Verizon Q4 2022 Quick Take: Time Is Running Out (NYSE:VZ)

It has been a tough year for the Verizon Communications Inc. (NYSE:VZ) stock. Despite an attractive dividend yield backed by robust free cash flows that should have been favored under the current risk-off market climate blighted by surging costs of growth, VZ stock has underperformed the broader market.

Verizon shares have lost close to a third of their market value through 2022, while key market benchmark S&P 500 (SP500) has lost about a fifth of its value over the same period. The Verizon stock, despite its leading market share still, also trails the performance of key rivals T-Mobile (TMUS) and AT&T (T), which eked out impressive market-defying gains of more than 20% and 2%, respectively, through 2022. The stark contrast in the performance of Verizon shares against its rivals’ and the broader market continues to underscore investors’ angst over the sustainability of the valuation premium it has held in past years, which prices in a market leadership advantage that it appears to be rapidly slipping through its fingers.

2023 will be a make-or-break year for Verizon. So far, the company has made wireless service revenue growth a priority over building subscription volume to ensure cash flow expansion, which its valuation and expected shareholders’ returns (i.e., dividends) are pinned on. And considering the robust subscription growth and impressive revenue beat in the fourth quarter – which is consistent with prior quarter trends – the strategy appears to be working. Looking ahead, the first half of 2023 is likely to give Verizon an added benefit of softer PY comps, given rapid churn experienced during this time last year. The price increases implemented in mid-2022, and continued graduation of existing customers to more profitable unlimited plans via targeted contract offerings like Welcome Unlimited and Bring Your Own Device are also expected to have a more evident impact in 2023 and bolster y/y growth trends in the first half for Verizon. Building consistency on revenue and margin expansion, while minimizing subscription churn will remain critical for Verizon as it works through the last leg of its capital-intensive 5G network build-out. Paired with the anticipated fade-out of current macroeconomic challenges, 2024 will turn a new page for Verizon as it optimizes monetization on investments made in prior years and scale returns.

Although execution risks remain elevated, given the hard task of stemming massive market share loss while Verizon looks to buy just enough time to ramp its 5G and broader consumer wireless ambitions up to par with competition, the stock’s list of negatives – spanning near-term macro risks, continued churn, and ensuing fundamental weakness – have likely been priced in. The stock now trades at about 8x estimated earnings, down from a median of over 12x in previous years, and on par with industry peers like AT&T, which trails Verizon’s consumer wireless market share by wide margins still. Taken together with Verizon’s industry-leading dividend yield at current levels, and consistency of the payout (Verizon has not cut dividends for 16 years) buoyed by early signs of fundamental improvement observed in the fourth quarter, VZ stock now makes an attractive long-term investment pick for the income-focused investors.

An Overview of Verizon’s 4Q22 Results

Verizon delivered a robust fourth quarter, underpinned by 217,000 postpaid phone net adds (excluding disconnections pertaining to 3G network shutdown), surpassing consensus estimates of 194,000 postpaid phone net adds and a significant improvement from the prior quarter’s 8,000. Total wireless retail postpaid net adds, inclusive of broadband, reached 1,434,000 – marking the “best single quarter performance in seven years.”

Revenue also exceeded consensus expectations by $160 million, up 3.5% y/y to $35.3 billion in the fourth quarter, underscoring early signs supportive of management’s strategic shift in focus towards prioritizing average revenue per user (“ARPU”) growth by encouraging graduation to higher priced unlimited plans, instead of merely boosting subscription volume. Specifically, consumer revenue increased by 4.2% y/y to $26.8 billion, primarily “driven by wireless service revenue,” which grew by 6.1% in line with management’s commitment.

Adjusted EPS of $1.19 in the fourth quarter was also in line with consensus estimates, despite a decline from the same period in the prior year as expected due to continued C-band build-out, 3G decommissioning, TracFone integration, and other costs. However, with broadband being a bright spot – particularly pertaining to adoption of its higher margin fixed wireless access (“FWA”) business (discussed further below) – the segment has likely helped cushion some of the elevated cost pressures experienced over the past quarter.

