High Margins at Verizon Wireless Unlikely to Last

Verizon Wireless is unlikely to maintain higher margins due to competitive pressures from the resurgent plans of Sprint and T- Mobile.

Jan 27, 2014 at 10:00AM

For the fourth quarter of 2013, Verizon Communications (NYSE:VZ) reported a surge in operating margins in the wireless sector due to lower subsidies for new accounts. The question is whether the wireless provider can continue generating these higher margins with Sprint Nextel (NYSE:S) and T-Mobile (NASDAQ:TMUS) in customer-acquisition mode.

While Verizon is generating solid gains in FiOS Internet and video segments, the company is increasingly dominated by its wireless division. In total, fourth-quarter revenue only gained 3.4%, but the company was able to hold expenses down. The combination sent operating margins surging, but the lack of spending to attract new customers could hurt growth in 2014 and beyond.

Subscriber additions decline
Verizon added 1.7 million net additions for the fourth quarter to reach 102.8 million total retail wireless connections. Net additions were actually a 26% drop from the 2.2 million additions acquired during the same period in 2012. Is this a sign that competition from Sprint and T-Mobile is heating up?

T-Mobile had total net customer additions of 1.65 million, compared to a loss in the year-ago period. While a lot of the additions were in the wholesale segment, branded postpaid added 869,000 subscribers.

Sprint hasn't released fourth-quarter customer additions yet, but the increase in the build out of the 4G LTE network during 2014 should lead to a major competitive shift. The company spent most of the last two years transitioning customers off the old Nextel network. Unfortunately, that move pushed millions of customers off Sprint-controlled networks to the likes of Verizon Wireless.

Are the surging margins sustainable?
The increase in retail service revenue by 7.5%, and the nearly $800 million reduction in costs of services, led to a surging operating margin of 29.5%, up from 24% in the year-ago period. The combination also led to free cash flow of $22.2 billion for the year. With the completed deployment of the 4G LTE network, the company will no longer grow by covering additional populations. On one hand, this will help keep capital expenditures in check, with investment expected to be nearly flat in 2014 at around $16.75 billion. On the other hand, the maxed-out network means that competitors like Sprint and T-Mobile will catch up and whittle away at the competitive advantage.

In the case of T-Mobile, the "un-carrier" concept appears to be gaining steam. The bold moves to un-bundle smartphone costs from wireless service contracts is, naturally, attracting lower-end revenue customers.

For Sprint, additional spectrum from Clearwire and the build out of 4G LTE service will leave the wireless provider in a substantially more competitive position at the end of 2014. At that point, the company should have roughly 200 million people covered by the 4G network. With a larger spectrum position than both AT&T and Verizon, analysts expect Sprint to have a compelling network advantage over the two larger rivals, with more capacity and faster Internet speeds. While a technological possibility, the company will have to execute in order to actually attract and retain customers.

Bottom line
With real competitive threats from Sprint and T-Mobile, it will be difficult for Verizon to remain a leader without offering better deals. The wireless leader might find itself losing subscribers this year if it doesn't offer a less-profitable pricing solution. T-Mobile has already matched Verizon's customer additions during the fourth quarter, and Sprint is finally becoming competitive with a 4G network. The drastic reduction in network and pricing advantages during the year will undoubtedly place a strain on the customer additions. Investors shouldn't expect margins to remain this elevated into 2015, with price quickly becoming the differentiating factor in wireless provider decisions.

With Verizon trading at only 12 times forward earnings, the stock trades at a reasonable valuation, but one that provides limited upside if margins are pressured going forward. 

Profit from the revolutionary changes in the smartphone industry
Want to get in on the smartphone phenomenon? Truth be told, one company sits at the crossroads of smartphone technology as we know it. It's not your typical household name, either. In fact, you've probably never even heard of it! But it stands to reap massive profits NO MATTER WHO ultimately wins the smartphone war. To find out what it is, click here to access the "One Stock You Must Buy Before the iPhone-Android War Escalates Any Further..."

Mark Holder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers