Verizon Communications, Inc. (VZ): Why You Should Own It


This article was published by Robert Rubin at The Researcher

Let's move past the impressive dividend of $2.00/share, yielding 5.35%, for a minute. In an income starved market, one could make the case that owning VZ common just for the dividend alone is very compelling, as there is no reason to believe the dividend is in jeopardy, and VZ could be held as an income-producing, bond surrogate (as the business is quasi-utility in nature and quite stable). However, I own VZ for reasons other than the dividend, as I can see upside to the stock of over 20% from the current $37.35/share, making an investment at this point even more compelling.

Let's consider the following:

· The stock is undervalued relative to the growth potential and the stability of the core business. You can look at the valuation two ways. Using the consensus EBITDA for 2012 of $37.9 billion, assigning a multiple of 5.5x gets you to a value for shareholders of $45.33/share (I am using 5.5x to align the enterprise more closely with the larger media conglomerates and smaller telecommunications companies, which all trade north of the current sub-5.0x multiple that VZ is fetching). While a multiple is subjective, aligning VZ closer to peers with a similar growth profile makes for a reasonable argument. The second way to look at the stock is using a sum of the parts analysis. Under that scenario, valuing the wireless business at 7.50x (to reflect an alignment with peers and the growth potential) and the wireline business at 5.0x (light relative to peers on the wired side, but we are being conservative), you get to a value of $44.41 per share.

· The consolidated entity had $13.4 billion of cash and $592 mm of short-term investments on the balance sheet as of December 31, 2011, which could be used for shareholder initiatives (special dividend, increase in the common dividend or share repurchases). While the enterprise carries leverage of $55.2 billion, the company has deleveraged from the $62.3 billion high in 2009 (on the heels of the Alltel Corp. acquisition) and with consistent FCF generation expected going forward into the foreseeable future, it is reasonable to assume that the cash on hand could be used to enhance shareholder-value (VZ is under 1.5x levered on a gross basis, and carries an A3/A- rating with the agencies, so there is flexibility to use cash for shareholders).

· VZ is a FCF machine. Over the past five fiscal years, VZ has generated FCF of (in descending order, starting with 2011), $13.5 billion, $16.9 billion, $14.5 billion, $10.3 billion and $8.8 billion. The company pays the dividend, and has billions left to spare to fund acquisitions, reduce debt or do other "stuff". It is never a bad thing to invest in companies that generate substantial amounts of FCF.

· Verizon Wireless appears poised to have a rebound year relative to a ho-hum 2011. Execution around wireless is the risk to the stock, as I see it, and will drive whether or not VZ is worth just the dividend or achieves the upside potential that I see possible in the shares. Wireless had a so-so year in 2011 in terms of growth, generating $26.5 billion of EBITDA, versus $26.1 billion in 2010 (growth from previous years was much more impressive). The reason was margin deterioration, as the EBITDA margin dropped to 44.8% in 2011 from 46.9% in 2010 (and Operating Margin declined to 26.4% from 29.5% over the same time period). The company cited the cost of the iPhone as the primary driver of margin deterioration. During the 4Q 2011, Wireless hooked-up 4.3 mm iPhone 4S phones, which pressured the margin. In 2012, assuming the pace of hook-ups slows and the trend in data usage and APRU continues, there is no reason to assume that growth doesn't resume in Wireless (my assumption around the sum of the parts reads to a 10% growth in wireless, which could prove light).

· Speaking of APRU, a quick question: how many of my loyal readers are seeing this on their smartphone? Data (which none of us seem to be able to live without) is controlled by VZ, AT&T, Inc. ( T ) and a few other players. Prices to the end-user are going to go up (people will pay). This will lead to further margin expansion. Over the next few years, regardless of the US economy, smartphones will become even more prevalent than they are, and data usage will increase. This will prove good for VZ over the longer-term (finding ways to increase the bandwidth and performance, which are in huge demand, is a high class problem).

· Along those lines, 4G is expanding. More data usage. Charge more! Good!

· Wireline is doing ok, and should FiOS continue to grow (and the investments that VZ has made in the Global Enterprise Business begin to bear fruit), there is no reason to believe that segment EBITDA won't hold (at least) the $9.0-$9.5 billion or so (and not drag on the enterprise). I could spend more time around wireline, but the reality is that all I want to see from wireline is stability and a slowdown in the inevitable move away from wired phone service (with other offerings by VZ in place to offset the melting ice cube). The growth is in wireless. So far so good, though, on wireline not creating too much damage to the financial condition.

As I see it, VZ has upside through Verizon Wireless, a stable enough platform in wireline, is coming off what felt like a transition year and the market has ticked the stock down over 7.0% year-to-date (which includes the dividend to be paid in a few weeks). The soft 2011 has been priced in. Upside on execution exists, and to get back to my opening point, the dividend is there to support you from here on out.

I like VZ here. The stock seems like a great buy it and put it away for 2012 story.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: CMCSA , DISH , S , T , VZ



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