TMUS - Verizon: Blazing-Fast 5G Is A Buy Signal

2023-06-06 19:30:13 ET

Summary

• Verizon has the fastest 5G home internet in the nation. And its mobile 5G now blankets metropolitan areas, sporting blazing-fast mmWave.
• This could spell trouble for competitors like AT&T. Meanwhile, Verizon's revenue growth is outpacing competitor T-Mobile.
• I will shine light on key risks: The debt, the dividend, and the competition (Potentially including Amazon).
• In the decade ahead, I project total returns of 15.5% per annum for Verizon.

Verizon's Value Proposition Is Strong

To understand where Verizon's cash flows are headed, we first need to understand Verizon's customers. These customers are faced with choices: Switch to T-Mobile or AT&T, stay loyal to Verizon, upgrade their existing plan, etc. This all depends on Verizon's value proposition. Let's begin.

For many years, Verizon's been known to have the best mobile coverage in the nation. And, this is still the case when it comes to 4G. Competitors like T-Mobile ( TMUS ) have glaring holes in their 4G coverage:

Meanwhile, analysts have called for the underperformance of Verizon Communications Inc. ( VZ ) due to its lagging 5G coverage. This is where my opinion differs. You see, Verizon has been focusing its 5G efforts on major cities and urban areas throughout the United States. This is where the vast majority of the population resides ( 83% ). Verizon is targeting these customers. And, according to RootMetrics, Verizon has the best 5G experience in major cities.

Recently, Verizon has been blanketing U.S. cities with C-band (Mid-Range) 5G. Novotech reports that C-band "provides an ideal balance between speed and coverage." Let's take a look at the map:

In the above map, the red dots are metropolitan areas where Verizon has extensive 5G coverage. The orange areas represent the company's 4G coverage.

If we zoom in further, we'll see Verizon's blazing-fast mmWave 5G. Verizon has deployed mmWave in highly populated areas within each major city. Here is a look at Chicago. The streets with Verizon's mmWave are marked in dark red:

As you can see, Verizon's taken a very targeted approach to 5G. I suspect this approach will pay off as it provides the majority of the population with blazing-fast 5G.

The Leader In 5G Home Internet

Pairing with this already strong value proposition, Verizon offers the fastest 5G home internet in the nation. T-Mobile's 5G home internet is much slower , and until recently, AT&T ( T ) did not offer the service. Below, you can see the download and upload speeds of the top two companies in the space (Verizon has an enormous edge over T-Mobile):

Note that AT&T recently began offering 5G home internet to select customers at $55 a month with reports of download speeds between 40-140 Mbps. However, AT&T does not see this as a competitive or strategic product and is far behind.

Meanwhile, Verizon's 5G home internet was ranked #1 by Forbes . Verizon offers this service to its mobile customers at just $25 per month. This is an incredibly cheap price for home internet of this quality. You can also see the incentive here; why go with T-Mobile or AT&T when you can get Verizon's insanely cheap, insanely fast home internet bundled in for a fraction of the price? While it appears Verizon is sacrificing profitability on these $25 plans, the offering should buoy market share and draw customers into Verizon's highly profitable mobile plans.

To pile it on the competition even more, Verizon offers very favorable family plans that drastically reduce the price per customer. Verizon will even throw in Disney+, ESPN+, and Hulu free-of-charge on eligible plans . The company does all of this while maintaining industry leading profitability:

Risks

In my first article on Verizon (Dated June 2022), I highlighted risks such as the company's debt, rising interest rates, competition, and technological change. With these risks now top of mind, the stock has collapsed. This time around, I'm digging deeper into Verizon's debt, dividend, and competition.

Verizon's Debt

Verizon has $140 billion of long-term debt, approximately 4.3x its operating income. As Verizon's debt rolls over at higher interest rates, it increases the company's interest expense. This is already underway:

Source: Forward estimate by author (2022 figures rounded)

Note that in acquiring 5G assets, Verizon's been overspending on CapEx. The company's depreciation and amortization is only $17 Billion, the same as the guidance for 2024 CapEx spend. I believe Verizon's normalized earnings power is approximately $21 billion, closer to its current net income.

