VZ

Publicly traded companies mentioned herein: AT&T Inc (T), Charter Communications Inc (CHTR), Comcast Corp (CMCSA), T-Mobile US (TMUS), Sprint Corp (S), Verizon Communications Inc (VZ)

Highlights

In the presenter’s view, Verizon (VZ) is currently trading at a compelling valuation with an extremely favorable risk/reward profile. ($53; 6.9x 2019 consensus EBITDA and 11x forward earnings estimates). With its 4.5% yield and the potential for modest multiple expansion, VZ could provide shareholders with an IRR of between 4% and 27% looking out to 2020 (a two-year anticipated holding period). The optimism is based on an inflection in the core business driving better than expected revenue and EBITDA growth, as well as the potential for market share gains as VZ rolls out its 5G wireless offering (5G broadband provides some optionality as well). If the growth story plays out in VZ’s favor, the EV/EBITDA multiple could improve to 7.5x, and the stock could be worth $73 by the end of 2019, and $82 by the end of 2020.

• Verizon’s core business seems to be experiencing a positive inflection. The transition to unlimited wireless plans over the past two years has been a headwind for average revenue per user (ARPU), but now VZ is lapping those numbers and net subscriber adds are accelerating.

  • Based only on growth of postpaid wireless, VZ’s most profitable business, the presenter can see a path to low single-digit (%) revenue growth.

• Historically, VZ has been able to take share when there is a market transition. Looking back at the shift to 4G and that rollout, Verizon captured 2 - 3 points of market share. It stands to be first to market in 5G, and given the core business trends and premium network, the presenter fails to see a reason VZ can't/ won't take share over 2 - 3 years.

  • If VZ takes 2 - 3 points of market share, the presenter estimates a 5% boost to its subscriber growth. This could take two years to materialize, but layered on top of 2% - 3% core revenue growth, it boosts revenue growth to at least the mid-singles.

  • Separately, 5G broadband success can be considered as having option value, but its success is not crucial to the bullish thesis.

    • Technically, VZ says 5G broadband works. If it does, share can potentially be taken from Charter, AT&T, Comcast, etc.

• VZ’s margins should improve. First, core postpaid wireless subscriber dollars are the highest gross margin dollars Verizon earns. Second, VZ has a $10B cost reduction program in place that spans the next five years. Third, capex hasn’t changed much in absolute terms due to 5G, and it is unlikely to spike as bears suggest.

  • The company has been efficient with SG&A on new subscriber adds (this expense has been declining per-sub by high singles every year over recent years).

  • The cost cutting plan is worth ~30 bps per year to margins. Combined with the lower SG&A per sub added, there’s a “reasonable path” to 40 bps of margin expansion annually over at least the next 2 - 3 years (the Street is not modeling EBITDA margin improvement).

  • VZ has clearly been investing in 5G. Bears say capex will spike, but it hasn’t changed much and when the presenter looks back at the transition to 4G in late 2010 - early 2011, capex did not spike. Additionally, Verizon is known to be “very efficient” with its capex spending, and new CEO Hans Vestberg has a strong background in network infrastructure (he was VZ’s CTO and President of Global Networks before taking the helm, and prior to VZ Vestberg was President & CEO of Ericsson).

• Given low Street estimates for the next two years, the entry point in the low $50s looks very attractive to the presenter:

Verizon Communications Inc (VZ) - Key Stats/Consensus Estimates

Data from recently filed statements, estimates from S&P Capital IQ

• Putting better-than-expected revenue growth and margin improvement together results in ~7% EBITDA growth, compounded. A 7x multiple to EBITDA is a 35% discount to the market, and given VZ’s size, a small improvement in the multiple is obviously meaningful for the stock price. The way the numbers shake-out, by the end of 2020 the long position in VZ should earn an IRR of 27%; with a downside case of a +4% IRR (due to the 4.5% dividend yield). Assuming the presenter’s model is accurate, the magnitude of gain will depend on the whether the EV/EBITDA multiple rerates to 7.5x or 8x.

  • The downside multiple is probably 6x EBITDA, at worst. In his opinion, it’s difficult to see the multiple falling, never mind losing a full turn when the Street is only assuming a 1% - 2% compound growth rate for revenue and EBITDA, and flat EBITDA margins.

  • Overall, ~60% of the presenter’s thesis is driven by core business acceleration, and 40% is the step into 5G over the next 12 months.

  • Assuming a 7.5x multiple to forward EBITDA, the presenter pegs the target price at $73 by the end of 2019, and $82 by the end of 2020.

When asked about the benefits of 5G and the impact T-Mobile+Sprint could have if the deal goes through, the presenter replied:

• The reason consumers’ phones don’t work well in stadiums is the huge latency issue. Think about all the data intensive apps and when your phone breaks down. The lower millimeter wave tech allows for much more consistent, and better throughput to customers. That’s a good example of what 5G can do, and a more consistent experience is very important (the network will be able to concentrate more power into a denser location; consumers will see benefits in their day-to-day use).

  • The fundamental service improvement is separate from the optics of people wanting the latest, greatest phone. The [5G] rollout is mid-2019, and new equipment will be needed. It is not clear if all OEMs are committed to it, but Motorola has said its new moto Z can be paired with a moto mod to access Verizon’s 5G network.

  • New 5G phones are not included in the presenter’s estimates, but could be important for subscriber growth.

• TMUS and S were trying to compete for share. The combination of the two could help industry dynamics if the newco acts more rationally. High levels of promotional activity created a difficult environment over the last two years, but things have been much better over the last 6 months.