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Verizon Has Marginal Concerns in Q2

Raymond McConville
News Analysis
Raymond McConville

Verizon Communications Inc. (NYSE: VZ) turned in a solid second quarter that was in line with Wall Street's expectations, but concern over slowing growth and profit margins have the company's stock trading down nearly 2 percent this afternoon. (See Verizon Reports Q2.)

For the second quarter of 2007, Verizon earned $1.68 billion, or 58 cents per share, on revenues of $23.3 billion. In the same quarter last year the company earned $1.61 billion, or 55 cents per share, on revenues of $21.9 billion.

Table 1: Verizon's 2Q07 Scorecard

2Q07 2Q06 Y/Y Change
Revenue (Millions) $23,273 $21,886 +6.3%
Earnings (Millions) $1,683 $1,611 +4.5%
GAAP EPS $0.58 $0.55 +5.5%
Access Lines 43,288,000 46,950,000 -7.8%
Broadband Subscribers 7,686,000 6,125,000 +25.5%
Video Subscribers* 1,300,000 n/a n/a
*515,000 FiOS TV subscribers and 785,000 DirecTV subscribers

Verizon also announced today that it would be acquiring Rural Cellular Corp. (Nasdaq: RCCC) for $2.67 billion. The price includes $755 million in equity at $45 per share. Rural will bring 716,000 customers in 15 states to Verizon Wireless and could also bring significant synergy savings to the company.

"In our opinion, this merger will generate increased profitability both from top-line growth and expected cost savings," writes Banc of America Securities LLC analyst David Barden in a research note this morning.

Just as AT&T Inc. (NYSE: T) reported in its earnings call last week, Verizon's strongest asset is its wireless division, where the company reported a 17 percent increase in total service revenue. Data is also proving to be a huge growth area. Data revenues were up 70 percent.

Verizon's FiOS TV service added another 167,000 customers to bring the current total to 515,000, and the FiOS Internet service added 203,000 to bring that total to 1.1 million. But with the success of FiOS comes the decline of legacy services like PSTN lines and DSL.

While Verizon pointed out that line loss from traditional copper is on the decline, it also conceded that FiOS is cannibalizing DSL, which only added 85,000 subscribers this quarter. "The net adds were lighter than they should have been. We do expect reduction, but DSL was not our focus this quarter," said COO Denny Strigl on the call this morning. "We moved a lot of our staff over from DSL to FiOS."

The high cost of FiOS on both the IT side and the marketing side was a concern for several analysts on the call, because it continues to cut into the company's margins and has led to lower EBITDA margins compared to some of Verizon's peers.

"This is an issue of momentum," said CEO Ivan Seidenberg. "I think first you see momentum on the top line, and then you'll start to see it on the margin line." Seidenberg expects this to happen by late 2007 and early 2008.

"Overall, we believe sentiment remains conservative, despite the strong stock performance, on the prospects for FiOS to not simply stop diluting growth, but to transform into a positive growth contributor," writes Banc of America's Barden. Barden also notes that he believes the market will eventually gain appreciation for the inflection in FiOS dilution expected for 2007.

Shares of Verizon are off $0.74 (1.76 percent) to $41.26 in midday trading.

— Raymond McConville, Reporter, Light Reading

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