Looking ahead, Verizon expects further improvements to its wireless service revenues, which is consistent with management’s strategic shift towards prioritizing cash flow generation by bolstering ARPU and optimizing monetization on its market leading consumer wireless subscription base. The company expects wireless service revenue to expand 2.5% to 4.5% in the current year, which would exceed 2022’s 2.4% y/y expansion that took a hit with substantial churn in earlier parts of the year. Adjusted EPS is guided at $4.55 and $4.85, which is shy of consensus expectations for $4.97.

5G is Both an Opportunity and a Threat…

…and it is still very much up in the air on which side Verizon will ultimately land on. As mentioned in the earlier section and in a previous coverage, execution risks remain elevated as Verizon continues on an upstream battle against the growing 5G prowess of T-Mobile and competitive industry promotions that are rapidly eroding the company’s consumer wireless market share, while related network build-out costs continue to weigh on its profit margins, which is in line with management’s mediocre guide on EPS relative to consensus estimates.

Essentially, 5G has Verizon in a deadlock. Verizon’s expansive network and competitive pricing were key to building its market leadership in past years. But T-Mobile’s advanced build-out of its 5G network has been largely a threat that marked the beginning of Verizon’s “third-straight year of below-industry growth, going from first to last in mobile-subscriber gains”. Recall from our previous coverages exploring Verizon and AT&T’s 5G capacities – both companies trail rival T-Mobile, which was given a leg up in the 5G race following its merger with Sprint in 2020. This left Verizon no choice but to onboard the capital-intensive endeavor and hasten its 5G network build-out.

But 5G also creates a longer-term growth opportunity for Verizon if executed adequately. The company now faces an ever-increasing urgency to complete deployment and ramp up monetization of its 5G network as rapid consumer wireless subscription churn in recent quarters also underscores a loosening grip on its leading market share of the consumer wireless market. It is essentially a time constrained – in addition to capital-intensive – race, as competition closes in on Verizon:

The absence of any downside surprise [would help] allay investor concerns about mounting 5G costs, and gives the company time to builds out its service.

Source: Bloomberg News

Looking closer at Verizon’s core businesses that revolve around its 5G network – wireless mobility, fixed wireless access, and enterprise – it is clear that the company remains deep in the execution phase, with much left to do and little time left on the clock to mitigate risks of succumbing to the increasingly “competitive environment in the wireless industry” and restore investors’ confidence in the stock.

Consumer wireless: Despite gaining 217,000 net postpaid phone subscribers in the fourth quarter, which is a meaningful improvement from the previous quarters, Verizon still trails significantly behind T-Mobile’s impressive 927,000 gained over the same period and AT&T’s projected 631,000, underscoring continued share loss to competition. While management has made it clear on its commitment to prioritizing wireless service revenue growth over subscription volume expansion to ensure cash flow generation, churn remains a very upfront challenge for Verizon and underscores its need to remain nimble in balancing ARPU growth without compromising on its postpaid subscription count.

Especially in the current macroeconomic climate where consumers are becoming increasingly price sensitive, providing a clear value-for-money proposition is critical to ensure minimized churn while ARPU continues to expand to ultimately contribute to earnings growth. And it remains a debate on whether Verizon’s service is on par with its ambitions to further its wireless revenues. While the company expects its C-band spectrum – which offers faster connectivity speeds (explained in detail here) – rollout to reach 200 million POPs (points of presence) by the end of the current quarter, T-Mobile already reaches 260 million POPs with the equivalent mid-band spectrum and is fast-approaching 300 million POPs within the near-term (T-Mobile’s widespread low-band spectrum already reaches more than 323 million POPs). Meanwhile, AT&T is also rapidly catching up, being “well ahead” of its expectations for its C-band coverage to reach 200 million POPs before the end of this year.

