Krause Fund Research
Spring 2016 April 18, 2016
Telecommunications Verizon Communications, Inc. (NYSE: VZ)
Recommendation: BUY
Analysts
Joe Holz Current Price: $51.73 [email protected] Target Price: $62.00- $72.00 Joe Johnson [email protected] Stock Performance Highlights 52-week High $54.49 52-week Low $38.06 Company Overview Beta 0.74 Verizon Communications, Inc. (VZ) is an industry leader in Average Daily Volume 17.191M the integrated telecommunication sector. They offer products and services through their wireline and wireless operating Share Highlights segments, with a majority of their business deriving from Market Capitalization $211.12B their wireless operations. Their services range from voice, Shares Outstanding 4.24M text messaging, high-speed mobile internet, fiber optic Book Value per share $4.03 internet, entertainment, TV services, business solutions, and EPS (2015 annual) $4.37 more. Verizon currently serves 112.11 million wireless P/E Ratio 11.84 customers, and provides the best network coverage in the Dividend Yield 4.38% U.S. We are currently issuing a BUY recommendation for Dividend Payout Ratio 51.72% Verizon Communications, Inc. (VZ) at a current price of $51.73. Company Performance Highlights ROA 7.70% Verizon Offers Stable Value ROE 116.60% Profit Margin 13.96% Gross Margin 60.07%
Sales $131.62B • Dividend to continue at 3.00% growth rate – Verizon’s dividend yield of 4.38% is an attractive alternative during times of low interest rates for fixed income investors. With a Financial Ratios nine-year record of growing dividends at roughly 3.00%, Interest Coverage 6.74 Verizon’s dividend yield will maintain as a positive feature. Debt/Equity 6.18 Debt/Assets .45 • Fixed demand offers stable wireless revenue streams –
With consumers deeming wireless services as more of a necessity, Verizon will be able to maintain a steady stream of Industry Metrics wireless revenues. ARPU (monthly) $55.07 • Seeking out alternative revenue sources – Verizon ARPA (monthly) $152.63 continues to find new ways to increase revenue growth. They Churn Rate (Postpaid annual) .96% are currently working on entering the advertising market as well as beating the industry in the release of 5GLTE One-Year Stock Performance technology. VZ is Blue, S&P is Green (Source: Yahoo! Finance) • Debt levels are too high – Verizon’s debt levels are a cause for concern, as increases in the interest rate may hinder their ability to participate in opportunities that arrive in the market. • Price War & Competition – With the telecom industry being highly competitive, a current price war has put pressure on Verizon’s ability to maintain their high margins.
Economic Outlook the rights to the rest of their wireless segment from Vodafone. The cost of debt is directly correlated with the Gross Domestic Product interest rate environment in the economy, which causes GDP represents the overall growth in the economy, and a Verizon to be particularly sensitive to a change in the strong performance will signify progress towards a rates. healthier economy. Real GDP in Q4 2015 was 1.4%, and we believe in the short-term that it will stay relatively 9 The federal funds rate has been at all-time lows in the flat. In two to three years, our prediction is that it will recent periods, with their current target rate being .50%. slightly increase to 1.6%. Our pessimism is attributable to We do not believe the Federal Reserve will raise rates in the ever growing and changing global economy, as well the short term; however, we do see rates increasing to as the U.S. still trying to find their economic footing. around 1%-1.5% in two to three years. Our assumptions Increases in the GDP may perhaps indicate a willingness are based off the Fed stating their desires to increase rates, of consumers to purchase more connectable devices, as well as our prediction that inflation will raise during higher priced plans, and equipment that is more the same period. Even though the federal funds rate is an expensive. However, we believe the growth of the important economic driver, the industry is driven by long- telecom industry is correlated more directly with term rates. These rates are influenced by the government’s penetration rates and consumers’ opinions of whether or participation in quantitative easing, which drives down not wireless services are a necessity. Our prediction is interest rates on the long end of the yield curve. The backed by high smartphone penetration rates as well as Federal Reserve, however, has recently stated that they consumers perception of wireless technology as a are done with the easing process. necessity. Verizon’s postpaid service connections have 6 already reached 83.7% smartphone penetration. Even The YTM of a 30-year U.S. Treasury bond currently is though GDP has been at relatively low levels in recent 2.66%.12 Our team believes in the short-term that this rate years, the telecom industry has not seen major growth will maintain its current level, but will rise to around declines. The average growth rate in the last three years 3.00% in two to three years. Our assumption of the rate for Verizon’s retail postpaid connections has been 4.81%, increasing slightly is a function of inflation, interest rates indicating a steady growth of new customers in their 15 standing at all-time lows, demand, and the Fed ending wireless segment. Telecom analysts are still trying to quantitative easing. Sovereign bonds around the world are determine the overall impact that GDP has on the lowering the interest rates and even some are choosing to industry. The graph below shows changes in the real GDP encompass negative rate policy. We believe this will for the last 10 years. drive up the demand for U.S. long-term bonds, forcing rates to maintain only slightly above their current status. The rates will not decrease because of demand due to our belief that inflation will increase, and that the Federal Reserve would like to see the rates go up. With the Federal Reserve halting their quantitative easing, the interest rates at the long end of the yield curve will increase. The Graph below represents the current U.S. yield curve.
Data Source: Bloomberg economic calendar
Interest Rates Interest rates are a major economic driver for the telecom industry, as they must continuingly fund their highly capital-intensive projects. These projects include but are not limited to innovative research and development, infrastructure expansion, acquisitions, and the purchase of spectrum licenses. These capital-intensive requirements force the industry to maintain high debt levels. Verizon Source: U.S. Department of Treasury recently issued $54B worth of debt to finish purchasing
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Corporate bond yields are also positively correlated with then recognize a decrease in earnings growth due to their U.S. treasury securities, using their YTM as a base to inability to relocate their higher costs to the consumers. determine what rates they will offer on their own debt issues. BofA Merrill Lynch U.S. Corporate BBB effective yield index states that the average corporate bond YTM is 3.78%, while Verizon’s long term corporate bond currently offers a YTM of 4.58%.2,15 This indicates they are offering a spread of 192 basis points above the comparable 30-year U.S. Treasury bond. Due to the positive correlation corporate bonds have with their respective treasury bond, we believe that the market will demand higher yields on corporate bonds in two to three years. The average yield reaching around 4.00%, and in Verizon’s case around 5.00%. With Verizon having 110B Source: Bloomberg.com in debt, an increase in interest rates would not be
beneficial towards their profitability. An increase in rates Government Regulations also may put further constraints on Verizon’s free cash The FCC is the main regulatory agency that over sees the flows, limiting them on participating in positive expansion efforts. We believe investors should pay close telecom industry. They monitor the amount of wireless spectrum that is owned by each firm. This spectrum is attention to Verizon’s ability to pay down their debt levels, and the effects on their margins with an interest what allows companies to send data and telephone signal to their consumers. Spectrum is usually sold to the firms rate increase. Below is a visual graph showing the change through auctions held by the FCC. The limited amount of in U.S. corporate bond’s effective yields over time. spectrum creates a large barrier to entry in this industry. Furthermore, the FCC has been overseeing any potential acquisitions by industry giants like AT&T and Verizon to prevent the creation of a monopoly.21 It is unlikely to see government regulations increase in the near future. The industry may realize a rise in spectrum license costs as limited amounts during a competitive market will drive auction prices higher. We also expect to see the FCC to continue acting with strict scrutiny towards any wireless mergers and acquisitions.
Industry Analysis Source: FED of St. Louis Industry Overview
The telecom industry provides consumers with the ability Inflation Rates to communicate and enjoy entertainment at constantly Telecommunication company earnings are inversely increasing speeds. The industry is made up of three sub- affected by rises in inflation rates. As inflation rates sectors: alternative carriers, wireless telecom services, increase, the expenses each firm must pay increase, and integrated telecom services. The integrated sector therefore hurting the bottom line. This industry is makes up the largest portion of the industry with 94.6% involved in a constant price war and lacks the ability to of the market cap because of top performers, AT&T and pass these higher costs on to their customers. If a firm Verizon.22 attempted to do this, the customer would simply move their business to a competitor. Inflation currently sits at 1%, which we project to remain constant for the next 6 months. We are forecasting that inflation will grow roughly to 1.5% in the next 2-3 years.9 This forecast comes with the assumption that it will rise to match historical trends in inflation that usually are between 1.5% to 2.00%, as shown in the graph below. The industry will
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Total Wireless Connections (In Millions)
128.64 112.11
56.1 63.28
Source: S&P Capital IQ Verizon AT&T Sprint T-Mobile
When comparing the top firms in the industry based on Source: Company 10K’s their wireless service revenue, AT&T and Verizon dominate the market share. Sprint and T-Mobile fight for Segment Analysis around 30% of the revenues available for wireless Wireline services. Due to small private companies not being listed Wireline offers voice and data services through a vast in the comparison, the data is slightly skewed. However, infrastructure that spreads across the whole country. This still represents the fact that Verizon and AT&T control segment targets mostly businesses due to the need of most of the industry’s revenue. The graph below higher levels of data sharing and transmission.23 Both demonstrates the breakdown of service revenue from the AT&T and Verizon are witnessing a slowing or negative past year. growth rate in their wireline connections, which hurts their bottom line. AT&T saw their broadband connections Mkt Share based off Service Rev drop 1.6% Y/Y.16 While Verizon still recognized a 14% positive broadband connection growth it was down to a 38% .25% increase Y/Y from a 2.11% increase between 2013 and 2014.15 These trends show the market continuing to 16% ease away from wireline technology.
