Verizon is set to report its Q4 earnings on Thursday, January 22. In the previous quarter, the carrier’s healthy wireless subscriber growth helped overall operating revenues increase by 4.3% year-over-year (y-o-y) to about $31.6 billion. The wireline business reported a marginal slump in total operating revenues, although consumer revenues grew by 4.5% y-o-y on strong FiOS subscriber adds. Net income grew by over 65% to $3.7 billion in the quarter, reflecting the fact that the company now enjoys complete control over Verizon Wireless, after acquiring Vodafone’s 45% stake in February last year.

For the fourth quarter, the company expects postpaid gross adds to grow both sequentially as well as year-over-year. Verizon’s postpaid gross adds in Q3 2014 and Q4 2013 were 1.53 million and 1.65 million, respectively. However, growing competition and the ongoing price war in the U.S. wireless market will continue to put pressure on Verizon’s EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) margins in the fourth quarter, company CFO Fran Shammo stated at the UBS Global Media and Communications Conference last month. The company also expects churn rates to be higher sequentially as well as y-o-y due to higher competition.

We have a price estimate of $53 for Verizon’s stock, which is about 15% ahead of the current market price.

Network Quality, “More Everything” Advantage To Boost ARPA

Verizon introduced an upgraded 4G network last year to improve its network quality, retain existing users and attract new subscribers. The upgraded LTE network, XLTE, has already been launched in over 400 cities and can potentially be twice as fast as Verizon’s existing 4G network, depending on user location. This helped Verizon in being ranked as the best overall network in the U.S. in the latest mobile network performance report by RootMetrics, leading all other carriers in reliability, network speed, data performance as well as call performance.

After lagging behind rivals T-Mobile and AT&T in adding new subscribers for several quarters, Verizon added about 1.4 million postpaid connections during Q2 2014 and reported an even better performance in the third quarter. In the first nine months of 2014, Verizon added 3.5 million postpaid subscribers compared to AT&T’s 2.44 million, T-Mobile’s 3.6 million and Sprint’s loss of about a million postpaid subscribers.

Considering that Verizon was not as aggressive with its marketing or plan pricing in 2014 as its rivals, its subscriber addition figures are reflective of the fact that customers are willing to pay a premium for better network quality. It also suggests that network quality is as important a factor in attracting customers as competitive pricing, which is likely to continue to benefit the carrier going forward.

To effectively compete in the saturated U.S. wireless market, Verizon made its first big move in February last year when it renamed its ”Share Everything” data plans “More Everything”, increased the data allocation for subscribers and started offering heavy discounts. These “More Everything” plans were immensely popular, as evidenced by the fact that 57% of all postpaid accounts on Verizon’s network were using these plans by the end of Q3 2014, up from 42% in Q3 2013 and 55% in the previous quarter.

Verizon benefited from offering these discounts, as subscribers started adding more mobile devices to their shared data plans, which eventually encouraged many of them to shift to higher data tiers. This was reflected in the fact that its retail postpaid average revenue per account increased by about 3.5% y-o-y to $161.24 per month, and its retail postpaid connections per account improved from 2.72 in Q3 2013 to 2.82 in Q3 2014. We expect ARPA to grow in the fourth quarter as well, owing to the carrier’s superior network quality and focus on increasing data usage per user.

Competition To Hurt Churn

Competition has been intense in the U.S. wireless market in the past few quarters, with Sprint’s race-to-the-bottom pricing strategy and innovative low-cost offerings such as the “Cut your bill in half” event, “Double the Data” and “iPhone for Life”. T-Mobile also continued to innovate around its “Uncarrier” initiatives and AT&T cashed in on the price sensitive market sentiment with its equipment financing plans (“Next”).

Although Verizon has done well in adding new subscribers to its over 106 million strong subscriber base in this competitive environment, its churn rate is likely to be negatively impacted as price sensitive customers switch to other less expensive service providers. The carrier has maintained a low retail postpaid churn of about 0.93-0.94% in the past several quarters but we expect it to report slightly higher churn figures in the fourth quarter. Refer to How Do U.S. Wireless Carriers’ iPhone 6 Plans Stack Up? for a quick comparison on the cost of ownership of an iPhone 6 with different service providers.

Margins Under Pressure Despite Rising “Edge” Adoption

Verizon’s wireless segment EBITDA service margins declined by 60 basis points year-over-year to 49.5% in Q3 2014, on account of rising competition, higher promotional activity and lower adoption of the company’s no-subsidy “Edge” plan. The percentage of subscribers opting for the company’s “Edge” plan likely declined from about 18% in Q2 to about 12-13% in the third quarter. However, Verizon’s CFO stated last month that adoption rates of the “Edge” plan had been around 24% in the fourth quarter, or double the third quarter trend. While this will have a positive impact on wireless service margins, higher discounts and promotional activities to counter aggressive marketing by rivals are likely to offset such gains.

(Credit: Web)