Verizon Falls a Penny Short - Analyst Blog

Verizon Communications (VZ), the second largest U.S. phone company, declared its fourth quarter and fiscal 2010 earnings results before the opening bell. The company reported fourth quarter adjusted earnings of 54 cents per share missing the Zacks Consensus Estimate by a penny. Higher discounts on Verizon's family and unlimited plans ahead of its iPhone debut next month are dragging earnings below expectations.  

Adjusted earnings were above the year-ago earnings of 50 cents, driven by continued strength in Wireless, FiOs and strategic business services.

Adjusted earnings excludes non-operational gains of 39 cents per share, which includes 50 cents associated with the change in Verizon's pension accounting, partially offset by 5 cents related to Alltel merger, and 6 cents for severance and other related charges.

On a reported basis (GAAP), earnings per share plunged 47.7% year over year to 90 cents in fiscal 2010.

Total revenue inched up 2.3% year over year to $26.4 billion in the reported quarter and was above the Zacks Consensus Estimate of $26.5 billion. Including last year's revenue from divested operations, total revenue dropped 2.6% in the fourth quarter and 1.2% year over year to $106.6 billion in fiscal 2010.

Segment Results

Wireless: The segment's revenue climbed 5.7% year over year to $16.2 billion in the reported quarter. Service revenues increased 7.7% to $14.2 billion. Data revenues grew 25.5% year over year, driven by the healthy adoption of integrated devices.

Retail churn and total churn (customer switch) improved year over year to 1.37% and 1.34%, respectively. Verizon continued to generate low retail post-paid churn, which was 1.01% during the fourth quarter. Retail post-paid ARPU (average revenue per user) remained strong increasing 2.5% year over year to $53.50. 

Verizon exited the year with 94.1 million wireless customers. Net customer additions in the quarter were 0.95 million compared with 2.2 million in the year-ago quarter. Verizon's subscriber growth plunged 55.8% year over year as it struggled to compete with its major rival AT&T Inc. (T) in the smartphone market. In addition, Verizon had 8.1 million other connections such as machine-to-machine and telematics, bringing total wireless connections to 102.2 million at the end of 2010.

Total retail customer base upped 2.4% to 87.5 million from the year-ago quarter. Net retail post-paid subscriber additions for the quarter were 872,000.

In December, Verizon Wireless, Verizon's venture with Vodafone Group Plc (VOD), launched its fourth-generation Long Term Evolution (4G LTE) mobile broadband network in 38 major metropolitan areas covering one-third of the American population and in more than 60 commercial airports. Verizon Wireless plans to expand its 4G LTE network in 140 markets additional by the end of 2011.

Wireline: Revenue from the segment wireline dipped 2.8% year over year to $10.3 billiondue to continued declines across global wholesale and enterprise businesses. Total Broadband connection at the end of the fourth quarter was 8.4 million, up 2.8% year over year.

Momentum for the FiOS fiber-optic network in the U.S remains strong, having already covered 15.6 million premises at the end of fiscal 2010. During the quarter, Verizon added 182,000 and 197,000 new customers for its FiOS TV and FiOS Internet services, respectively. The company exited fiscal 2010 with 3.5 million (up 26.3% year over year) FiOS TV customers and 4.1 million (up 24.2%) FiOS Internet customers.

The penetration rate of both FiOS Internet and FiOS TV surged to approximately 31.9% and 28.0%, respectively, across all markets from the year-ago level of 28.3% and 24.7%. Total broadband and video revenue, including FiOS Internet, FiOS TV and HSI (DSL-based high-speed Internet) leaped 18.4% year over year to $1.8 billion in the fourth quarter.

Cash Flow

Verizon generated $33.4 billion cash from operations in 2010 compared with $31.4 billion in the prior year. Capital expenditure was $16.5 billion in the year, down 2.5% year over year. Free cash flow climbed 16.4% year over year to $16.9 billion in full-year 2010.

Our Analysis

We expect Verzion growth prospects to be strong driven by new customers, higher smartphone adoption, 4G LTE mobile broadband network, and the sale of Apple Inc.'s (AAPL) iPhones in February, which will lead to improved revenue growth.

The sale of iPhone by Verizon will mark the end of exclusivity that its largest competitor AT&T iPhone has been enjoying since 2007, and will likely drive subscriber growth in 2011. However, Verizon may spend to promote the iPhone this year, which might hurt margins in the short term.

Further, the offerings of various devices including smartphones that support 4G network would strengthen Verizon's position with respect to Sprint Nextel Corp. (S), the first to launch handsets on its nationwide 4G service in 2010.

On the flip side, persistent erosion in access lines, high promotional and restructuring expenses, and intense competition from cable companies and other alternative services providers may be the downside.In addition, the 4G infrastructure may be an obstacle if other service providers shift to different generation technologies.

We are currently marinating our long-term Neutral rating on Verizon with the Zacks #3 Rank (Hold).