Wireless Wireless technology involves transmitting data and voice through wireless spectrum that is dispersed from 32% surrounding towers. Spectrum is acquired through licensing auctions that are held by the FCC or through Verizon AT&T Sprint T-Mobile secondary market transactions with other wireless carriers. The focus in the wireless segment is data, with Source: Company 10K’s 4GLTE being the fastest speed available. Verizon expects
to start releasing 5G to the market in 2017, which is Revenue in this industry relies heavily on the number of sooner than the industry-predicted 2020 release date. connections each firm has. The result of the fight over Speeds from 5G networks are expected to be up to 50 wireless subscribers is the current telecom price war. In times faster than 4G.24 We anticipate this release to lower order to retain customers and maintain a low churn rate, our churn rate as well as attract consumers away from firms must offer highly competitive prices. Verizon has their current service provider. Wireless sales continue to the lowest churn rate among the four top competitors in dominate the industry, as wireline continues to decline. the industry.19 The low churn rate and premium prices The industry has achieved a 90% penetration rate amongst compared to their competitors allows Verizon to achieve adults, and we predict that this will reach 100% in the the highest service revenue in the industry. Verizon and future.13 AT&T also own 67% of total wireless connections, as seen in the following graph. Industry Trends The Shift from Wireline to Wireless Wireless services are constantly growing as connection speeds increase and people are acquiring more one than one connectable device. In 2015, there were
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approximately 1.4 connections per capita.25 This includes Metrics for comparison phones, tablets, and car connections. With market With the telecom industry being highly competitive, the penetration being this high, we know that telecom is a ability of firms to retain their customers is important for mature industry and is nearing a steady-growth state as their future success. The industry’s average churn rate shown below. was 1.33% in 2015, with Verizon having the lowest churn rate at .96%.19 Verizon loses less subscribers than their competitors, but are able to still charge more for their products and services. They also maintain the highest margins in the industry, showing that Verizon’s management team controls their cost structure better than their major competitors do. Verizon’s profit margin of 13.96% is the best compared to the other major U.S. publicly traded wireless companies. This perhaps can be attributed to their low churn rates, high number of customers, and low cost structure compared to their sales. The table below compares the different margins amongst the industry’s top U.S. based firms.15 Company AT&T VZ Sprint T- Source: IBISWORLD.com Mobile Mkt Cap 235B 209B 14B 32B Our team has forecasted Verizon will reach a steady- Div. Yield 5.00% 4.38% 0% 0% growth state in 2020. This forecast matches up with the Payout 81.01% 51.72% 0% 0% predicted industry forecast. Potential room for growth Ratio exists in growing their tablet connections and car space Total 126B 110B 34B 26B connections. With government regulations regarding Debt hands-free driving, wireless connection in cars is D/E 1.02 6.18 1.56 1.59 becoming more important and affordable, as more Operating 16.88% 25.12% -5.5% 6.44% consumers are demanding it. These technological Margin advancements and trends in the wireless industry have Profit 9.09% 13.96% -9.7% 2.12% caused a cannibalization of the wireline sales of integrated Margin firms as well as an overall decrease in wireline only Gross 54.33% 60.07% 45% 53.52% companies. Margin Churn 1.09% .96% 1.87% 1.39%
Rate Fiber Optics Source: 10k’s for each company, Yahoo finance! While landlines and other wireline services are realizing negative growth, fiber optics is recognizing growth as this As discussed earlier, telecom companies use large trending innovation continues to spread across the amounts of debt to fund their infrastructural and country. Fiber optic capabilities deliver Internet and expansion needs. The average D/E for the television services at much faster speeds than broadband industry, excluding Verizon, is 1.39.19 Verizon obtained or wireless. There is high capital intensity involved with larger amounts of debt due to their acquisition of fiber optics because of the need to create the infrastructure Vodafone’s stake in Verizon’s Wireless segment. As you and technology. Verizon has recently decided to bring can see in the table above, Verizon’s D/E of 6.18 is much 26 their fiber optics services (Fios) to Boston. Verizon higher than the industry’s average. The management team currently offers fiber optic services in ten different states has committed to work on reducing debt levels down to in the North East region of the U.S. This will allow pre-acquisition levels. However, this will take valuable Verizon to better compete against cable firms like company time, put restraints on their cash flows, and Comcast. Many times consumers only have one option for perhaps hinder their ability to participate in revenue cable due to location restrictions, so fiber optic ventures generating projects. from telecom companies could gain high interest from cable consumers dissatisfied with their providers. Catalysts for Growth/Change Technology & new products With smartphone penetration reaching above 80% at the top two firms, AT&T and Verizon, the industry will need
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to develop new innovative products and services to revenue streams. With 90% of adults in the U.S. currently maintain revenue growth. In 2014, Pew Research found owning a cellphone, it is safe to say many consumers that 90% of adults already own a cellphone; this further consider their devices a necessity moving forward. The more demonstrates that the industry needs to diversify industry also has an 84% penetration rate for adults whose their revenue streams.13 Verizon is currently looking to household income is less than $30,000/year.13 This shows move into the advertisement and video market, while that consumers are still willing to pay for their wireless AT&T is focusing on their recent acquisition of plans regardless of their income. For risk adverse DirectTV. The rest of the industry will need to follow suit, investors that are looking for a steady equity investment or risk falling further behind. Besides pursuing new with consistently growing dividends, large telecom business segments, the industry can also focus on companies are a strong area to consider. developing new innovative wireless products and services. Currently the industry is focusing on developing ARPU & Price Wars: 5GLTE, Machine to Machine, business solutions, and Currently, the industry is experiencing a highly fiber optic expansion. competitive price war. With the ability to gain completely new cellphone users among adults shrinking, major Installment & Wireless Plans wireless providers are lowering prices to retain current Telecom companies are no longer focusing on the customers and entice subscribers to switch over from their traditional subsidized phone purchasing option, but carrier. This has lowered average revenue per user in instead are offering customers installment plans. The recent years, causing some growth pains for telecom negative effect of this option is that customers are not companies. As seen in the graph below, all four of the under a two-year service contract and are free to cancel major publicly trade wireless providers have seen a their services at any time. However, the customers still decrease in their ARPUs. must finish paying of their devices. These plans may allow the industry to sell new phones more often, and Postpaid ARPU therefore create a steady stream of equipment revenue. This has created a new area of competition throughout the $65.00 industry as the different companies fight to offer the $60.00 cheapest financing options for their customers. Sprint now offers leasing and installment plans, while Verizon $55.00 2013 and AT&T focus on their financing plans. The industry 2014 would prefer to focus on offering the financing plans, as $50.00 2015 this pays off the entire cost of the device. When a $45.00 customer leases a phone, they only have to pay for the time they are actually using the device. This option saves the consumer money, but may reduce equipment revenue growth for the industry over time. There currently is not enough data to analyze the effects, but will need to be Source: Company 10k’s looked at in the future. Consumer’s demands for lower prices also puts strain on Key Investment Positives/Negatives the industry’s margins. Companies such as Sprint, which currently has profit and operating margins of (9.69%) and Defensive Stock & Dividends (5.49%), is not able to endure much more pressure on The telecom industry is a safe haven for investors looking their revenues.17 Verizon is leading the industry with for a fixed income stream. Industry leaders Verizon and profit and operating margins of 13.96% and 25.12%. AT&T offer dividend yields of 4.38% and 5.00%, as well However, because of fixed costs associated with high as payout ratios of 51.72% and 81.01%.15,16 Both of these amounts of debt and maintaining their infrastructure, the telecom companies provide dividend yields above the industry as a whole wants prices to stabilize. There are current bond market yield. Corporate bonds rated BBB still areas of opportunity for the wireless providers to and above have an estimated average yield of 3.78%.2 increase their revenues. Besides interest in expanding into Verizon has also consistently increased their dividend by new projects, the industry can also focus on increasing roughly 3.00% for the last nine years, which provides consumers’ dependency on their data services. Currently, investors a steady growth of fixed payments. The industry just 7% of smartphone users depend on their devices for also sees a consistent demand for their wireless products internet access.13 Pending an increase in this statistic, we and services, which sets up the companies for steady
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believe that telecom companies will recognize higher growth; however, Mass Markets is still experiencing a service revenues. One way they can focus on increasing slight growth rate. their consumers’ data usage is through competitive hotspot plans, which allows customers to use their For the ninth consecutive year, the board has declared an cellphone’s internet on their personal computers and increase in dividends. The annual dividend for 2015 was tablets. With the industry looking for new ways to $2.23 (4.38%), which is a 2.7% increase Y/Y. With their stimulate growth, we are not overly concerned with the EPS being $4.37 this past year, Verizon had a payout ratio shrinking ARPU. of roughly 51% in 2015.15 AT&T is the only other major wireless competitor that currently offers dividends, which Company Analysis were $1.92 (5.00%) with a payout ratio of roughly 81% in 2015.16 Both competitors rank above the S&P’s average Overview Dividend Yield of 2.12%, making these stocks attractive Verizon Communication Inc. (VZ) is the holding to investors looking for a safe haven during times of low company that consists of multiple subsidiaries, such as interest rates and high market volatilitiy.8 Verizon Wireless, Verizon Fios, and recently AOL. While they offer products and services in both Wireless and Verizon saw a large increase in their debt levels in 2014, Wireline segments, their management’s main goal is to mainly from the strategic purchase of Vodafone’s 45% create and maintain the largest and most reliable wireless indirect stake in Verizon Wireless. The total Wireless network in the U.S. To achieve this goal they are Transaction cost Verizon approximately $130B, which expanding their infrastructure as well as innovating new was paid for with mostly cash and common stock. $54B products and services to generate higher consumer of the cash portion was funded through acquiring long- satisfaction and company value. Verizon’s target market term debt.15 Another reason for Verizon’s high debt levels consists of retail consumers, businesses of all sizes and is the yearly increase in capital expenditures due to government agencies. constant market demand for higher bandwidth capacity. Currently, Verizon has total contractual obligations of In 2015, wireless operating revenue was 91.7B, which $244B, which includes their long-term debt of $110B. represented 69.7% of their 131.6B total operating Verizon’s debt levels will place a burden upon their revenue. Wireline contributed 28.7%, with other revenue ability to pursue valuable investment opportunities, as our providing around 2% of total revenue. The following projected $77B worth of FCF through 2020 will be largely chart demonstrates the breakdown of segment revenues 15 consumed to paying off these obligations. The Vodafone from 2014 to our forecasted CV year of 2020. Transaction also limits potential projects by requiring Segment Revenue as % of Total Revenue Verizon to maintain a certain leverage ratio or recognize 100% an increase in their credit rating before taking on any more debt obligations.15 80% Wireless Products and Services: 60% Wireline Verizon has both a wireless and wireline operation, in 40% Other which they offer a variety of products and services.