T-Mobile, AT&T, And Amazon

The collapse of AT&T and Verizon's stocks over the past year can be largely attributed to competitor T-Mobile (Along with macroeconomic issues). T-Mobile merged with Sprint, gaining market share in 2020, and has since been accumulating large debts to build out 5G across the nation, spanning both cities and rural areas. T-Mobile saw a big jump in revenues in 2020, but its revenues have since flatlined, giving up sales share to Verizon:

T-Mobile has made very little profit and has paid no dividends in order to fund its low prices on phone plans. But, as evidenced by the revenue gains, or lack thereof, since July 2021, T-Mobile's strategy is doing a better job of gaining subscribers than creating value for shareholders. The company appears to be acquiring bargain hunting, thrifty customers. These customers are not good for profitability. And, in my opinion, Verizon's value proposition remains rock solid.

AT&T, on the other hand, has no clear value proposition. This becomes more evident when we look at research reports like this from OpenSignal :

2023 5G Experience Report

Struggling to differentiate itself in mobile 5G, AT&T is also last in 5G home internet and middle of the pack in 4G LTE coverage.

Overall, I think the competitive risks facing Verizon have been exaggerated. Keep in mind, the above OpenSignal report was generated for the entirety of the United States. In urban centers, Verizon is dominating 5G. According to a study done by RootMetrics in the second half of 2022, "Verizon took home 85% of awards in major metropolitan markets (747 awards out 875)."

Also, note that Amazon ( AMZN ) is reportedly in talks with Verizon, T-Mobile, and Dish Network Corp. ( DISH ) to offer phone plans to its Prime subscribers. With reports of phone plans ranging from free to $10 a month, this sounds like an arrangement in which one of these companies would lose money. My guess is that Amazon would lose money on this arrangement in order to strengthen Prime membership loyalty. But, according to Forbes , this isn't a sure thing:

"In a statement, Amazon told Forbes it is 'always exploring' additional benefits for Prime subscribers, but doesn't have immediate plans to add wireless at this time."

If this did occur, it would obviously hurt industry pricing power and subscriber counts for all other providers. However, at such low rates, I question the quality of plans that could be offered by Amazon. In wireless phone plans, you often get what you pay for.

Thesis Risk

Companies benefit from having rational competitors and competent management. When competitors focus solely on gaining share, profits tend to suffer. For my thesis to play out, you need a certain degree of rationality among oligopoly players Verizon, T-Mobile, and AT&T in the decade ahead. You also need Verizon's marketing team to get customers to realize the value in the company's products. If Verizon were to lose significant market share and interest rates remained elevated, the company's debt would become more burdensome; this would reduce growth, increase risk, and lower returns.

Long-Term Returns

I suspect the drop in Verizon's share price will be a catalyst for positive change. We'd like to see Verizon improve its working capital position (Current ratio) and start using cash flow, rather than debt, to continually strengthen its long-term value proposition.

I believe Verizon is capable of growing its $21 billion of normalized earnings at 3.5% per annum. I think we will eventually see upward pressure on phone plan prices across the industry. Americans have some of the best 4G and 5G access in the world. Meanwhile, companies like T-Mobile and AT&T are earning exceptionally low returns on capital while carrying enormous debt-loads:

In my opinion, these companies have little choice but to raise prices.

Inflation is another tailwind for Verizon. Consumers are price takers when it comes to essential products. Recently, Turkish telecom companies have seen strong gains in revenue and net income, preserving investors' capital through a highly inflationary period. During the inflationary period of the 1970's , AT&T also did quite well. Mordor Intelligence estimates that the U.S. telecom industry will grow at a compound annual rate of 3.67% through to 2028; however, in an inflationary environment, growth may exceed expectations.

In the decade ahead, I estimate compound annual returns of 15.5% per annum for Verizon:

Note: This is a base-case estimate.

In Conclusion

Verizon trades at just 7x earnings. But, in my opinion, the company's value proposition is rock solid. We know Verizon has the best 4G coverage in the nation. What many are just beginning to realize is that Verizon also has the best 5G home internet in the nation. And, according to RootMetrics, Verizon is #1 in 5G across major cities. Phone plan and home internet prices should increase with inflation as competitors AT&T and T-Mobile begin to feel the squeeze. With prospective returns of 15.5% per annum, I have a strong buy rating on Verizon.

Until next time, happy investing!

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