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Why Verizon Communications Inc. Shareholders Have Something to Worry About

By Adam Levy - Apr 5, 2017 at 2:00PM

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Actually, make that two somethings: competitive pressure and how management deals with it.

The U.S. wireless industry is fiercely competitive these days. The smaller carriers, T-Mobile (TMUS -0.39%) and Sprint (S), have been extremely aggressive in their efforts to grab share from an increasingly saturated market. T-Mobile has been very proactive with its pricing and promotions, while Sprint is content to undercut the competitor's pricing at every turn. As a result, Verizon (VZ 0.00%) and AT&T (T -1.00%) are both seeing pressure on their results.

Most recently, we've seen the return of unlimited data plans, something Verizon insisted was unnecessary right up to the point when it finally unveiled its new offer. Meanwhile, Verizon continues to make sizable acquisitions and expenditures in digital media in an effort to diversify away from the wireless industry. Both factors should give Verizon investors something to worry about.

A Verizon office building.

Image source: Verizon.

The new unlimited plans will hurt Verizon in the short term

Verizon's new unlimited data plan should attract a fair number of customers while keeping many of Verizon's current subscribers from leaving. Verizon has lost postpaid phone subscribers in the first quarter of each of the last two years. That should change this year.

The problem is, it won't generate as much revenue per subscriber. President of Operations John Stratton even said as much during an investors conference earlier this year. "The first guys that you see come across are typically the ones who benefit greatest sort of on their bottom of the bill," he said. Verizon's new unlimited plan costs less than its previous highest-tier plan, so those subscribers will switch instantly, putting pressure on revenue per subscriber.

Meanwhile, Verizon will see its costs per subscriber increase as it delivers more data to customers' smartphones. A big piece of Verizon's branding is its network reliability. It needs to continue investing in its network to maintain its leading position.

On the positive side, Verizon has managed to maintain its unlimited plan pricing above its competitors. Verizon's unlimited plan costs at least as much as comparable plans on the market. Verizon's ability to maintain premium pricing is a good indicator that its brand is still strong.

Acquisitions will destroy shareholder value

Faced with meager growth in the wireless industry, Verizon has made several large acquisitions to boost its presence in digital media. AT&T is also pursuing acquisitions, but on an even larger scale. AT&T spent $49 billion to acquire DirecTV, and it agreed to buy Time Warner (TWX) for $85 billion. Verizon's billions in acquisitions look like small potatoes by comparison.

Still, both buying sprees could easily destroy shareholder value by leaving the companies in weakened financial states. If and when they need money to support their core wireless businesses, they'll likely have to tap the debt markets. Both companies already carry over $100 billion in debt, although that's supported by stellar cash flows.

Verizon's decision to enter the digital media and advertising space is interesting. While the market for digital advertising is growing quickly (making it attractive), that market growth comes mainly from two companies. Verizon's ability to take share is suspect.

Why I'm still holding onto my Verizon shares

While I believe Verizon could feel some pain in the short term as competitive pressures continue to weigh on its wireless business, I'm still bullish in the long run. At some point, T-Mobile and Sprint will feel pressure to produce meaningful cash flows, making their current pace of promotions and discounts unsustainable. Both companies have weak balance sheets being propped up by parent companies.

At some point, something has to give at T-Mobile and Sprint. Perhaps an acquisition or merger takes the pressure off of subscriber growth. There have been several rumors circulating about a tie-up with a pay-TV provider, which would allow the new merged company to compete more effectively against the TV-wireless juggernaut of AT&T without resorting to undercutting pricing.

Either way, Verizon's long-term position still looks good considering the strength of its wireless network and the size of its retail customer base. I'll be monitoring the situation with the smaller competitors closely, and I'm hoping management doesn't make any more big acquisitions, but unless things change considerably, I'm fine holding my shares. After all, the company is paying me a hefty 4.7% dividend to be patient.

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Stocks Mentioned

Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
$50.96 (0.00%) $0.00
Sprint Corporation Stock Quote
Sprint Corporation
AT&T Inc. Stock Quote
AT&T Inc.
$20.78 (-1.00%) $0.21
T-Mobile US, Inc. Stock Quote
T-Mobile US, Inc.
$136.54 (-0.39%) $0.54
Time Warner Inc. Stock Quote
Time Warner Inc.

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