20% Wireless Verizon’s wireless segment makes up the majority of their 0% total revenue, at 69.7%. In 2015, the segments total 2014 2015 2016 2017 2018 2019 2020 revenue was 91.7B, showing a Y/Y growth of 4.6%. The Data Source: Verizon 2015 10k segment’s revenue can be broken up into service, Our projections show that wireless revenues will make- equipment, and other. The service portion makes up the up approximately 77% of Verizon’s total revenues by largest revenue source for wireless at 70.4B and is 76.8% 2020. That is roughly a 7% increase from the current of the segment’s operating revenue. However, these 2015 revenue contribution from wireless. This is due to the figures show a 3.1% decrease Y/Y. Verizon also incurred deteriorating demand in the wireline segment. Evidence a decrease in their monthly-postpaid service ARPU of 15 of this decline can be seen in the decreasing connection 7.12%. As discussed in the industry analysis, all the growth rates. The Global Enterprise and Global major wireless competitors have been realizing decreases Wholesale operations are recognizing negative revenue in their ARPU. This is mainly due to the price war that is taking place within the industry. We have forecasted that
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wireless service revenues will rebound in 2016, growing by 1.00%. This is mainly due to our prediction that Verizon will realize a 4.78% increase in their postpaid Wireless Retail Connections wireless subscribers. Verizon on average has gained this (In Millions) 133.13 138.34 percentage of customers the last four years. However, 122.61 127.88 with nearly 100% of the adult market owning cellphones, 108.21 112.11 117.35 we believe that their postpaid connections will grow at a decreasing rate. We projected a decrease from 4.78% in 2016 to 4.58% in 2017, continuing that trend until reaching a steady state in 2020 at 3.98%. Verizon will also continue to see slight growth in their service revenues 2014 2015 2016 2017 2018 2019 2020 based on our predictions that their connections per Source: Verizon 10K account will continue to grow by .05 connections per year, which perhaps allows the company to receive more The percentage of postpaid connections that use revenue from larger data allowances. smartphone devices hit an all-time high for the company in 2015 at 83.7%.6 In theory, higher smartphone The industry is expecting to launch 5GLTE around the penetration would lead to more connections that are year 2020, while Verizon has hinted at releasing their profitable because customers would have to purchase data 24 5GLTE technology around 2017. We have forecasted plans. However, the constant price war occurring within that this will help generate higher service revenue growth the industry has forced Verizon’s monthly ARPA to in 2017 and 2018, at 1.50% and 2.25%. We also believe decline to $152.63 in 2015, which is a 4.5% decrease that the price war will hit a wall, as the two companies Y/Y.15 We have forecasted that the ARPA will experience driving down prices are already receiving narrow growth in 2016 of .50%, mainly due from an increase of margins. Sprint and T-Mobile have been two of the connections per account. Not only are smartphones leaders in driving down the industry’s prices, as they reaching extremely high penetration rates, other compete to gain wireless subscribers. They both currently connectable devices will allow Verizon to expand their have operating margins of (5.49%) and 6.44% in revenue-generating base. Devices such as tablets, 17,18 2015. This hinders their ability to drive prices down connectable cars, and watches will cause consumers the much further. need for higher data allowances as usage increases.
Verizon’s Equipment revenue on the other hand showed Within the postpaid connections, Verizon experienced a a 54.4% increase Y/Y, generating 16.9B worth of revenue low churn rate at .96%, which is a decrease of .08% 15 in 2015. Verizon’s method of using installment plans, Y/Y.15 They have the lowest churn rate when compared such as their Verizon Edge program, is the leading cause to the other major U.S. wireless carriers, with the industry for this dramatic increase. We have predicted that their average of the four big telecom companies being 1.33%.19 equipment revenue growth will slow down to 5.00% in This shows an increase in customer satisfaction and 2016, mainly due to Verizon’s high penetration rate of loyalty during a very competitive time in the market. Even smartphone users. In the future, most of the revenue from though competitors’ prices appear to be lower, the equipment will be existing customers upgrading their reputation of being reliable has value to Verizon’s current devices. This will allow for some growth in customers. Open Signal used data from around 376 equipment revenue, however will not be as high as their million tests, to conclude that Verizon and T-Mobile are
growth in 2015. tied for the fastest download speeds out of all the carriers. They also presented Verizon with the award for having Verizon offers both postpaid and prepaid wireless the best and widest 4GLTE coverage.14 We predict that services and equipment. The largest portion of their Verizon’s churn rate will rise slightly to .98%, but stay 112.1m retail connections is postpaid, representing 95% steady at the low rate. The slight increase is mainly due to 4 of their market share. We have predicted that they will the end of the price wars, with a few subscribers switching continue to grow their total wireless connections at 4.67% to cheaper services. In the long run, as smartphone in 2016. Some of the connection growth will be due to penetration nears 100%, it will put a cap on wireless customers switching from traditional wireline services to revenue growth. Verizon will have to not only maintain wireless services. The graph below demonstrates our their low churn rate, but also find ways to entice forecast for wireless retail connections, with the average consumers to switch to their service. This will perhaps growth being 4.30%.
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force Verizon to find alternative ways to increase wireless Global Enterprise is the medium to large business and revenues, such as tablets, hotspots, and car connections.6 government portion of the wireline segment. This group represented the second largest portion of the wireline Wireline revenue at 36%. There was a decline of 5.2% in Global Verizon’s wireline segment makes up 28.7% of their total Enterprise revenue Y/Y compared to 2014.15 We have revenue in 2015.15 This segment is comprised of three forecasted that the decline in this portion of the business different market breakdowns: Mass Markets, Global segment will continue to occur, with a decreasing rate of Enterprise, and Global Wholesale. The graph below will 4.58% through our CV period of 2020. We based our represent the composition of the three different market assumption on that total voice connections will continue breakdowns based on revenue. to decrease at an increasing rate, starting at -7.11% in 2016. We also see businesses and government agencies % of Total Wireline Revenue moving more and more into wireless technology. 1% 16% However, there are still areas in which Verizon could 47% achieve growth. Those solutions include IP communications, infrastructure, cloud services, security, and machine-to-machine technology (M2M). Verizon sees the greatest growth opportunity and revenue generator through advances in the M2M services. As the 36% M2M market is just starting to expand, there is still yet to be data to support the suggestion. However, we believe Mass Markets Global Enterprise that the M2M market is indeed an area of opportunity for Global Wholesale Other Verizon to diversify their income and create technological
Source: Verizon 2014 10k advances. Not only is this currently being applied to the Global Enterprise consumers, but eventually retail Mass Markets is the retail consumer and small business customers will purchase these services for more advanced portion of the wireline segment. The major products and remote home control and other uses. services offered to these customers is the Verizon Fios TV, internet, and digital voice. These commodities offer The Global Wholesale operations sells Verizon’s access to high-speed internet through fiber optic facilities and networks to other companies, so that they technology, local and long distance calls, and TV can rebrand and sell to their own customers. This is the entertainment. This group represents the largest portion of smallest portion of the wireline revenue at 16%. Verizon the wireline revenue at 47%. The growth rate for mass realized a decrease in Global Wholesale’s revenue by markets revenue experienced 2.4% Y/Y compared with 3.4%.15 We expect the decline in the Wholesale 2014. We believe the increase in revenue was obtained by operations to continue as prepaid carriers choose to lease the slight increases in Fios internet and entertainment from cheaper corporations. Two of the largest prepaid connections to a total of 12.8M.15 The increase in carriers, Boost and Cricket, use Sprint to provide for their connections may be attributed to customer’s ability to network needs. We have forecasted the Verizon will customize their packages, which is an attractive substitute experience a continual decline of 5% in their wholesale to what cable and satellite companies have to offer. business. Verizon’s Fios services are currently available in 10 different states, all located in the Northeastern part of the Marketing Strategy country.15 We have forecasted that Mass markets will Verizon focuses on advertising that their network has the grow at a decrease rate, starting with 1.50% in 2016. The more reliable and extensive coverage in the U.S. As I growth will occur based on consumers wanting to leave mentioned earlier, Open Signal concluded that in fact their internet providers such as Comcast, and switch to the Verizon does have the best coverage. This method seems fiber optic technology. However, the growth is minimal to work for their business, as Verizon achieved the lowest as more consumers and local businesses are switching to churn rate in the industry at .96%. Verizon did not spend wireless products. the most in advertising last year. AT&T out spent them AT&T is the only other telecom company to offer on advertisement, as they try to push for more wireless competitive products in this category, as they have now subscribers. However, Verizon does spend significantly acquired DirectTV. more than the other two major U.S. carriers. The graph below compares the different amounts spent on advertisement in 2015.