And on the performance front, Verizon’s 5G network remains a work in progress that also trails T-Mobile in terms of speed, consistency and availability. Specifically, T-Mobile’s 5G network currently boasts download speed of 216.56 megabits per second (“Mbps”), while Verizon’s is at a distant 127.95 Mbps, though both networks offer similar consistency with the latter underperforming the former by a smidge (Verizon 76.1% vs. T-Mobile 77.2%). Verizon’s 5G availability – which measures the percentage of users “on 5G-capable devices that spend the majority of their time on 5G” – also trailed at a distant 34.3% compared to rivals T-Mobile and AT&T’s 69.2% and 64.5%, respectively.

The company’s distant third place pertaining to availability draws concerns over the sustainability of its strategy to focus on “up-tiering” subscribers to pricier unlimited 5G plans, in our opinion. While the latest revenue beat is consistent with greater adoption to its pricier 5G unlimited plans (more than 40% of postpaid customers are on Unlimited premium; 70% to 80% of postpaid customers are on unlimited plans), 34.4% availability signals that uptime and utilization across its 5G network remains relatively low, despite it being the second best in terms of speed and coverage. While management’s recent announcement that “C-band usage represents 15% to 20% of all usage on its network, despite [it] only being available in 46% (72) of its markets,” is impressive, the comparable availability metric against peers indicate that Verizon still lags in ensuring its postpaid customers find value in what it offers. This could potentially imply that the average wireless mobility consumer remains price-driven rather than performance-driven when it comes to the switch to 5G, underscoring that execution risks remain high regarding Verizon’s longer-term efforts in retaining market share while also improving its wireless service revenues, as market feedback indicates its value proposition remains relatively weaker to that offered by peers still.

Meanwhile, on the prepaid front in consumer wireless, Verizon remains in the early innings of capitalizing on this cohort of end-users. While the integration of TracFone – the budget prepaid consumer wireless brand it had acquired in late 2021 – continues to progress and would be supportive of Verizon’s capitalization across various consumer segments over the longer-term, the business’ relatively price sensitive consumer base will likely be a roadblock ahead of the looming economic downturn. This was likely a primary contributing factor to the 175,000 net loss in consumer wireless prepaid subscribers sustained by Verizon in the fourth quarter, underscoring continued softness in the segment over coming months. Meanwhile, ramping up the premium no-contract prepaid equivalent, Total by Verizon, which launched late in the third quarter, remains in early stages that is still a ways to go before catching up to dominant share within the segment currently held by competitors T-Mobile and AT&T’s “Metro” and “Cricket” equivalents, respectively.

While Verizon’s foray in the prepaid consumer wireless market is a step in the right direction in complementing its goals of bolstering wireless service revenue growth and expanding cash flow generation over the longer-term by capturing greater share across multiple consumer segments, there is still much work left to do in ramping up all of the new services put into place and have them place an evident impact on the bottom line.

Fixed wireless access (“FWA”): FWA has been a relatively resilient corner at Verizon, with 262,000 net adds in the fourth quarter. Paired with 342,000 in the third quarter and 450,000 in the first half of 2022, FWA net adds have exceeded 1 million in full year 2022. The service, which effectively enables consumer home wireless internet connection by “[beaming] signals directly to a home Wi-Fi router” from an “outside wireless network” like its 5G C-band spectrum, will remain critical to improving the economics of Verizon’s consumer broadband business. While the current annual FWA net add run-rate remains well short of what is needed for the company to achieve 4 million to 5 million sign-ups by mid-decade, adoption across the consumer and enterprise (explained further in the “Enterprise Private 5G Networks” section below) markets is expected to accelerate over coming years as the build-out of its 5G network nears completion.

