Verizon: Does Not Have Any Leverage Left (NYSE:VZ) (2024)

Verizon (NYSE:VZ) has made a big bet on the 5G era by investing tens of billions of dollars in building its network. Some analysts have pointed out that new 5G applications like Internet of Things, AR, VR, and others will increase data usage which should give telecom companies greater pricing power and help increase average revenue per account. However, this is unlikely because most of the incremental value from these applications will go towards the companies building the applications instead of telecom companies carrying the data. In the previous article, it was mentioned that the massive dividend payments are already giving a big competitive disadvantage to Verizon.

We have already had a very low increase in revenue per user happen in the 4G era. The massive growth in data consumption helped video streaming, social media, gaming, and other companies. However, revenue growth in telecom giants like Verizon and AT&T (T) has been abysmal. Most of T-Mobile's (TMUS) revenue growth came from growth in subscriber base. This trend is likely to continue in the 5G era.

Customers are unlikely to expand their budget for telecom services to the extent that it will move the needle for Verizon in terms of revenue growth. At the same time, Verizon will need to make higher investments in capex to keep up with the competition. It will also have to launch more discounts for its plans in order to prevent customers from moving to another network. The long-term impact of these factors can cause lower returns in Verizon stock compared to the broader market and makes the stock a big value trap for investors.

Broken dreams

In a recent article, Jordan Sauer mentioned that a blazing-fast 5G connection will help Verizon. However, a counter-argument is that Verizon's leadership in 4G did not translate to good returns for investors. The launch of 4G services led to significant interest in telecom stocks as they were essential to provide all the new applications launched using 4G technology. However, the last decade has seen massive wealth destruction by Verizon and AT&T. Some of it is the fault of the management as they moved to non-core businesses to kickstart growth. But a major factor behind the poor performance of telecom stocks in the last decade is the fact that they do not have significant pricing leverage.

The government has ensured that there is healthy competition in the industry and it does not become a duopoly. Despite the massive increase in data usage in the 4G era, customers are not willing to increase their telecom budget beyond a point. We can look at the SEC filings of Verizon which shows that in 2011 the retail postpaid average revenue per account was $134.51. In 2017 it was $135.99 and in 2022 it was $125.97. The ARPA of Verizon has not kept up with inflation which has increased by 30% during the same time. During the same time, the data consumption has increased manifold but it has not led to any real increase in the customer budget for telecom services.

An alternate viewpoint

There is certainly a possibility that Verizon is able to positively surprise Wall Street with a higher growth trajectory in the 5G era. This will depend a lot on the ability of the management to carefully invest the cash flow. Verizon would need to invest it judiciously to build a 5G network that is in reality and customer perception significantly better than the competition.

Figure 1: Recent FCC map showing Verizon's 5G coverage.

FCC recently released a map showing the 5G coverage of major providers nationwide. Verizon's coverage is behind that of AT&T and T-Mobile. In terms of fast 5G, Verizon's coverage is at 8.1% compared to 12.5% for T-Mobile. Verizon produces massive cash flow which can be diverted to build a better network coverage.

It should be added that in an extreme scenario, Verizon's management can also decide to cut or eliminate the dividend which should save the company a whopping $11 billion a year. Investment of this resource in building the network can completely change the 5G ranking within a few years.

Growth in the 5G era

From a social perspective, 4G technology was a massive leap as it allowed people to work from anywhere and gave high-speed connection on their mobile. This helped in massive innovation of new services. We do not know the new services which might be launched on the back of 5G technology but it is possible that the impact on the lives of an average customer would not be as significant as the 4G era. The government regulation would make sure that there are good options for customers to pick network providers. This would limit the ability of telecom providers to increase their ARPA.

In a recent research report, it is estimated that mobile data traffic will grow by 27.9% CAGR by 2030. This seems like a very positive tailwind for the telecom players. However, the government has a strong interest in making sure that the pricing of plans does not become too expensive for customers. This is one of the key reasons why the ARPA of Verizon and other players will not grow substantially in the 5G era.

There is a lot of interest in virtual reality, the Internet of Things, and other applications. Companies like Meta (META) are investing tens of billions of dollars in these applications. The telecom infrastructure forms the backbone and is an integral part of the tech industry. This makes it vital that the Big Tech companies will try to limit the increase in individual 5G plans. They can do this through lobbying the government directly or even an entry into the telecom market like Amazon's initiative to offer low-cost mobile service to Prime members.

The long-term impact of these factors is that we could see another decade of ARPA growth falling behind inflation. This will limit the revenue growth of Verizon and reduce the growth potential for the stock.

Unending capex needs

While Verizon has not been able to increase the ARPA, it still faces significant competition in terms of 5G network coverage. We have seen Verizon invest massively in order to buy spectrum and improve the network in the last few quarters. It is likely that Verizon will need to maintain a high level of capex in order to have a good 5G network coverage and to prevent subscribers from moving to other competitors.

It should be noted that Verizon needs to pay a massive dividend which costs $11 billion annually. On the other hand, T-Mobile does not spend on dividends which allows the company to invest in better network, aggressive plan pricing, and discounts to attract new subscribers. It is difficult for Verizon to show subscriber growth while competing with an aggressive player like T-Mobile. Poor subscriber growth and modest ARPA growth can cause lower-than-expected revenue growth in Verizon which would limit the ability of the stock to give good returns.

Future trend in Verizon stock

The 5G era can bring new technologies and applications to our lives. Data usage will increase significantly in the next few years. However, it is unlikely that we will see ARPA growth that can beat inflation. The regulators would also ensure that there is good competition in this industry and that the telecom plan pricing does not become too expensive. Big Tech companies also have a big interest in keeping the plan pricing affordable for customers.

Verizon is already losing customers to T-Mobile and this trend can accelerate as T-Mobile continues to invest in its network and launches more aggressive plans. All these factors will limit any upward potential for Verizon stock in the 5G era. Verizon will still produce massive cash flow but due to its dividend policy, there is very less wiggle room with the management to reduce debt or to increase subscriber growth through better plan pricing.

Figure 2: Total returns of Verizon, SPY, and Nasdaq-100 tech index.

Verizon's total returns in the last ten years have significantly underperformed the broader S&P 500. Verizon stock gave total returns of a mere 15% which did not keep up with inflation. During the same time period, the Nasdaq-100 technology index has given close to 500% returns.

This shows that the growth in data usage has helped tech companies launch more innovative and profitable applications. However, higher data usage has not given pricing leverage to Verizon. In the near term, we should continue to see an increase in data usage which would require Verizon to increase capex. The competitive pressure will limit the growth in plan pricing and overall revenue for Verizon making it difficult for the stock to outperform the broader market.

Investor Takeaway

The 5G era will see higher data consumption and new applications leveraging higher data speeds and low latency. But this is unlikely to help Verizon stock in gaining a higher revenue per account. We have already seen this trend in the 4G era where a massive increase in data usage did not result in an increase in ARPA for Verizon. Verizon's ARPA in 2011 was $134.51 while it was $125.97 in 2022. This shows that Verizon's ARPA did not keep up with inflation. Despite some changes in how it calculates the average revenue we can easily see that Verizon does not have a pricing leverage.

The 5G era will require continuous investment from Verizon which makes it more difficult for the company to reduce its debt pile. The subscriber growth for Verizon will also be low as T-Mobile continues to give discounts. Verizon has given very low total returns in the last few years and the 5G era could also be a value trap for investors in Verizon stock.

Bluesea Research