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growth in 2020. These assumptions are mainly tide to Advertising Expense Verizon’s plans for rolling out their 5GLTE, while still (In Billions) maintaining their infrastructural needs. The below visual 3.63 bellows represents our forecasted capital expenditures through our CV year of 2020.7 2.75
1.5 1.6 Capital Expenditures (In Billions)
18.8 Verizon AT&T Sprint T-Mobile 18.5 18.1 Source: All four of the companies 10Ks 17.9 17.7 17.7
17.2 Analysis & Management Guidance As stated in the above parts of the analysis, earnings were 2014 2015 2016 2017 2018 2019 2020 overall good in 2015 at $4.37 a share. The overall consolidated net income attributable to Verizon was Source: Verizon’s 10K $17.8B at the end of 2015, which is a growth of 85.8% Y/Y.15 This major growth rate is due largely to Verizon Production and Distribution purchasing Vodafone’s 45% indirect interest in Verizon Production Wireless, therefore allowing them to maintain all of the Through Verizon’s networks and distribution channels profits created by their wireless segment. Verizon’s they are able to cover 98% of the United States with ability to maintain steady net income growth Y/Y, with 4GLTE data.4 This infrastructure consists of cellular the exception of 2014 due to the Wireless Transaction, has towers, smaller cell antennas, spectrum emitted from allowed them to continue to increase their yearly antennas, and miles of underground fiber optic cable. dividend. Verizon now provides a dividend yield of Their coverage ranks as first among competitors. 4.38%, and a payout ratio of 51.72%.15 The only other 4G LTE Network as of April 2016 competitor to pay a dividend is AT&T, who had a dividend yield and payout ratio of 5.00% and 81.01% in 2015.16 We have forecasted that Verizon will maintain their same 3.00% increase of dividends in our valuation model, which would increase their payout ratio to 54.35% in 2016. We expect net income to decrease slightly in 2016, mainly due to revenue growth slowing down. However, net income will grow slightly in 2017 and beyond due to the revenue growth increases with the release of 5GLTE and connection growth.
Source: Verizon Wireless.com Management has expressed their goal to achieve their credit rating they had prior to the Vodafone transaction, AT&T is making a push to expand their infrastructure and and using cash flows to continue paying down their high compete with Verizon in more locations across the levels of debt. S&P’s credit rating of Verizon was A-, country. In fiscal year 2015, AT&T spent $17.7B on until they downgraded the company to BBB+ after wireless spectrum licenses compared to Verizon’s Verizon borrowed around $50B for the acquisition. $9.9B.15,16 Verizon’s latest acquisition of spectrum However, Verizon’s management has still forecasted that coming from an FCC auction held in 2014. The auction their capital expenditures in 2016 will be between $17.2B cost Verizon $10.4B, which had to be paid by February 7 and $17.7B. This is roughly in line with what they had 2015. Therefore, it is already reflective in their current used in 2015, which in turn would allow them to maintain financial data.8 This transaction is being funded by the their growth structure. With the high demand for constant recent sale of wireline assets to Frontier Communication. infrastructure improvement, we have forecasted that Further details about this sale are available later in the Verizon will grow their capital expenditures by 1.00% in report. 2017. With their capital expenditures peeking at 2.00%
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AT&T also spent $19.2B on capital expenditures VZ T S TMUS 15,16 Market Cap compared to Verizon’s $17.7B. The next largest firm, 204.63 225.95 11.08 29.74 based on revenue, is Sprint and they spent $5.9B and $163 (B) million on capital expenditures and spectrum, Wireless respectively.17 This 2014 Sprint data (last publicly Connections 112.11 128.64 56.1 63.28 available data), shows the huge difference between the top (M) two competitors and the rest of the field. With AT&T Service spending more than competitors in both of these Revenue 91.68 73.71 -1.87 1.76 categories, it shows that this huge conglomerate is (B) looking to become the premier wireless carrier in the EPS $4.37 $2.37 $-.42 $.60 Dividend United States. This could lead to a higher churn rate for 4.38% 5.00% N/A N/A Verizon if AT&T can successfully establish itself as the Payout Wireless top competitor. $86.6 $81.1 $40.0 $24.0 Licenses (B) ARPU Distribution (monthly $55.07 $56.88 $56.72 $47.68 Verizon distributes their services by using both direct and ‘15) indirect forms of sales. The direct forms include company Source: Yahoo Finance!, Company 10K’s & Statista operated stores, telemarketing sales force and Verizon Destination Stores. The Destination Stores are high-tech This chart helps depict the large size difference between centers that demonstrate Verizon’s ability to innovate Verizon, AT&T, and the rest of the industry. Even with new technology. Verizon is working on making all of fewer connections, Verizon has larger wireless service their company-operated stores more like these revenue than AT&T, showing they can generate higher Destination Stores to attract more customers. The indirect margins. With wireless licenses cost directly correlated forms of distribution include the sale of Verizon services with the amount of spectrum the company owns, it is no in stores such as Best Buy and Wal-Mart. Both prepaid wonder Verizon and AT&T provide more coverage. Both and postpaid services are offered here. Verizon also sells the industry leaders offer strong dividend yields, which prepaid services in small stores such as Dollar General supports our team’s opinion that Verizon is a safe haven and drug stores. This attempts to reach consumers who for investors looking for a fixed income. have lower income. Through their distribution tactics, Verizon increased their connections by 3.6% Y/Y.8 Sales & Acquisitions Frontier Communications Competition Verizon announced in February 5, 2015 that they were Verizon faces a substantial amount of competition not selling their wireline operations in California, Texas, and only from traditional wireless carriers, but also other Florida to Frontier Communications for approximately corporations such as Google. Google offers fiber optic $10.5B pre-tax. The sale of the assets included the transfer services that compete directly with Verizon’s Fios of Fios customers, high-speed internet services, and local service. The wireless market in particular is a very and long distance voice connections. The businesses competitive industry due to the limited customer base a being sold generated $5.4B worth of revenue in 2013, carrier can attract. Directly related to this competitive which was the last year this data was available. Frontier landscape is the pricing of plans and equipment will also be assuming $0.6B worth of Verizon Debt as part continuing to decline. A key example of recent of the transaction. The transaction is set to close in the 8 competition is the marketing strategy of competitors to beginning of 2016. We see this as a strategic move for offer subsidies for switching to their carrier from another. Verizon to focus their resources on more profitable The market is also facing limited amounts of spectrum for projects in both wireline and wireless segments. Verizon their network to operate efficiently. Below is a table will use the funds from this sale in order to help pay for 27 comparing major wireless carriers and key financial their recent $10.4B wireless license acquisition. metrics.15,16 AOL Verizon finished the purchase of AOL in 2015 for $4.4B. Many believe Verizon acquired AOL to obtain a digital platform to help launch their own online digital advertisement services. AOL possessed an advanced advertising network, particularly in the video streaming
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market. This will help Verizon diversify their revenues and launch their video streaming and advertising services. This is important strategic move for Verizon, since the wireless revenues are expected to flatten in the future.1
Yahoo! Verizon is looking to acquire Yahoo in order to improve their online advertising revenue. This acquisition would add to their online revenues by combining them with the aforementioned AOL. Verizon currently owns a lot of Source: Yahoo Finance! information that they could use to successfully advertise As discussed earlier on in the industry analysis, telecom to specific target markets. As of mid-April, Verizon was companies are a safe haven in times of market leading the bidding process. The expected auction price uncertainty. Currently, the bond market is offering of Yahoo is expected to stand between $4-8 billion.26 We historically low interest rates for investors looking for a could not add the potential acquisition of Yahoo to our fixed income stream. Verizon becomes an attractive forecasted revenues because of the inability to accurately alternative as they offer a dividend yield of 4.38% and a predict mergers and acquisitions. payout ratio of 51.72%.15 Verizon’s dividend yield is
higher than the average corporate bond yield of 3.78%, Catalysts for Growth/Change and the 2.66% offered by the 30-year U.S. Treasury Product and Service Development bond.2,12 If Verizon wants to continue to experience growth in connections and revenues, they must continue to develop With adult consumption of wireless services reaching innovative products and services. They must be adaptable 90% penetration rate and even 84% among households to change in customers’ demand of services, while who make less than $30,000 a year, we believe that providing cheaper plans and equipment prices. In wireless products and services are a becoming a fixed addition, consumers are increasing demand for more costs.13 Many consumers are moving away from the access to data. This is evident in the increase of traditional landline services, as seen in Verizon loosing smartphone penetration. However, because of 7.11% of their landline voice connections in 2015, to competitors driving prices lower, Verizon must find ways wireless products and services. With consumers deeming to maintain high margins while still offering competitive cellphones a necessity, demand for wireless services is prices. A way that Verizon is looking to increase revenue becoming steady. This shows value in the company as is adding more connections per account through tablet, their revenues will stay relatively steady. Therefore, we car, and other connections. have forecasted that revenues will grow at a steady state of .94% in 2020. The growth rate is slim because Another way to further develop their product and services penetration is high in the wireless market, causing is the continued search for key assets to complement and companies to look elsewhere if they want to continue diversify their existing services. They have already growing revenue at higher rates. Verizon is looking for successfully attempted this with the purchase of AOL, ways in which to boost revenue, such as video and are looking into companies such as Yahoo!. With advertisement. Their recent acquisition of AOL and their AT&T purchasing DIRECTV, Verizon may need to look attempt to acquire yahoo for their advertisement into acquiring a similar firm in order to expand and technology shows that Verizon is committed to entering remain competitive in their Fios operations. We believe that market. Verizon must focus on creating or finding new revenue generating projects that diversify their operations. Verizon does have an industry high Debt to equity ratio of 6.18.15 As discussed earlier, Verizon is experiencing Key Investment Positives/Negatives higher debt levels due to their acquisition of Vodafone’s During a current time of volatility and uncertainty in the stake in Verizon’s wireless business. They now own market place, Verizon has outperformed the S&P and 100% of their wireless business, but some of the upside their major competitors YTD. With the beginning of 2016 his hindered by Verizon needing to pay down their high being a volatile time in the stock market, Verizon has been debt levels. Management has stated that they are going to realizing steady returns as investors look for a safe focus on paying down Verizon’s debt, and we have investment. The top blue line in the graph below forecasted that they will pay off 5.00% of the debt every represents Verizon.
