Verizon Communications (NYSE:VZ) is in an enviable position as a leader in its two primary business segments. However, maintaining this leadership position may be too costly to consider the stock an appealing investment.
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During the most recently completed quarter, wireless revenue grew to 57.6% and improved total revenues by 27.7% year over year. This revenue increase was the back of strong continued organic growth at Verizon Wireless and the acquisition of Alltel, which was completed on January 9, for $5.9 billion in equity. Verizon owns a majority 55% stake in Verizon Wireless while Vodafone (NYSE:VOD) owns the remaining 45%. (Find out which companies collapsed after merging, read Biggest Merger and Acquisition Disasters.)
Wireline revenue fell 5.2% to account for the rest of revenue as Verizon added 300,000 Fiber Optic cable customers and experienced respectable business services growth. Total quarterly sales advanced 11.3%, to $26.9 billion. Reported earnings fell 17.5%, to 52 cents per share, but according to the company only fell 6% when stripping out what it considers one-time or non-recurring items.
Analysts currently project full-year revenue to grow 11% to about $108 billion as Alltel will continue to enhance top-line figures. They are calling for full-year earnings of $2.51, which would represent a year-over-year increase of 11%.
Verizon's businesses generated $8.2 billion in average annual free cash flow over the past three years, which works out to $2.88 per share using the most recent quarterly share count figures and exceeds reported earnings by a fairly wide margin. At the current share price, the free cash flow multiple is 10.3 times, which is quite reasonable. Verizon also sports a generous dividend yield of 6.4%, which only eats up about $5 billion in free cash flow each year and leaves room to fund acquisitions and repurchase shares. (Find out what these company programs achieve and what it means for stockholders, read A Breakdown Of Stock Buybacks.)
The only major investment drawback is that Verizon must deploy tens of billions in capital to maintain its capital-intensive businesses and fund acquisitions to remain competitive and keep arch rivals such as AT&T (NYSE:T), Sprint (NYSE:S), and U.S. Cellular (NYSE:USM) at bay. As a case in point, the Alltel acquisition has pushed long-term debt to nearly $60 billion, or 42% of total capitalization. Annual returns on invested capital hover in the high single digits, which barely justifies its costs of capital. AT&T and U.S. Cellular report similar levels of ROIC, though Verizon is slightly outperforming these peers on this metric.
Another drawback is the industry is extremely competitive. Fortunately, Verizon stands out as a market leader in both business segments, along with AT&T. Sprint and T-Mobile, which is owned by Deutsche Telecom (NYSE:DT), are currently a distant third and fourth and rumors have swirled that they may combine operations. But given current industry dynamics, Verizon is not appealing enough to warrant dialing up for the shares.