot spots. Company Comparison Last Quarter: Company Comparison Last Year: 5

6 6 Month Performance Comparison: 5 Year Performance Comparison: Internationally 6

7 Analyst Opinion: Valuation: I chose to use the Two-Stage Discounted Free Cash Flow Valuation Model. For the growth rates, I simply took the top line revenue growth (9.6%) of the last year (2008 to 2009) and applied it to the next 5 years, gradually reducing it after that. To determine the Discount rate: I used a beta of.62, validated from 2 sources. Risk free rate of 3.7 which is the current 10 year treasury rate. Further I used a market return rate of 9% This yields 7%. Taking this number into consideration with buffets 10% standard, I chose to use 8% to discount the future cash flows. The rest of the numbers were taken directly of the 2009 financial statements ending 12/31/09. Using this model, I calculated Verizon has an intrinsic value of $21.21, significantly lower than the current market value. Not only overvalued, but the increasing competition puts this stock as a sell. Further, while it pays a solid dividend, the last ex-dividend date was in early January, so it should not come for another 2 months. 7

8 Other Information More details on Google s announcement On the new service: That s 20 times the speed of the fastest residential connections from AT&T Inc., Verizon Communications Inc. and Comcast Corp., and more than 1,000 times faster than the cheapest connections. The FCC is set to introduce its broadband strategy by March 17 to ensure all U.S. citizens have access to high-speed Web service. Chairman Julius Genachowski said in a statement yesterday that Google s trial will serve as an American testbed for the next generation of services. By building its own network, Google would be going around AT&T, Verizon and Comcast to provide Internet-access directly to homes, giving it control over how data is delivered to consumers. Google has lobbied for net neutrality legislation to prevent carriers from giving preference to some content providers over others. Verizon Said to Be Planning to Put Skype on Its Mobile Phones Verizon Wireless, the largest U.S. wireless carrier, will include Skype Technologies SA s Internet- calling software on phones to stave off competition from AT&T Inc., according to two people familiar with the matter. The service will let customers make Skype calls over the company s 3G data network, said the people, who requested anonymity because the agreement hasn t been announced. Verizon and Skype said yesterday that they will hold a joint press conference Feb. 16 at the Mobile World Congress in Barcelona, Spain. The companies gave no further details. 8

9 Income Statement: 9

10 Balance Sheet: 10

11 Statement of Cashflows: Sources: r=11&from=badge#/vz/n-0012?from=sankey ?reflink=MW_news_stmp r=11&from=badge#/vz/n-0012?from=sankey 12?reflink=MW_news_stmp ttle_with_verizon and 11