Verizon’s FWA broadband service currently covers over 30 million households, making consistent positive progress towards its target of covering 50 million households and 14 million businesses by mid-decade. Timely execution of these targets remain critical to ensuring Verizon’s longer-term cash generation ambitions. Specifically, FWA enables better economics for its broadband business, given nominal incremental costs and timeliness of deployment. For instance, while its Fios fiber network took “22 years to pass 17 million households”, Verizon’s FWA reached over 30 million households in “less than one year”. FWA also enables Verizon to optimize returns on past investments by leveraging its existing 5G wireless connection sites, which more than half of are now powered by its own fiber network as well. FWA installation is also less costly for both the end-user and Verizon – unlike fiber, which requires scheduling a technician to set up access, hefty set-up costs for the end-user and labor costs for Verizon, and lengthy installation time, FWA is fully self-installed by connecting the router to power, and inserting the sim card “associated with [the] 5G internet gateway” into the device, which takes less than five minutes.

And Verizon’s deeper push into prepaid wireless also makes a competitive advantage for its FWA business on the consumer front, given it provides end-users greater flexibility in times of growing economic uncertainty. Verizon began offering a “pay-as-you-go” home internet option “aimed at bargain hunters” in partnership with Walmart (WMT) under its recently acquired TracFone prepaid brand. Dubbed “Straight Talk Home Internet” operated by TracFone, the pay-as-you-go, or prepaid, home internet service “will use the Verizon fixed wireless network” and enable further scale, which would contribute positively to overall wireless service profit margins over the longer-term.

Both the prepaid Straight Talk Home Internet FWA offering, and Verizon-brand FWA offering, should also allow the company to better capitalize on the secular decline in cable broadband:

The result is continued expected challenges for cable, with limited customer activity, those increased fiber deployments and corresponding heavier competition from fixed wireless. “Cable high-speed data revenue growth was effectively halved in ’22 and we expect it to halve again in ’23,” the team said, expecting EBITDA growth in that industry to slow to low single digits.

Source: Seeking Alpha.

Currently, about a third of FWA subscribers are new to Verizon, underscoring the service’s increasing penetration into both existing urban and new suburban / rural markets for incremental share in broadband. With about a quarter of “rural Americans consider access to high-speed internet in their local community to be a major problem,” Verizon’s FWA offering is well positioned for substantial low-cost growth headroom over the longer-term. FWA penetration in new markets is also expected to complement Verizon’s aspirations to retain consumer mobile market share by serving as a gateway for end-users in new markets to its 5G network capabilities, creating potential cross-selling opportunities.

Enterprise Private 5G Networks (enterprise FWA): On the enterprise front specific to 5G opportunities, Verizon’s earlier aspiration to achieve $2 billion in “B2B [business-to-business] wireless revenue” through the deployment of private 5G networks used for powering mobile / multi-access edge computing (“MEC”) by mid-decade has been set back during early stages of rollout given industry’s infrastructure was not yet ready for extensive deployment.

Mike Rollins

And on the subject of MEC, you mentioned earlier the opportunity to get more private 5G deals with customers. Is Verizon still on track for a goal of $2 billion of MEC in B2B wireless service revenue by 2025 from the 5G initiatives?

Hans Vestberg

I think we have seen a little bit slower pickup in the beginning, and partly our fault or industry fault because the ecosystem wasn’t there…We need certain radio-based stations for private networks, different price ranges. We need modems for certain things, et cetera. So, you need more than the handset and the macro side. That is now in there. So, we would now have offerings for cheaper private 5G network with certain suppliers and more high level, high quality. We didn’t have this optionality. And that’s why we now started seeing that we’re actually meeting the customer demands of building private 5G network…So, for us, this year, in ’23, is more about taking those deals…We are very early out building with some of the large hyperscalers solutions, and now we also have the ecosystem for radio…We strongly believe in private 5G networks. And that’s a revenue [stream] we don’t have today…

Source: Verizon Communications at Citi 2023 Communications, Media & Entertainment Conference (Transcript).