12 year. We wanted to be realistic, as Verizon will still need 1.56%, and will reach a steady decline rate of 1.47% in cash flows to invest in projects such as 5GLTE 2020. We do believe that mass markets, the consumer and technology. The debt levels have also lowered Verizon’s small business customers of the wireline division, will credit rating from A- to BBB+, which will perhaps force grow at a decreasing rate. We have forecasted that Mass them to offer higher returns on future debt issues. We Market revenues will grow by 1.50% in 2016, and then believe that Verizon is capable of handling the repayment decreasing the growth rate by .10% per year until reaching of their debt obligations, but will require a long amount its steady rate of 1.10% in 2020. The growth predictions of time for them to reach similar levels before the is mainly due to consumers signing up for fiber optic Vodafone transaction. With the average industry debt to internet services as well as Verizon offering business equity ratio being 1.39, other telecom companies may be solutions for small businesses. However, we have in a better position to take advantage of opportunities that anticipated Verizon’s global wholesale and global arrive in the market.19 enterprise revenues to continue declining. Both sections have declined over the last three years due mainly to consumers switching to wireless products and services. In Valuation Discussion which some of the decline will be offset by an increase in Revenue Decomposition wireless as consumers switch products and services that Verizon’s wireless segment is the largest revenue they are consuming within the Verizon brand. generator for the company, with the division contributing 69.66% of their total revenue in 2015.15 We forecast that Overall, we have forecasted that Verizon’s total revenue on average during the next four years the segment’s will grow by 1.11% on average over the next four years, revenue will grow at 2.18% until it reaches its steady and then leveling off at a .94% growth rate in 2020. There growth rate of 1.81% in 2020. Wireless service revenue are still areas in which we see Verizon increasing their represented 53.49% of total revenue. We have service growth rates. With current management expressing their revenue growing at an average rate of 1.69% during the desires to enter the mobile video and advertising market, next four years, and then steadily growing at 1.75% Verizon could create a whole new segment within their thereafter. We determined low growth rates based on the corporation. They have already acquired AOL, and high competitive nature in the industry that is driving currently are considering purchasing Yahoo! for their prices down, 90% of adults already own cellphones, and advertising technology. It will be important to keep an eye Verizon already having 83.7% of their postpaid wireless on the development of these products and services, and to customers owning a smartphone.13,6 analyze Verizon’s ability to enter the market.
Wireless equipment contributed 16.17% of their total Margins & Costs revenue in 2015. We have equipment sales growing at Verizon has been able to maintain their gross margin at 3.75% on average during the next four years, and will 60% for over ten years. Their management team does an reach a steady 2.00% growth rate in 2020. Equipment exceptional job at producing goods and services at a revenue has been skyrocketing in the last two years steady cost structure. We have forecasted that their gross mainly due to the creation of the Verizon Edge program. margin will maintain at 60% through our CV period. Installment plans are increasing wireless carriers’ revenue Verizon also recently pushed their operating margin to on equipment because they no longer subsidize at around 25%, and we believe this will maintain as well extremely high levels. The plans also allow consumers to through the CV period. We believe they are able to afford more expensive devices due to the fact they don’t achieve this by keeping their SGA costs steady at 23% of have to pay for them upfront, and in essence are receiving sales. Even though the industry is highly competitive, we financing with no interest payments. We believe don’t see the need for Verizon to increase their SGA equipment revenues will slow down to our forecasted expenses. One of the main components of their SGA is growth rates mainly due to high penetration rates and the advertisement expense, in which Verizon maintains Edge program loosing its new car smell. With penetration growing around 5%. Even with our forecast of Verizon rates already being high, most of the equipment sales will paying 5% of their debt off every year, we believe they be based on existing customers upgrading their current will maintain their profit margin around 14%. Our devices. forecasts show that Verizon will be able to maintain profitability at a steady rate. The wireline segment represented 28.66% of total 15 revenue in 2015. We have forecasted that the segment will decline on average during the next four years by
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Capital Expenditures and beyond. With a marginal tax rate of 37.1%, Verizon’s Management stated in their press release of their 2015 after-tax cost of debt is 2.88% until increasing slightly to financials that their goal is to maintain their capital 3.09% in 2018 and beyond. With our prediction that expenditures at $17B in 2016.7 Thereafter, we forecasted Verizon will pay off 5.00% of their debt annually, the that their cap ex will grow at 1%, 1.5%, and 1.75% weight associated with debt in the WACC equation leading up to a steady growth rate of 2% in 2020. These decreases marginally every year. This in turn causes our predictions are based off the notion that telecom WACC to increase over our horizon until reaching our CV companies must continue to maintain and expand their WACC of 5.51%. infrastructure. The industry also sees shifts into new technology, such as 5GLTE. These network changes DCF_EP require Verizon and other wireless carriers to invest Using our Discounted Cash Flows and Economic Profit heavily into new technology to offer faster and more models, we derived an intrinsic stock value of $65.23. reliable services to consumers. This would imply that Verizon currently has a stock that is extremely undervalued by the market. Our value WACC drivers, net operating profits less adjusted taxes and Since Verizon’s management has stated their desire to pay invested capital influence this stock price. We have a down their debt until they reach credit ratings and debt continuing value NOPLAT growth rate of 1.39%, which levels prior to the Vodafone transaction, we used a we choose as our CV growth rate for our model. Our low variable WACC in our models. Verizon still maintains a growth rate begins in terminal year 2020. This quick good credit rating, with S&P giving them a BBB+ rating. approaching terminal year is due to the industry being in We forecasted our CV WACC to be 5.51%. a mature state as well as Verizon nearing 100% smart- phone penetration. Verizon will create this added value Cost of equity for its shareholders through its stable revenues during a We used CAPM in determining the cost of equity for our volatile economy. We found this model to be the most WACC calculation. Our cost of equity is 6.37% until effective in valuating Verizon’s stock because it takes into increasing to 6.71% in 2018 and beyond. The increase is account the factors that we truly believe are driving the due to our assumption that the risk free rate will increase value of the firm. While dividends and other firms in the based on our economic analysis. We based our risk free industry do effect Verizon’s value, we think that rate of 2.66% in our model off the 30-year U.S. Treasury Verizon’s stable revenues and close proximity to their bond’s YTM.12 Our team predicts that the rate will stay terminal year force us to focus more on internal value the same until increasing slightly to 3.00% in 2018. We drivers. used a 5.00% equity risk premium in our forecast, which is based off the historical geometric average. We DDM determined over time that this premium would stay Through the construction of a dividend discount model, steady. To conclude Verizon’s .74 beta, we used we discovered an intrinsic stock price of $73.24. We think Bloomberg’s 2 year, weekly raw beta.20 This parameter this model may not create the most realistic stock price was used to capture their volatility following their for Verizon. Telecommunication companies and Verizon reacquisition of Vodafone’s stake in Verizon Wireless specifically have been known to offer high dividend roughly two years ago. On average, 65.8% was the weight payouts. They currently have a payout ratio of 52% while put on equity in the WACC equation. the S&P average payout ratio was roughly 41%.28 Although Verizon is above the S&P average, we do not Cost of Debt think this higher payout ratio creates an added intrinsic We have forecasted Verizon’s pre-tax cost of debt at value premium of 37% from their current stock price. We 4.58%, which is made up of the risk free rate plus a default would not recommend using the DDM to generate an spread. To determine our default spread, we found a intrinsic stock price for Verizon. current Verizon bond that has an equivalent maturity compared to the 30-year U.S. Treasury bond. The bond’s Relative P/S Valuation YTM offers 4.58%, therefore having a 192 basis point It was difficult to perform a relative valuation for the spread over the risk free rate of 2.66%. We decided to telecommunication industry due to the size differences in keep the spread consistent due to our belief that their the competing firms. Verizon and AT&T are much larger credit rating will stay the same. Based on our economic and realize higher revenues. They also both have positive analysis that the risk free rate will increase to 3.00%, our P/E ratios, while Sprint recognizes a negative P/E. We forecasted pre-tax cost of debt increased to 4.92% in 2018 decided to perform our valuation using P/S because of the
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industry being in a mature state and most firms COGS as % of Sales/SGA as % of Sales recognizing stable revenues. Although Verizon and Verizon has kept their costs relatively steady in the past; AT&T achieved sales levels about five times higher than however, the sensitivity test shows that the stock price is Sprint and T-Mobile, we think that P/S does a good job of volatile if their expenses were to change. Our analysis capturing the intrinsic value of Verizon.3 Our valuation shows that if SGA and COGs as a percentage of sales gave us an intrinsic stock price of $64.45 and $61.44 were to increase by 1% each, the target stock price would based on P/S ratios in 2016 and 2017, respectively. The decrease from $64.81 to $55.63. This represents a 14.16% intrinsic value derived from this method needs to be used decrease in the value of the stock. The sensitivity comes with caution due to the vast differences in sales between from the fact that SGA and COGs decrease the firm’s the firms in the telecom industry. noplat, therefore causing the DCF target price to decline.
