We recently purchased Verizon (VZ) in client accounts. VZ is a telecommunications company offering wireless services to consumers and businesses in the U.S. The company also provides wireline services over its fiber-optic network as well as a traditional copper-based network. VZ’s growth is driven by the wireless service, namely how quickly it can grow its user base and increase the revenue per user. VZ is competing with AT&T (T) and T-Mobile (TMUS) for wireless customers in this saturated market.
The wireless carriers, specifically VZ and T, started to rise on our screen as their valuations fell. They have never screened particularly well given their high debt loads and modest returns on capital. However, as the stock prices fell in 2022, the valuation became too tempting to ignore. So, while the underlying market growth is not exciting, the fundamentals make VZ an appealing investment.
Comparing T, TMUS and VZ…. And TMUS is out
We started by comparing the three carriers’ fundamentals. The quick and dirty story is that TMUS is growing the fastest, T is the cheapest, and VZ has the best returns on capital. Comparing wireless user metrics reinforced this story. VZ has the strongest history of growing revenue per user and the largest user base (focusing on postpaid customers). TMUS has grown users the fastest and reduced churn (the rate at which customers leave). T is somewhere in the middle- not growing users or revenue per user particularly fast.
After our initial review, we eliminated TMUS from consideration. We did not like TMUS’ profile. While the growth has been impressive, it does not trade at a heavy discount to the market or pay a dividend. Given the underlying market is not growing, we did not want to pay a premium for a company, and we wanted the floor that a dividend provides. VZ and T fit this profile since they trade for about 7x the expected earnings, a significant discount to the market.
Can We Trust T and VZ’s Capital Management?
We are equity investors and want to be confident the company invests its capital prudently. Both VZ and T have made missteps recently. VZ acquired AOL in 2015 and Yahoo in 2017 only to sell both properties last year for about $5B, or roughly half the total acquisition price of $9B. Similarly, T acquired Time Warner around the same time as VZ acquired AOL and Yahoo, only to sell in 2021 (completed this year). VZ’s AOL/Yahoo attempt to expand its media presence was a mistake costing the company billions. T’s Time Warner acquisitions cost $107B and was sold for $42B, costing the company tens of billions.
Both companies have hopefully put these media diversions in the past. T is led by John Stankey, a T executive since the early 2000s, promoted to CEO in 2020. VZ is led by Hans Vestberg, formerly the Ericsson CEO, joining VZ in 2017. While we are not comfortable with past company miscues, seeing new outside management like Vestberg is a positive. Given that VZ’s most important priority is to provide great wireless service over a strong network, we like his background at network equipment provider Ericsson.
Can You Hear Me Now?
VZ, T, and TMUS all tout their networks when advertising. TMUS has a ton of spectrum and offers ample access to a 5G network, although some of the speeds are similar to an LTE network. VZ has a massive LTE network and is working to catch both TMUS and T on the 5G side. T has some 5G network and confusingly called some of its LTE network 5GE. Currently, TMUS is the leader in the clubhouse, but VZ and T will start to catch up next year as more of its purchased C-band spectrum becomes available. Our bottom line was the networks are similar enough that it won’t be the differentiating factor.
It All Comes Down to Cash Flow
Financials were the most discussed portion of the research process. As noted, T has had missteps with its capital allocation, and it shows in its financials. In addition to Time Warner, T recently sold off the majority share of its DirecTV subsidiary. T also has a Mexican wireless subsidiary fighting an uphill battle against much larger players. VZ has cleaner financials and as mentioned, a more impressive track record.
On a cash flow basis, VZ is simply larger and generates more cash. This enables the company to better cover its capital expenditure (CapEx) needs and its dividend. Both companies project CapEx to fall, but given the competitive industry in which they operate, we assume they will maintain a high level. All three companies constantly advertise the quality of their networks and money must be spent to maintain those networks.
We view the dividend, its sustainability, and its (modest) growth as integral to this investment. VZ has the higher credit rating, better interest coverage, and the strongest cash flow. This is especially important in the current rising rate environment. All told, VZ is in the best shape financially and this offsets the benefit of T’s modestly lower valuation.
In summary, we view VZ as an attractive investment since it pays a generous dividend, has the cash flow to support the payout, and sells for a low multiple of its earnings.