Although that matter has since been resolved, with the company prioritizing private 5G network opportunities this year, the ambitions might have come at an inopportune time given mounting macroeconomic challenges that have resulted in uncertain IT budgets across the industry. Specifically, tech industry names including Salesforce (CRM) have observed elongated sales cycles as boardroom executives take a “more measured approach to their purchasing decisions…talking pennies, [and] not millions” ahead of the looming economic downturn, which could become a spill-over macro-driven challenge for Verizon’s enterprise 5G ambitions as well in the near-term. While longer-term secular growth trends pertaining to private 5G network adoption remains intact, given key digitization trends that require lower “latency performance comparative to the latest Wi-Fi standards,” near-term macroeconomic headwinds could further dial up Verizon’s execution risks pertaining to capturing enterprise 5G opportunities.

Looking Ahead

But despite the double-whammy of market share loss and weakening fundamentals in the midst of the transition to 5G, Verizon is nearing the light at the end of the tunnel. Specifically, 2023 should mark the final year of substantial capital spend towards Verizon’s 5G program. Recall that when “Verizon reclassified C-band capex into its definition of BAU [business-as-usual] capex, it added $10 billion of C-band-related capex into its projections.”

So, ’23, we still have money left from the C-band. Remember, we took $10 billion extra for the C-band deployment over a three year and the last year is [2023].

Source: Verizon Communications at Citi 2023 Communications, Media & Entertainment Conference (Transcript).

The company expects capex spend to range between $18.25 billion to $19.25 billion in the current year, inclusive of “the final approximately $1.75 billion of the incremental $10 billion of C-Band-related capital spending.” Once deployment is complete, management expects capital spend to revert back to normalized levels in the pre-5G-investment era at the $17 billion range, which would mark “the lowest capital intensity in the industry in the world” as a percentage of revenue.

Another plus is that despite substantial consumer wireless mobility churn observed in earlier 2022, and modest reacceleration in growth over recent quarters, Verizon is still the market leader in terms of market volume with active monthly subscribers in the 100+ million range, while rivals T-Mobile and AT&T remain in a distant second and third place with a total monthly active customer count in the 90 million and 80 million range, respectively. And as it continues to up-tier subscribers to pricier and more profitable unlimited plans, Verizon will likely make progress towards its goal of expanding wireless service revenues – so long as churn maintains within reasonable levels, which we believe Verizon still has much left to work on considering a churn rate of 1.06% in postpaid retail wireless over the fourth quarter, accelerating from 0.92% in the third quarter, 0.81% in the second quarter, and 0.83% in the first quarter.

Taken together with a cost-savings program underway that is expected to drive annualized spending reductions of $2 billion to $3 billion by mid-decade, Verizon could be well set for a potential turnaround once 5G deployment work settles. The anticipated timeline on ramping up 5G monetization upon completion of core network build-out efforts later this year / early next year is also expected to coincide with an improving macroeconomic backdrop.

In the meantime, the company’s “best highest-quality consumer base in the industry” remains a competitive advantage in mitigating risks of lengthening payment cycles observed at peers like AT&T and T-Mobile in recent quarters. This, alongside a pay-out ratio of about 50% based on full year 2022 dividends paid totaling $10.8 billion and net income of $21.7 billion, which marks a reasonable margin for funding additional future growth investments, will remain the key to reinforcing its 16-year and counting streak in keeping / increasing dividends – a core focus for its income-heavy investor base.

We want to continue with our dividend. We are, I think, the only telecom company in the world that has kept or increased the dividend for 16 consecutive years. And we think that’s what Matt and I want to continue to do. We want to give our Board an opportunity to continue to do that. That’s important.

Source: Verizon Communications at Citi 2023 Communications, Media & Entertainment Conference (Transcript).

Although competitive headwinds and hefty 5G build-out costs remain key overhangs on Verizon’s performance, the related list of negatives – counting near-term macroeconomic challenges as well – are likely reflected in its current market value.

With its fundamental prospects still supported by a viable business in wireless services and market-leading consumer subscription volume, alongside self-sufficient cash flows to fund the near-completion build-out of its 5G network, Verizon Communications Inc. has become a compelling income investment at current levels. This is especially true if persistent market-driven swings bring it back to previous October lows on par with multiples as observed at peers in the 7x range of estimated earnings.