In a recent story, the Los Angeles Times reported, "Verizon (NYSE:VZ) is accused of forcing Internet phones on landline users." According to the article, the Utility Reform Network found multiple complaints that Verizon "doesn't maintain its copper network" and is pushing households toward "less reliable Internet phones." This leads to a few questions. Why does Verizon want customers to move away from its copper landline business? How would this transition affect customers? What does this mean for investors?
Copper = costs
Whether Verizon is "pushing" customers toward Internet telephony or customers are allowing themselves to be led that way isn't a debate I'll take up here. However, the simple truth is, the landline business is dying and companies from Verizon, to AT&T (NYSE:T), to CenturyLink (NYSE:CTL), want customers to move on to their upgraded services.
The decline in the traditional voice business is hardly a secret, but the speed at which customers are leaving their landlines behind is surprising. In its current quarter, CenturyLink reported a more than 5% decline in voice line customers. Verizon did slightly worse with a greater than 6% decline, and AT&T lost a staggering 11% on a year-over-year basis.
The truth is, Verizon and others want customers to move on from copper landline connections because the service is expensive to maintain. In addition, these companies have spent billions on new fiber optic installations to push high-speed Internet and video services. If customers will accept voice over Internet calling, the company can focus on its fiber network and eventually shut down the copper network.
To put it another way, FiOS is like Verizon just put down a freshly paved highway. The problem is, traditional landline customers are telling the company they want to drive on an old cracked side road because they are afraid of potholes that could develop on the highway.
Do the majority of customers really care?
When it comes to what customers get out of making the switch to voice over Internet calling, the debate comes down to reliability versus cost. Companies like magicJack and Vonage have become the companies they are largely by showing customers that there is a cheaper way to call than a traditional landline.
One way many justify keeping their traditional landline is based on the worry that they won't have service if the power goes out. To try and quell this fear, each of the companies we've mentioned offers a battery backup solution for their services.
AT&T states its battery backup unit will support about 4 hours of usage, Verizon says 8 hours, and CenturyLink's battery is designed for several hours of power as well. Unless the power is out for an extended amount of time, voice over Internet services from these companies should be just as usable as a traditional landline.
That being said, many customers are making the choice to avoid landline service completely in favor of their wireless service. For Verizon in particular, this is a very good thing.
What does it mean for Verizon investors?
Traditional voice lines are being cancelled and carriers are doing what they can to help ease the transition to voice over Internet services. With these two forces in play, Verizon stands to benefit tremendously if the old copper network can be left behind.
Verizon's wireless service has more than 96 million postpaid subscribers and this leads AT&T and others by a fairly wide margin. With a nearly 30% operating margin from its wireless division, Verizon Wireless is highly profitable.
However, the Verizon wireline business is a different story. The company reported an operating margin of just 1.3% last quarter, compared to 10% from AT&T Wireline, and almost 15% from CenturyLink.
As you might imagine, with Verizon Wireless growing revenue by 6%, and the company's high-speed Internet and video offerings growing by 11% or better, the company is being held back by its traditional landline business. If Verizon can move these copper customers to FiOS, the company's wireline operating margin should expand.
Given that Verizon generated over $20 billion in core free cash flow last year, any expansion in the company's margins would mean even more cash for investors. While AT&T and CenturyLink would also benefit from a move away from copper landlines, Verizon dominates the wireless field and has the lowest free cash flow payout ratio of the group.
Though Verizon's yield of more than 4% can't match AT&T at over 5%, or CenturyLink's almost 7% payout, the company's cash generation is unmatched. Any margin expansion would just increase this lead, and could mean better dividends for Verizon investors. That is something that investors can rely on while enjoying their FiOS service.