Verizon is scheduled to release its Q4 2013 results on January 21st. We will be keenly watching the carrier’s smartphone sales as well as wireless net additions, which should have received a boost during the holiday season. The carrier is likely to see data ARPU rise due to growing smartphone penetration and increasing adoption of 4G LTE, but heavy smartphone subsidies during the holiday season are likely to have caused its margins to take a hit. It will be interesting to see the impact of increasing competition from T-Mobile, which recently launched the iPhone on its network and is aggressively going after rivals with its ‘Uncarrier’ strategy, on Verizon’s wireless net adds in Q4. T-Mobile recently announced its porting ratio figures, and while Sprint and AT&T seem to be the worst hit by T-Mobile’s new service plans, even Verizon seems to be losing more subscribers to T-Mobile than it can gain.
Our $50 price estimate for Verizon is about in line with the current market price.
LTE’s importance in a saturated market
The U.S. wireless market has become increasingly saturated with wireless connections having exceeded the population in mid-2011. This has made acquiring new subscribers, especially those that pay for the higher-margin postpaid data plans, very tough for the wireless carriers. Despite this, Verizon has banked on its better 4G LTE coverage to do well on the postpaid front in the recent years. Verizon has led LTE deployment in the U.S., completing its initial LTE deployment ahead of rivals and currently looking to widen the gap by increasing network density with LTE-Advanced and supporting new features such as VoLTE (Voice over LTE) ahead of rivals.
2012 saw Verizon rack up 5.1 million postpaid net adds versus AT&T’s 1.4 million for the full year. The trend continued in 2013 as well, with Verizon adding 2.7 million net postpaid subscribers through the end of the third quarter. In the same period, the second largest U.S. wireless carrier, AT&T, added only about 1.2 million postpaid net subscribers. (See Behind In LTE Coverage AT&T Spends Big To Gain New Customers)
Verizon Encourages Data Consumption
Gradually, however, the reality of a saturated wireless market seems to be catching up with Verizon in the absence of a steady supply of defecting iDEN subscribers from Sprint and the presence of a resurgent T-Mobile. Also, its LTE coverage lead over rivals isn’t as wide as was at the start of 2013. As a result, Verizon’s Q3 postpaid net adds declined to about 930,000 from over 1.5 million during the same period last year. The carrier said that supply constraints for the recently launched iPhone 5S prevented net adds from being higher in Q3, so the picture should be a lot clearer during Q4′s earnings call. However, it is unlikely that the carrier will report Q4 postpaid net adds higher than last year’s.
In order to counter growing competition from rivals, Verizon has come up with strategies to increase consumer loyalty and better hold on to its existing customer base. It recently launched a new program called Verizon EDGE, in response to T-Mobile’s aggressive moves, which allows subscribers to upgrade their smartphones every six months so long as they have paid off 50% of the unsubsidized cost of the phone. The carrier has also launched Mobile Share data plans that allow subscribers to add more mobile devices to their service account. Customers who subscribe to these initiatives get further entrenched in the Verizon ecosystem, making it tougher to switch carriers. This is important because rising competition seems to be increasing Verizon’s churn numbers of late. Compared to 0.93% in Q2 2013, Verizon had a churn of 0.84% in the same period last year. Higher churn implies that a carrier is losing more of its existing subscribers, leading to higher costs as it looks to acquire new ones.
However, the increasing adoption of shared data plans will decrease the average revenue per device since non-smartphone connected devices consume much less data. But Verizon’s revenues from each individual subscriber should also rise at the same time, as users connect more devices to its wireless network. It should also help shore up service margins due to low data consumption of these connected devices. Moreover, since the shared data plans are tiered, an increasing usage of Verizon’s high-speed LTE network will cause subscribers to jump to the higher tiers, enabling the carrier to better monetize its existing subscriber base.
Verizon’s Margin-Defending Initiatives To Offset Impact Of Smartphone Subsidies
Driving Verizon’s ARPA (average revenue per account) levels is also the increasing level of smartphone penetration within its subscriber base. Last quarter, almost 85% of Verizon’s retail postpaid activations in Q3 were smartphones, with 33% of those upgrading being first time smartphone buyers. This helped increase its smartphone penetration within the postpaid subscriber base to more than 67% – up from 58% at the start of the year. Increasing smartphone penetration helped drive postpaid ARPA, as smartphone users are usually heavy data users as well. Verizon’s postpaid ARPA grew to over $155 in Q3 2013, almost 7% over the same period last year .
Smartphone sales may increase postpaid subscriber additions and bring in substantial data revenues, but they are also very expensive due to the huge subsidies that carriers provide in return for long-term contract plans. For example, a basic model of the iPhone 5S costs around $650 for carriers who then subsidize it heavily to sell the handset for $199. We expect strong holiday buying to have depressed Verizon’s margins sequentially in Q4. However, Verizon has been able to manage its expenses well, driving operational efficiency through initiatives such as the $36 upgrade fee and the sale of tablets such as the new iPad at unsubsidized rates. (See Verizon Introduces Smartphone Upgrade Fee; Looking For iPhone Subsidy Relief) The carrier has also recently increased the minimum upgrade eligibility from 20 months to 24 in a bid to increase the upgrade cycle and mitigate the margin impact. As a result, wireless EBITDA margins in the first three quarters of 2013 increased almost 200 basis points over the same period last year. We expect a similar strong year-over-year margin improvement in Q4 as well.
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Source: Forbes Business