Investors Make Early Call on Verizon

JANUARY 26, 2011   the wall street journal

By MARTIN PEERS

As far as would-be Verizon iPhone users are concerned, the best is yet to come. From an investor standpoint, however, it's arguably already here.

Verizon shares, after rising 1.6% Tuesday, are trading at 16 times the mid-point of 2011 earnings per share implied by the company's guidance for 5%-8% growth, adjusted for various items. That's hardly cheap: Since 1996, according to UBS Securities analyst John Hodulik, Verizon shares have on average traded at about 15 times the coming 12 months' earnings.

Investor enthusiasm is understandable. Next month's launch of an iPhone on Verizon Communications' majority-owned Verizon Wireless, along with the recent launch of Verizon's next-generation LTE high-speed wireless network, are two huge positives for the carrier.

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Indeed, Verizon is projecting its smartphone penetration among contract customers nearly doubles to 50% by the end of this year, from 26% at the end of 2010. Smartphone users generate double the average revenue per user than more basic phones, which don't require data plans. No surprise, then, that Verizon projects revenue growth of between 4% and 8% this year, well above 2010's 1.9%.

Whether Verizon meets its EPS growth target, though, depends partly on how it meets the smartphone penetration projections. Based simply on Verizon's 83 million contract customers as of Dec. 31, the projection implies the company signs up 20 million new smartphone customers this year. That's more than double the 2010 increase in Verizon's smartphone customer count.

The big swing factor for profit is how many of these extra phones are Apple devices, which carry higher subsidies than other smartphones. So the more iPhones sold, the lower Verizon's earnings will be this year. Next year it gets the profit benefit; indeed, the company said it expected earnings-per-share growth in 2012 to about double this year's number.

But Verizon didn't give a projection for how many iPhones it expects to sell. Executives said their earnings projections reflected the Wall Street consensus number of 11 million iPhone activations this year. That figure easily could be too low, particularly given the pent-up demand from Verizon subscribers that likely exists. AT&T, which has significantly fewer contract customers than Verizon, activated 10.3 million iPhones in 2009 and 10.9 million for the first nine months of 2010. Strategy Analytics estimates AT&T activated 16 million for all of last year.

What's more, the 11 million estimate implies Verizon expects to sell nearly 10 million other smartphones. Even with the benefit of new LTE handsets (which won't include, at least initially, the iPhone), that seems unlikely. More likely, then, a higher proportion of Verizon's new smartphone activations will be for iPhones. That would suggest Verizon's 2011 earnings will tend toward the lower end of guidance. That's good news for 2012 profits. Only thing is, priced at 13-14 times 2012 earnings, the stock reflects that already, too.

Write to Martin Peers at martin.peers@wsj.com