Verizon or AT&T?

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January 15, 2010 | Stocks | | Author Asif

I received a question from a subscriber about Verizon asking if I would consider picking up Verizon’s stock over AT&T. I started this analysis for the December 2009 investment newsletter but did not get a chance to finish it back then and hence am publishing it as a blog post instead. While his question was only about Verizon and AT&T, I included both Sprint and Comcast in the comparison tables listed in the valuation section below. With the baby bells increasingly moving into bundled offerings that include TV service and Comcast offering phone service, I figured it would be a good idea to see how Comcast stacks up against the baby bells.

Growth for Verizon and AT&T is being driven primarily by wireless and service bundles that include TV, phone, internet service and cell phone even as they are losing wireline business. The focus of this post is the valuation comparison tables at the bottom but I have briefly touched upon the two factors that are driving growth at these companies.

FiOS or U-verse?

Verizon had planned on investing $18 billion by 2010 to build out its fiber optic network and launch the FiOS service. I still recall the stock dropping back in 2006 when that news came out but the carrier had no choice to invest or be left behind. FiOS is generating $1.4 billion in quarterly revenue right now with Average Revenue Per User (ARPU) of $137/month when compared to standard consumer ARPU of $75/month. Using the quarterly revenue and monthly ARPU number provided, Verizon had approximately 3.41 million FiOS subscribers by the end of the third quarter of 2009. They expect to add a million new FiOS subscribers a year. Even if Verizon ends 2010 with 5 million FiOS subscribers, this would still be well below the 7 million subscribers estimated by the company back in 2006 when they started investing in FiOS. The investment in FiOS will be “substantially” complete by the end of 2010.

AT&T’s equivalent service called U-verse is tracking well behind Verizon with 2 million subscribers as of December 9, 2009 but is growing at a much faster clip. Revenue from U-verse is expected to top $2 billion in 2010 and customers who purchase these services are less likely to leave AT&T, thereby reducing churn. Looking at the bundles offered by Verizon and AT&T, it looks like Verizon’s $99.99 bundle offers more bang for the buck especially when you take into account the FiOS internet service (up to 15 Mbps downloads and 5 Mbps uploads) when compared to the $132 triple play bundle offered by AT&T with their Pro internet service (3 Mbps downloads) and U200 TV service.

iPhone or Droid?

Over the last decade, I have used mobile phone service from 5 different carriers starting with Voicestream Wireless (acquired by T-mobile) in 1999 to my current iPhone with AT&T. My worst experience was with Sprint and AT&T comes a close second in terms of connectivity issues. If I had the ability to transfer my iPhone from AT&T to another carrier like Verizon, I most likely would. When a journalist from AOL reached out to me a few weeks ago about AT&T’s service in the San Francisco bay area, I told him that my calls often drop especially while driving along highway 101 on the stretch just north of the San Francisco airport. A friend of mine who lives in the City runs into two dead zones during a short 10 minute commute to work. The question is not if AT&T will lose its iPhone exclusivity but when.

Verizon on the other hand is often mentioned as the carrier with the best network but every time I looked at the phone offerings from Verizon I used to come away unimpressed. The much anticipated release of the Motorola Droid running Google’s Android operating system sparked new interest in Verizon a few weeks ago. When having lunch with a friend earlier this week, he showed me his new Motorola Droid phone that he purchased after returning an iPhone. He told me that while there were certain things the Droid better than the iPhone, while the iPhone was like having a beautiful and charming person by your side, the Droid was the equivalent of a being in the company of a robot. I briefly tried the Droid and was not impressed. In contrast as you can see from this very detailed comparison of the iPhone vs. the Droid posted on our sister site AppStruck.com, a lot of iPhone users have found the Droid to be a worthy rival if not an iPhone killer.

Valuation:

AT&T activated 3.2 million iPhones just in the third quarter of 2009 and if you look at AT&T’s wireless ARPU for post-paid customers, the phone has been very beneficial to AT&T bottom line despite the data usage issues that the top 3% of iPhone users are creating for AT&T. Churn rates for iPhone users are also lower.

If you were to only consider the numbers in the tables below, one could easily make the case of investing in AT&T over Verizon after considering its wireless ARPU, profit margins, leveraged free cash flow and dividend yield. However when you look at churn, the balance sheet, valuation (EV/Operating Cash Flow or EV/Revenue) and management effectiveness metrics such as ROA or ROE, Verizon appears to be the better alternative. Finally throwing in the risk of AT&T losing its iPhone exclusivity and the early ramp of FiOS, I would personally pick Verizon over AT&T. Interestingly legendary hedge fund manager George Soros decided to buy both AT&T and Verizon for his portfolio but picked up a larger stake in Verizon.

Operating Metrics

Verizon (VZ) AT&T(T) Sprint (S) Comcast (CMCSA)
Churn (Q3 2009) 1.13% (post-paid) 1.22% (post-paid) 2.17% (post-paid) 2.7% (TV)
Wireless ARPU (post-paid) $52.78 $61.23 $56 NA
Gross Margins (Q3) 59.67% 58.24% 46.92% 60.67%
Operating Margins (Q3) 14.62% 17.46% (3.16%) 19.65%
Profit Margins (Q3) 4.31% 10.34% (7.88%) 7.43%
Return on Assets (ttm) 5.61% 4.88% (0.87%) 3.94%
Return on Equity (ttm) 11.77% 11.24% (15.62%) 7.5%

Financial Metrics

Verizon (VZ) AT&T(T) Sprint (S) Comcast (CMCSA)
Debt (billions) $62.82 $72.66 $21.66 $29.45
Cash (billions) $1.69 $6.17 $5.94 $0.92
Levered  Free Cash Flow (billions) $7.2 $14.66 $3.73 $3.79
Current Ratio 0.81 0.78 1.62 0.48
Dividend Yield 6% 6.2% NA 2.3%
Payout Ratio 94% 81% NA 24%

Valuation Metrics

Verizon (VZ) AT&T(T) Sprint (S) Comcast (CMCSA)
Price/Earnings 16.01 13.00 NA 15.56
Forward P/E 12.74 11.69 NA 13.89
Price/Sales 0.86 1.28 0.35 1.35
Enterprise Value/Operating Cash Flow (ttm) 5.09 6.15 5.73 7.22
Enterprise Value/Revenue (ttm) 1.44 1.82 0.83 2.16



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