ROIC COGs as % of Revenue/Wireless Service Revenue We calculated an ROIC of 10.07% in our terminal year of Growth 2020. This gives us an idea of how efficiently Verizon is With wireless service revenue being the largest using its resources. To determine if Verizon is effectively component of Verizon’s total revenue, we wanted to see creating shareholder value, we must compare it to the the target stock price volatility that would occur from a WACC from our terminal year. The WACC in 2020 was changing in the cogs as a percentage of revenue and forecasted to be 5.51%. Given that the ROIC of 10.07% wireless service revenue growth rate. Our analysis is greater than the WACC of 5.39%, we can conclude that determined that the target stock price is semi sensitive in Verizon is in fact creating shareholder value. a change of the two metrics. With a .50% increase in the wireless service growth rate and a 1% increase in the cogs Sensitivity Analysis as a percentage of revenue, the stock price decreased by We conducted a sensitivity analysis of our models to 6%. The test perhaps shows that the stock’s value is more determine the impact a variation in a particular sensitive to a change in the cost structure than a change in assumption would have on our target stock price. We the largest revenue component. decided to create six data tables to examine the sensitivity of our model. Default Spread/Risk Free Rate The risk free rate is an important metric in our valuation Market Risk Premium/Beta model due to the effects it has on both the cost of equity Both beta and the MRP are used in CAPM to determine and the cost of debt. The sensitivity analysis shows that Verizon’s cost of equity, and therefore impact the the target price does not change greatly when comparing companies WACC. The analysis suggests that our target a change in the risk free rate and default spread. Given an stock price, based off our DCF model, is very sensitive to estimated .50% increase in the risk free rate and the a change in either of these two metrics. This is logical due default spread, the target price only decreases by roughly to our WACC having on average 65% weight on equity. 3.70%. However, with our prediction that the risk free rate The table shows that given a .10 increase in Beta and .50% will increase to 3.00%, which is roughly a .50% increase, increase in the MRP, the target stock price would drop Verizon’s stock will decrease in value. The decrease will from $64.81 to $55.30. Which is a 14.67% decrease in be minimal if the default spread stays consistent. value. The percentage increases or decreases depending upon the combination. Marginal tax rate/default spread Both the default spread and the marginal tax rate are CV ROIC/CV NOPLAT Growth inputs into the after-tax cost of debt. The sensitivity The CV ROIC and CV NOPLAT growth rate are both analysis shows that given a change in either one of the used in CV formula to determine Verizon’s value of metrics the target price volatility is minimal. However, operations. While both metrics are important, our the model is slightly more sensitive to a change in the sensitivity test shows that a change in either metric does marginal tax rate. We determine this makes sense due to not impose a large impact on the target stock price. For the marginal tax rate being used to calculate the adjusted example, given a .10% increase in CV NOPLAT growth in the NOPLAT calculations, as well as figuring out the rate and a .25% increase in CV ROIC, the target stock after-tax cost of debt. Given a 1% decrease in the marginal price increases by only 2%. tax rate, the target price increases by 2%. Depending on the regulatory climate, the sensitivity of the model based
15 on the marginal tax rate may decrease the firm’s forecasted value.
Important Disclaimer
This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.
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2016.
[3] "Yahoo Finance! VZ, S, T, TMUS." Yahoo Finance. N.p., [17] Sprint 10K – 2014 2016. Web. 13 Feb. 2016.
[4] "Verizon At A Glance." Verizon.com/ourcompany. N.p., 2016. [18] T-Mobile 10K – 2015 Web. 15 Feb. 2016.
[5] "Dividend History." Verizon.com/Investors. N.p., 2015. Web. [20] Bloomberg Terminal 13 Feb. 2016.
[8] http://www.multpl.com/s-p-500-dividend-yield/ [24] "Wireless Quick Facts." CTIA. N.p., n.d. Web.
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Verizon Communications, Inc. Revenue Decomposition All figures stated in Billions (U.S. dollars), except for ARPU and otherwise stated Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Wireless Revenues Service 69.03 72.63 70.40 71.10 72.17 73.79 75.27 76.58 Y/Y Growth 8.32% 5.21% ‐3.08% 1.00% 1.50% 2.25% 2.00% 1.75% Equipment & Other 11.99 15.02 21.28 22.35 22.91 24.05 24.65 25.15 Y/Y Growth ‐1.19% 25.24% 41.74% 5.00% 2.50% 5.00% 2.50% 2.00% Total Operating Revenue 81.02 87.65 91.68 93.45 95.07 97.84 99.92 101.73 Y/Y Growth 6.79% 8.17% 4.60% 1.93% 1.74% 2.91% 2.12% 1.81% Wireless Connections (000') Retail PostPaid 96,752 102,079 106,528 111,625 116,742 121,861 126,960 132,019 Y/Y Growth 4.56% 5.51% 4.36% 4.78% 4.58% 4.38% 4.18% 3.98% Retail PrePaid 6,047 6,132 5,580 5,721 5,866 6,015 6,168 6,324 Y/Y Growth 6.09% 1.41% ‐9.00% 2.53% 2.53% 2.53% 2.53% 2.53% Total Retail Connections 102,799 108,211 112,108 117,346 122,609 127,876 133,128 138,343 Y/Y Growth 4.65% 5.26% 3.60% 4.67% 4.48% 4.30% 4.11% 3.92% Wireless Churn Retail Postpaid Churn Rate 0.97% 1.04% 0.96% 0.98% 0.98% 0.98% 0.98% 0.98% Total Churn Rate 1.27% 1.33% 1.24% 1.28% 1.28% 1.28% 1.28% 1.28% Wireless ARPA Retail PostPaid ARPA (Monthly) 153.93 159.86 152.63 153.39 154.93 156.86 158.43 159.62 Y/Y Growth 6.87% 3.85% ‐4.52% 0.50% 1.00% 1.25% 1.00% 0.75% Retail postpaid connections per acco 2.76 2.87 2.98 3 3.05 3.1 3.15 3.2 Wireline Revenues Mass Markets 17.38 18.05 18.47 18.75 19.01 19.26 19.49 19.71 Y/Y Growth 3.80% 3.82% 2.36% 1.50% 1.40% 1.30% 1.20% 1.10% Global Enterprise 14.18 13.65 12.94 12.35 11.78 11.24 10.73 10.24 Y/Y Growth ‐2.71% ‐3.76% ‐5.17% ‐4.58% ‐4.58% ‐4.58% ‐4.58% ‐4.58% Global WholeSale 6.59 6.19 5.98 5.68 5.40 5.13 4.87 4.63 Y/Y Growth ‐7.05% ‐6.13% ‐3.41% ‐5.00% ‐5.00% ‐5.00% ‐5.00% ‐5.00% Other 0.47 0.54 0.33 0.33 0.33 0.33 0.33 0.33 Y/Y Growth ‐11.93% 16.77% ‐40.15% 0% 0% 0% 0% 0% Total Operating Revenue 38.62 38.43 37.72 37.11 36.52 35.95 35.41 34.89 Y/Y Growth ‐0.82% ‐0.50% ‐1.84% ‐1.63% ‐1.58% ‐1.54% ‐1.50% ‐1.47% Wireline Connections (000') Fios Internet 6,072 6,616 7,034 7478 7882 8221 8525 8738 Y/Y Growth 11.95% 8.96% 6.32% 6.32% 5.40% 4.30% 3.70% 2.50% Fios TV 5,262 5,649 5,827 6011 6191 6361 6488 6586 Y/Y Growth 11.34% 7.35% 3.15% 3.15% 3.00% 2.75% 2.00% 1.50% Total BroadBand Connections 9,015 9,205 9,228 9251 9274 9297 9321 9344 Y/Y Growth 2.50% 2.11% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% Total Voice Connections 21,085 19,795 18,387 17079 15798 14598 13474 12423 Y/Y Growth ‐6.30% ‐6.12% ‐7.11% ‐7.11% ‐7.50% ‐7.60% ‐7.70% ‐7.80% Other Revenues 0.90 1.00 2.22 2.22 2.22 2.22 2.22 2.22 Total Revenue 120.55 127.08 131.62 132.77 133.81 136.02 137.55 138.84 Total Revenue Growth 4.06% 5.42% 3.58% 0.88% 0.78% 1.65% 1.13% 0.94% Verizon Communications, Inc. Income Statement All figures in Billions, except per share amounts Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Sales 120.55 127.08 131.62 132.77 133.81 136.02 137.55 138.84 Cost of Goods Sold excluding D&A 44.89 49.93 52.56 53.11 53.52 54.41 55.02 55.54 Gross Income 75.66 77.15 79.06 79.66 80.29 81.61 82.53 83.31 Depreciation 15.02 14.97 14.32 13.86 14.49 15.05 15.57 16.05 Amortization of Intangibles 1.59 1.57 1.70 1.70 1.49 1.31 1.08 0.81 Selling, General, & Administration Expense 27.09 41.02 29.99 30.54 30.78 31.28 31.64 31.93 Operating Income 31.97 19.60 33.06 33.57 33.53 33.96 34.25 34.52 Equity in earnings of unconsolidated Businessess 0.14 1.78 ‐0.09 0.00 0.00 0.00 0.00 0.00 Other income and (expense) ‐ net ‐0.17 ‐1.19 0.19 ‐0.2 ‐0.2 ‐0.2 ‐0.2 ‐0.2 Interest Expense 2.67 4.92 4.92 5.05 2.01 1.88 1.84 1.73 PreTax Income 29.28 15.27 28.24 28.33 31.31 31.88 32.20 32.59 (Provision) Benefit for Income taxes ‐5.73 ‐3.31 ‐9.87 ‐10.51 ‐11.62 ‐11.83 ‐11.95 ‐12.09 Net Income 23.55 11.96 18.38 17.82 19.70 20.05 20.26 20.50 Net income attributable to noncontrolling interests 12.05 2.33 0.50 0.53 0.59 0.60 0.61 0.61 Net income attributable to Verizon 11.50 9.63 17.88 17.28 19.10 19.45 19.65 19.88 Net Income 23.55 11.96 18.38 17.82 19.70 20.05 20.26 20.50
