VZ - Verizon's Gamble Will Not Likely Pay Off

2023-12-15 04:28:35 ET

Summary

• A recent report by WSJ mentioned that Verizon is looking to provide a bundle ad-supported version of WBD’s Max and Netflix at a cost of $10 per month.
• This is another initiative by VZ to boost its revenue growth and reduce the churn rate.
• The overall benefits for the Company are likely to be insignificant as it does not have a major leverage over streaming players.
• Verizon has reported a number of positive news in the last few weeks which has given a bullish momentum to the stock.
• Long-term investors should gauge the headwinds within the core service before pulling the trigger on VZ stock.

Verizon ( VZ ) has reported good numbers in the recent quarterly earnings. The free cash flow is increasing as the company limits major investments in the 5G network. WSJ has reported that Verizon is likely to make a big move by providing a bundle of ad-supported Warner Bros. Discovery's ( WBD ) Max and Netflix ( NFLX ) for its customers. The price tag for this bundle would be $10 per month compared to a separate cost of $17 per month. The details of the deal and the division of revenue between streaming services and Verizon are not known. However, it is unlikely that Verizon will gain a big percentage within this deal. In a previous article , it was mentioned that the capital allocation for Verizon's management is quite difficult due to the high dividend payout.

One of the most important tech deals of the last decade was between Google ( GOOG ) and Apple ( AAPL ) which made Google the default search engine on Apple's devices. It has been revealed that Apple received as much as 36% of Google's search revenue on its devices. Apple had a massive leverage over Google in this deal which allowed it to have a lucrative split of revenue. On the other hand, Verizon does not have a similar upper hand when dealing with streaming players. Most of the streaming companies can shop around from other telecom companies that offer the best deal.

Verizon stock has jumped by 20% since the quarterly earnings. The management was able to report good numbers in terms of cash flow and net additions. However, the long-term headwinds faced by the company are still strong. The churn rate of Verizon remains high and it is the highest among the three major telecom companies. The high-interest rate environment remains a major challenge for the company. Verizon is also facing strong competitive pressure from T-Mobile ( TMUS ) which is investing heavily to attract more customers. It is likely that Verizon stock will remain a value trap for long-term investors looking for a stable dividend stock.

Win-win-win deal with streaming players?

Verizon is planning to bundle an ad-supported version of WBD's Max and Netflix. This will lower the cost for customers by $7 per month. It will also help reduce the churn rate for streaming companies that have seen an increase in churn after the recent price hike in the industry. Verizon is also going to gain from this deal by increasing customer loyalty for its service which should help reduce the churn within the company. Verizon will also gain from a high-margin revenue stream through this deal.

Figure: Increase in serial churn among streaming companies.

Research by Antenna has shown that the average churn rates have been moving higher for the past few years. Even Harvard Business Review mentioned the problem faced by streaming companies where subscribers binge-watch their popular content and then unsubscribe. This destroys the customer lifetime value metric and limits the ability of the companies to plan future investments.

Figure: Average active monthly churn rate in premium SVOD.

The recent news of a bundle deal in Verizon shows that streaming players are ready to give a massive discount in order to reduce their churn rates.

Lack of leverage by Verizon

On the surface, this deal looks like a big tailwind for Verizon. Both Netflix and WBD have massive revenue bases and if this deal succeeds in reducing their churn rate they might replicate it for other streaming options. However, a key issue for Verizon is that it does not have massive leverage over streaming players.

As an example, we can look at the deal between Apple and Google which made the search engine of Google a default selection on all Apple devices. This deal has raked in billions of dollars for Apple in high-margin revenue stream. Apple had massive leverage over Google because of the "Walled Garden" built by Apple on its devices. Google had to pay a massive share of its search revenue to access Apple customers. On the other hand, the streaming players have an option to shop from among the top three telecom players. There are already many bundle streaming options available through other telecom companies. These bundle plans might help in adding additional revenue streams for telecom companies but they would not significantly move the needle in terms of profitability.

Long-term headwinds faced by Verizon

At one point, Verizon was able to boast of industry-leading churn rates with the lowest churn due to a loyal customer base. This has changed in the past few quarters. Verizon's churn rate is now in third place behind AT&T ( T ) and T-Mobile. In the recent quarter, Verizon announced retail postpaid phone churn of 0.90 percent. This was 2 basis points better than the year-ago period but it is still behind the other competitors. A similar story goes for its revenue base.

Figure: Verizon's revenue base in the last ten years.

Over the last ten years, Verizon's revenue base has barely moved. It did not even keep up with inflation despite being a very essential purchase for customers. On the other hand, Verizon has to spend a massive amount to improve its infrastructure in 5G era. This trend could continue over the next few years and we will again see a big investment by Verizon to build 6G network.

Verizon has enough cash flow to pay the dividends but the long-term growth story is non-existent.

Bullish case for Verizon

Despite the above-mentioned headwinds, Verizon stock has a few bullish factors working in its favor. The company is undertaking massive cost-cutting program which will help in improving the margins and cash flow. Over the next few quarters, Verizon will become a leaner organization. Improvement in new AI-driven customer service technologies should also help Verizon in reducing costs associated with this very labor-intensive part of the company.

Figure: Decline in VZ PE ratio over the last few years.

Another factor that many analysts supporting a bull theory in Verizon mention is the rock-bottom PE ratio and healthy dividend yield of the company. This valuation multiple has been on a decline for the last few years. Most of the decline coincides with the massive investment required in building the 5G network. As the capex requirement reduces, VZ stock could gain a more favorable sentiment.

Investors need to consider these bullish factors closely. However, it is likely that the negatives will far outweigh the positives for Verizon stock over the medium to long term. We have seen some improvement in the stock price over the last few weeks but it continues to trail S&P 500 by a very wide margin in YTD.

Impact on Verizon stock

Verizon stock has had a good run in the last few weeks. The stock has jumped by 20% since the last earnings report. However, the YTD total returns of Verizon stock is only 1.5% compared to 20% by S&P 500. Over the past 10 years, Verizon stock has been a big wealth destroyer with total returns of 20% compared to 200% return in S&P 500. In most years, the total returns of Verizon stock do not keep up with inflation. At the same time, Verizon is facing a massive debt pile which will get more severe if the high interest rate environment continues.

Figure: Verizon's total return in the last ten years.

Ten years back, Verizon had a big advantage over T-Mobile in terms of network. This advantage is not there in 5G era as most third-party estimates show better coverage through T-Mobile's 5G network. Investors looking to make a long-term bet on Verizon stock will need to look at this trend and not focus on quarterly results. A single quarter of estimate beating cash flow will not change the long-term story for the stock.

Investor Takeaway

Verizon is looking at new initiatives to increase revenue streams and customer loyalty on its network. One of the recent initiatives is to offer bundle streaming services at a big discount. This is unlikely to move the needle for the company as other competitors are already offering similar services.

Verizon has been a poor investment choice over the long term. It has not even managed to give inflation-matching returns in the last ten years. Investors also have to pay taxes on dividends if they intend to use them which further reduces the total returns in this stock. Despite a good quarter, the return potential of Verizon stock remains poor.

For further details see: