The telecom giant that is poised to disrupt Canada’s $19-billion wireless market has already proven its mettle in the ultra-competitive U.S. market.
Verizon Communications Inc., a company more than double the size of the three biggest Canadian telecom operators combined, consistently comes out on top in quality and consumer-satisfaction ratings in the United States.
It’s known for reasonable pricing: A family can use up to 10 smartphones on the “Share Everything” plan, getting unlimited talk and text, plus 4 gigabytes of data, for $40 (U.S.) per phone per month, plus a single $70 data charge that covers all the phones on the plan.
That is considerably less than the going rates in Canada and may provide a foretaste of what is to come if Verizon follows through on its northern expansion plan. It has submitted a $700-million (Canadian) offer to purchase Wind Mobile, sources say.
“Verizon is one of the best managed companies I’ve ever encountered in 30-plus years as a securities analyst,” says Gerard Hallaren of Janco Partners, a Denver-based investment firm.
“Verizon Wireless’s Share Everything plans provide superior service at a lower or competitive price to most of the market. I would expect them to behave similarly in Canada.”
Verizon Wireless, which is 55-per-cent owned by Verizon Communications, has built its reputation largely on the quality of its network. Its “Can you hear me now?” commercials, launched over a decade ago, are still well-remembered enough to form the punchline for recent commentary on the U.S. government’s phone-records spying scandal.
But what is still unclear is how Verizon might proceed if it does come to Canada. While Mr. Hallaren sees Verizon Wireless competing for consumers’ business, others believe it would see a Canadian acquisition as simply a way to supplement its offerings to U.S. customers who travel to Canada for business or personal reasons.
David Dixon, an analyst at FBR Capital Markets & Co. in Arlington, Va., says Verizon may be aiming to capture additional roaming revenue from existing Verizon customers who cross the border to Canada.
Mr. Dixon, who worked for both BMO Nesbitt Burns and RBC Dominion Securities before heading south, says Verizon would probably try to cover the downtown areas of Canada’s major cities and provide coverage along the highways that link them, but would stop short of attempting to build a truly national network.
“We think it is unlikely that Verizon Wireless would extend coverage to the less dense regions of the Canadian market,” he says. “They can do what they need to do effectively across the seven major cities, but will it rival the coverage you see in the U.S. market? I don’t think so.”
And that means, in his view, that a Canadian customer with nationwide options from the likes of Rogers Communications Inc., BCE Inc. or Telus Corp. would see Verizon as “really not that valuable, because [the network] wouldn’t be built out.”
If Mr. Dixon is right, the shares of the Canadian wireless giants were unjustly hammered this week.
But Canadian investors who want to hedge their bets may want to consider a stake in Verizon. Its shares have doubled over the last three years, a testament to the company’s success in the U.S. telecom wars.
Formed in 2000 through the merger of Bell Atlantic Corp. and GTE Corp., it has evolved from its roots as a provider of traditional “wireline” connections into people’s homes.
While it still derives nearly $40-billion (U.S.), or more than one-third, of its revenue from its wireline business in the eastern United States, that legacy operation provides almost none of its earnings. Wireless makes up the majority of its revenue and nearly all its profit.
That is also the area where the biggest challenges lie. Like other phone companies Verizon is facing a slowing environment for expansion as wireless-industry revenue growth slows to about 2 per cent a year.
Analysts are almost evenly divided on the prospects for Verizon’s shares, with half of the 40 observers who cover the company rating the stock a “buy,” and just under half rating it “hold.” (There’s also one “sell” recommendation, according to Bloomberg.)
Those who are bearish on the stock point out that the recent rise in Verizon’s share price has resulted in a valuation above the company’s historic norms and above broader market averages.
“The [major telcos’] best days, from an outperformance standpoint, are probably behind them,” says analyst Christopher King of Stifel Nicolaus & Co.
Those who are more bullish see a best-in-class company with room for profit growth and an even higher dividend. “It’s a company operating at a very high level, compared with its competitors,” says Mike McCormack of Nomura Equity Research. “There’s a reason we should be paying a premium … for Verizon.”
Janco’s Mr. Hallaren, who has a “strong buy” rating and $68.67 price target on Verizon shares, is another bull. He believes the company’s FiOS service, which brought fibre-optics directly to each customer’s home, offers great potential to add to revenue through Internet and TV offerings. That should flow through to an increased dividend, Mr. Hallaren suggests.
Verizon currently yields 4.1 per cent, but it pays out under 30 per cent of its free cash flow, says the analyst team at RBC Dominion Securities. By comparison, the comparable figure for the Canadian telecom operators is 74 per cent.
The relatively low payout ratio at Verizon suggests the company could easily bump up its dividend. However, if interest rates continue to rise, making bonds more competitive with stocks, a sweetened dividend may not have much effect on the share price.
And there are the valuation issues to consider as well. The company’s forward price-to-earnings ratio has averaged nearly 17 in 2013, according to Standard & Poor’s CapitalIQ. That’s the highest in the company’s 13-year history. Its forward multiple of EBITDA, or earnings before interest, taxes, depreciation, and amortization, is at its most elevated level in nearly 10 years.
Mr. King, of Stifel Nicolaus, allows that some of the gains in Verizon’s shares have been well-deserved: The company increased market share in wireless, showed some improvement in margins in wirelines, and boosted its free cash flow as its heavy capital spending on the FiOS project tailed off.
He believes that Verizon and AT&T will dominate the U.S. telecom sector, but is concerned enough about Verizon’s valuation to cut his rating to “hold” last September. In an April report, he said “perfection [is] baked in at current levels, but perfection should continue.”
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