EPS ‐ Basic 4.01 2.42 4.37 4.23 4.67 4.76 4.80 4.86 Weighted Average Shares Outstanding 2.87 3.97 4.09 4.09 4.09 4.09 4.09 4.09 Total Shares Outstanding 2.87 4.00 4.24 4.26 4.27 4.29 4.30 4.32 Dividends per share 2.09 2.16 2.23 2.30 2.37 2.44 2.51 2.59 Dividend payout Ratio 52.17% 89.09% 51.01% 54.35% 50.65% 51.23% 52.25% 53.18% Verizon Communications, Inc. Balance Sheet All Figures in Billions Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Assets Current Assets Cash and Cash Equivalents 53.53 10.60 4.47 8.46 6.21 9.42 8.47 12.18 Short‐Term Investments 0.60 0.56 0.35 0.36 0.36 0.37 0.38 0.39 Accounts Receivable 12.44 13.99 13.46 14.18 14.29 14.53 14.69 14.83 Inventories 1.02 1.15 1.25 1.23 1.24 1.26 1.27 1.28 Prepaid Expenses and Other 3.41 3.32 1.96 3.62 3.64 3.70 3.75 3.78 Assets Held For Sale 0.79 Total Current Assets 70.99 29.62 22.28 27.84 25.74 29.28 28.56 32.46 Plant Property Equipment 220.87 230.51 220.16 237.86 255.74 273.89 292.35 311.18 Less Accumulated Depreciation 131.91 140.56 136.62 150.48 164.97 180.03 195.59 211.64 PPE, net 88.96 89.95 83.54 87.38 90.77 93.86 96.75 99.54 Investments in Unconsolidated Businesses 3.43 0.80 0.80 0.80 0.80 0.80 0.80 0.80 Wireless Licenses 75.75 75.34 86.58 87.44 88.32 89.20 90.09 90.99 Goodwill 24.63 24.64 25.33 25.33 25.33 25.33 25.33 25.33 Other Intangible Assets, net 5.80 5.73 8.34 6.642 5.151 3.84 2.758 1.953 Non Current Assets Held For Sale 10.27 Other Assets 4.54 6.63 7.51 7.51 7.51 7.51 7.51 7.51 Total Assets 274.10 232.71 244.64 242.95 243.62 249.82 251.80 258.58 Liabilities Current Liabilities Short Term Debt 3.93 2.74 6.49 6.33 4.20 7.07 5.65 8.86 Accounts Payable and Accrued Liab. 16.45 16.68 19.36 18.46 18.61 18.91 19.13 19.31 Liabilities Related to Assets Held for Sale 0.46 Other 6.66 8.65 8.74 8.74 8.74 8.74 8.74 8.74 Total Current Liabilities 27.05 28.06 35.05 33.53 31.54 34.72 33.51 36.91 Long Term Debt 89.66 110.54 103.71 98.52 93.59 88.91 84.47 80.24 Employee Benefit Obligations 27.68 33.28 29.96 29.96 29.96 29.96 29.96 29.96 Deferred Income Taxes 28.64 41.58 45.48 43.21 41.05 39.00 37.05 35.19 Non Current Liabilities Related to Assets for Sale 0.96 Other Liabilities 5.65 5.57 11.64 11.64 11.64 11.64 11.64 11.64 Total Liabilities 178.68 219.03 226.80 216.85 207.78 204.23 196.62 193.94 Common Equity 38.24 11.58 11.62 12.37 13.11 13.86 14.61 15.35 Reinvested Earnings 1.78 2.45 11.25 18.75 27.75 36.75 45.59 54.31 Accumulated and other comprehensive income 2.36 1.11 0.55 0.55 0.55 0.55 0.55 0.55 Common Stock in Treasury, at cost ‐3.96 ‐3.26 ‐7.42 ‐7.42 ‐7.42 ‐7.42 ‐7.42 ‐7.42 Deferred compensation‐employee stock ownership plans and 0.42 0.42 0.43 0.43 0.43 0.43 0.43 0.43 Non‐Controlling Interest 56.58 1.38 1.41 1.41 1.41 1.41 1.41 1.41 Total Equity 95.42 13.68 17.84 26.09 35.83 45.58 55.18 64.64 Total Liabilities & Equity 274.10 232.71 244.64 242.95 243.62 249.82 251.80 258.58 Verizon Communications, Inc. Cash Flow Statement All Figures in Billions Fiscal Years Ending Dec. 31 2013 2014 2015 Cash Flows from Operating Activities Net Income 23.55 11.96 18.38 Adjustments to reconcile NI to net cash provided by operating activities: Depreciation and Amoritization Expense 16.61 16.53 16.02 Employee Retirement Benefits ‐5.05 8.13 ‐1.75 Deferred Income Taxes 5.79 ‐0.09 3.52 Provision for Uncollectible Accounts 0.99 1.10 1.61 Equity in earnings of unconsolidated businesses, net of dividends received ‐0.10 ‐1.74 0.13 Accounts receivable ‐0.84 ‐2.75 ‐0.95 Inventories 0.06 ‐0.13 ‐0.10 Other Assets ‐0.14 ‐0.70 0.94 Accounts Payable and accrued liabilities 0.93 1.41 2.55 Other, net ‐2.95 ‐3.09 ‐1.41 Net Cash Provided by Operating Activities 38.82 30.63 38.93 Cash Flows from Investing Activities Capital expenditures (including capitalized software) ‐16.60 ‐17.19 ‐17.78 Acquisitions of investments and businesses, net of cash acquired ‐0.49 ‐0.18 ‐3.55 Acquisitions of wireless licenses ‐0.58 ‐0.35 ‐9.94 Proceeds from dispositions of wireless licenses 2.11 2.37 Proceeds from dispositions of businesses 0.12 0.05 Other, net 0.73 ‐0.62 1.17 Net cash used in investing activies ‐14.83 ‐15.86 ‐30.04 Cash Flows from Financing Activities Proceeds from long‐term borrowings 49.17 30.97 6.67 Repayments of long‐term borrowings and capital lease obligations ‐8.16 ‐17.67 ‐9.34 Increase (Decrease) in short‐term obligations, excluding current maturities ‐0.14 ‐0.48 ‐0.34 Dividends paid ‐5.94 ‐7.80 ‐8.54 Proceeds from sale of common stock 0.09 0.03 0.04 Purchase of common stock for treasury ‐0.15 ‐5.13 Special distribution to noncontrolling interest ‐3.15 Acquisition of noncontrolling interest ‐58.89 Other, net ‐5.26 ‐3.87 1.63 Net cash provided by (used in) financing activities 26.45 ‐57.71 ‐15.02 Increase (decrease) in cash and cash equivalents 50.44 ‐42.93 ‐6.13 Cash and cash equivalents, beginning of period 3.09 53.53 10.60 Cash and cash equivalents, end of period 53.53 10.60 4.47 Verizon Communications, Inc. Projected Statement of Cash Flows All Figures in Billions Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E CV (2020) Cash Flows from Operating Activities Net Income 17.82 19.70 20.05 20.26 20.50 Adjustments to reconcile net income to cash from operating activities
Less: Income attributable to non‐controlling interest ‐0.53 ‐0.59 ‐0.60 ‐0.61 ‐0.61 Add: Depreciation 13.86 14.49 15.05 15.57 16.05 Add: Amortization of intangibles 1.70 1.49 1.31 1.08 0.81 Change in deferred taxes ‐2.27 ‐2.16 ‐2.05 ‐1.95 ‐1.85 Changes (increases or decreases) in working capital accounts: Change in receivables, net allowance ‐0.72 ‐0.11 ‐0.24 ‐0.16 ‐0.14 Change in inventories 0.03 ‐0.01 ‐0.02 ‐0.01 ‐0.01 Change in prepaid expenses & Other ‐1.66 ‐0.03 ‐0.06 ‐0.04 ‐0.04 Change in accounts payable and accrued liabilities ‐0.90 0.14 0.31 0.21 0.18 Change in other liabilities 0.00 0.00 0.00 0.00 0.00 Net Cash Provided by Operating Activities 27.31 32.92 33.76 34.34 34.88 Cash Flows from Investing Activities (Increase) decrease in short‐term investments ‐0.01 ‐0.01 ‐0.01 ‐0.01 ‐0.01 (Increase) decrease in long‐term investments 0.00 0.00 0.00 0.00 0.00 Capital expenditures ‐17.70 ‐17.88 ‐18.15 ‐18.46 ‐18.83 Change in intangible assets 0.00 0.00 0.00 0.00 0.00 Change in Wireless Licenses ‐0.87 ‐0.87 ‐0.88 ‐0.89 ‐0.90 Change in discontinued operations 9.64 0.00 0.00 0.00 0.00 (Increase) decrease in other assets 0.00 0.00 0.00 0.00 0.00 Net Cash used in Investing Activities ‐8.94 ‐18.76 ‐19.04 ‐19.36 ‐19.74 Cash Flows from Financing Activities Proceeds from issuance (payments) of short‐term debt ‐0.16 ‐2.13 2.88 ‐1.43 3.22 Proceeds from issuance (payments) of long‐term debt ‐5.19 ‐4.93 ‐4.68 ‐4.45 ‐4.22 Payment of Dividends ‐9.78 ‐10.11 ‐10.45 ‐10.80 ‐11.17 Net Proceeds from sale/issuance of common stock 0.75 0.75 0.75 0.75 0.75 Net Cash provided by (used in) Financing Activities ‐14.38 ‐16.42 ‐11.51 ‐15.93 ‐11.43 Increase (decrease) in cash and cash equivalents 3.99 ‐2.25 3.21 ‐0.95 3.71 Cash and cash equivalents, beginning of period 4.47 8.46 6.21 9.42 8.47 Cash and cash equivalents, end of period 8.46 6.21 9.42 8.47 12.18 Verizon Communications, Inc. Common Size Income Statement Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of Goods Sold excluding D&A 37.24% 39.29% 39.93% 40.00% 40.00% 40.00% 40.00% 40.00% Gross Margin 62.76% 60.71% 60.07% 60.00% 60.00% 60.00% 60.00% 60.00% Depreciation 12.46% 11.78% 11.27% 10.44% 10.83% 11.07% 11.32% 11.56% Amortization of Intangibles 1.32% 1.23% 1.34% 1.28% 1.11% 0.96% 0.79% 0.58% Selling, General, & Administration Expense 22.47% 32.28% 22.78% 23.00% 23.00% 23.00% 23.00% 23.00% Operating Income 26.52% 15.42% 25.12% 25.29% 25.05% 24.97% 24.90% 24.86% Equity in Earnings of Unconsolidated Businessess 0.12% 1.40% ‐0.07% 0.00% 0.00% 0.00% 0.00% 0.00% Other Income and (Expense) ‐ net ‐0.14% ‐0.94% 0.14% ‐0.15% ‐0.15% ‐0.15% ‐0.15% ‐0.14% Interest Expense 2.21% 3.87% 3.74% 3.80% 1.50% 1.38% 1.34% 1.25% PreTax Income 24.29% 12.02% 21.46% 21.34% 23.40% 23.44% 23.41% 23.47% (Provision) Benefit for Income taxes ‐4.75% ‐2.61% ‐7.50% ‐7.92% ‐8.68% ‐8.70% ‐8.69% ‐8.71% Net Income 19.53% 9.41% 13.96% 13.42% 14.72% 14.74% 14.73% 14.76% Net income attributable to noncontrolling interests 10.00% 1.83% 0.38% 0.40% 0.44% 0.44% 0.44% 0.44% Net income attributable to Verizon 9.54% 7.57% 13.58% 13.02% 14.28% 14.30% 14.28% 14.32% Net Income 19.53% 9.41% 13.96% 13.42% 14.72% 14.74% 14.73% 14.76% Verizon Communications, Inc. Common Size Balance Sheet Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Assets Current Assets Cash and Cash Equivalents 44.40% 8.34% 3.40% 6.37% 4.64% 6.93% 6.16% 8.77% Short‐Term Investments 0.50% 0.44% 0.27% 0.27% 0.27% 0.27% 0.28% 0.28% Accounts Receivable 10.32% 11.01% 10.22% 10.68% 10.68% 10.68% 10.68% 10.68% Inventories 0.85% 0.91% 0.95% 0.92% 0.92% 0.92% 0.92% 0.92% Prepaid Expenses and Other 2.83% 2.62% 1.49% 2.72% 2.72% 2.72% 2.72% 2.72% Assets Held For Sale 0.60% 0.00% 0.00% 0.00% 0.00% 0.00% Total Current Assets 58.89% 23.31% 16.93% 20.97% 19.24% 21.53% 20.76% 23.38% Plant Property Equipment 183.21% 181.39% 167.27% 179.15% 191.12% 201.36% 212.53% 224.12% Less Accumulated Depreciation 109.42% 110.61% 103.80% 113.33% 123.29% 132.36% 142.19% 152.43% PPE, net 73.79% 70.78% 63.47% 65.82% 67.83% 69.01% 70.34% 71.69% Investments in Unconsolidated Businesses 2.85% 0.63% 0.60% 0.60% 0.59% 0.59% 0.58% 0.57% Wireless Licenses 62.83% 59.29% 65.78% 65.86% 66.00% 65.58% 65.49% 65.54% Goodwill 20.43% 19.39% 19.25% 19.08% 18.93% 18.62% 18.42% 18.24% Other Intangible Assets, net 4.81% 4.51% 6.33% 5.00% 3.85% 2.82% 2.01% 1.41% Non Current Assets Held For Sale 7.80% 0.00% 0.00% 0.00% 0.00% 0.00% Other Assets 3.76% 5.22% 5.71% 5.66% 5.61% 5.52% 5.46% 5.41% Total Assets 227.37% 183.12% 185.87% 182.98% 182.06% 183.67% 183.06% 186.24% Liabilities 0.00% 0.00% 0.00% 0.00% 0.00% Current Liabilities 0.00% 0.00% 0.00% 0.00% 0.00% Short Term Debt 3.26% 2.15% 4.93% 4.76% 3.14% 5.20% 4.10% 6.38% Accounts Payable and Accrued Liab. 13.65% 13.13% 14.71% 13.91% 13.91% 13.91% 13.91% 13.91% Liabilities Related to Assets Held for Sale 0.35% 0.00% 0.00% 0.00% 0.00% 0.00% Other 5.53% 6.81% 6.64% 6.58% 6.53% 6.42% 6.35% 6.29% Total Current Liabilities 22.44% 22.08% 26.63% 25.25% 23.57% 25.53% 24.36% 26.58% Long Term Debt 74.37% 86.98% 78.79% 74.20% 69.94% 65.37% 61.41% 57.80% Employee Benefit Obligations 22.96% 26.19% 22.76% 22.56% 22.39% 22.02% 21.78% 21.58% Deferred Income Taxes 23.76% 32.72% 34.56% 32.54% 30.68% 28.67% 26.93% 25.35% Non Current Liabilities Related to Assets for Sale 0.73% 0.00% 0.00% 0.00% 0.00% 0.00% Other Liabilities 4.69% 4.39% 8.84% 8.77% 8.70% 8.56% 8.46% 8.38% Total Liabilities 148.22% 172.36% 172.31% 163.33% 155.28% 150.15% 142.94% 139.68% Common Equity 31.72% 9.11% 8.83% 9.31% 9.80% 10.19% 10.62% 11.06% Reinvested Earnings 1.48% 1.93% 8.54% 14.12% 20.74% 27.02% 33.15% 39.12% Accumulated and other comprehensive income 1.96% 0.87% 0.42% 0.41% 0.41% 0.40% 0.40% 0.40% Common Stock in Treasury, at cost ‐3.29% ‐2.57% ‐5.63% ‐5.59% ‐5.54% ‐5.45% ‐5.39% ‐5.34% Deferred compensation‐employee stock owner ship plans and 0.35% 0.33% 0.33% 0.32% 0.32% 0.31% 0.31% 0.31% Non‐Controlling Interest 46.93% 1.08% 1.07% 1.06% 1.06% 1.04% 1.03% 1.02% Total Equity 79.15% 10.76% 13.56% 19.65% 26.78% 33.51% 40.11% 46.55% Total Liabilities and Equity 227.37% 183.12% 185.87% 182.98% 182.06% 183.67% 183.06% 186.24% Verizon Communications, Inc. Variable WACC t=0 2016E 2017E 2018E 2019E CV (2020) Risk Free 2.66% 2.66% 2.66% 3.00% 3.00% 3.00% Risk Premium 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% Beta 0.74 0.74 0.74 0.74 0.74 0.74 Cost of Equity 6.37% 6.37% 6.37% 6.71% 6.71% 6.71%
Debt Rating BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ Default Spread 1.92% 1.92% 1.92% 1.92% 1.92% 1.92% Pre‐Tax Cost of Debt 4.58% 4.58% 4.58% 4.92% 4.92% 4.92% Tax Rate 37.1% 37.1% 37.1% 37.1% 37.1% 37.1% After‐Tax Cost of Debt 2.88% 2.88% 2.88% 3.09% 3.09% 3.09%
MV Weight of Equity 63% 64% 65% 66% 67% 67% MV Weight of Debt 37% 36% 35% 34% 33% 33%
Forward WACC 5.09% 5.12% 5.16% 5.47% 5.51% 5.51%
Discount Factor 1.05 1.11 1.17 1.23 1.30
Implied Constant WACC 5.12% 5.14% 5.25% 5.31% 5.35% Verizon Communications, Inc. Value Driver Estimation Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Marginal Tax Rate 37.10% 37.70% 37.10% 37.10% 37.10% 37.10% 37.10% 37.10%
NOPLAT EBITA Sales 120.55 127.08 131.62 132.77 133.81 136.02 137.55 138.84 Cost of Goods Sold 44.89 49.93 52.56 53.11 53.52 54.41 55.02 55.54 Depreciation & Amortization 16.61 16.53 16.02 15.55 15.98 16.37 16.65 16.85 Selling, General, and administration Expe 27.09 41.02 29.99 30.54 30.78 31.28 31.64 31.93 Implied interest on operating leases 0.22 0.26 0.32 0.33 0.35 0.36 0.37 0.38 EBITA 32.18 19.85 33.38 33.91 33.87 34.32 34.62 34.90 Less: Adjusted Taxes Income Tax Provision 5.73 3.31 9.87 10.51 11.62 11.83 11.95 12.09
Plus: Tax Shield on Interest Expense 0.99 1.85 1.83 1.87 0.75 0.70 0.68 0.64 Plus: Tax shield on lease interest 0.08 0.10 0.12 0.12 0.13 0.13 0.14 0.14 Less: Tax Non‐operating income 0.05 0.67 ‐0.03 0.00 0.00 0.00 0.00 0.00 Less: Tax on Equity in Earnings of Unconsolidated Businesses 0.05 0.67 ‐0.03 0.00 0.00 0.00 0.00 0.00 Adjusted Taxes 6.75 4.59 11.84 12.51 12.49 12.66 12.77 12.87 Change in Deferred Taxes Deferred Tax End Period 28.64 41.58 45.48 43.21 41.05 39.00 37.05 35.19 Deferred tax Previous Period 24.68 28.64 41.58 45.48 43.21 41.05 39.00 37.05 Net Change in Deferred Tax Liabilities 3.96 12.94 3.91 ‐2.27 ‐2.16 ‐2.05 ‐1.95 ‐1.85 NOPLAT 29.40 28.20 25.44 19.13 19.22 19.61 19.90 20.17
Invested Capital Current Operating Assets Normal Cash 3.22 3.39 3.51 3.55 3.57 3.63 3.67 3.71 Accounts Receivable 12.44 13.99 13.46 14.18 14.29 14.53 14.69 14.83 Inventory 1.02 1.15 1.25 1.23 1.24 1.26 1.27 1.28 Prepaid Expenses & Other Current Assets 3.41 3.32 1.96 3.62 3.64 3.70 3.75 3.78 Current Operating Assets 20.08 21.86 20.18 22.57 22.74 23.12 23.38 23.60 Current Operating Liabilities Accounts Payable & Accrued Liabilities 16.45 16.68 19.36 18.46 18.61 18.91 19.13 19.31 Other Current Liabilities 6.66 8.65 8.74 8.74 8.74 8.74 8.74 8.74 Current Operating Liabilities 23.12 25.33 28.10 27.20 27.35 27.65 27.87 28.05 Net Operating Working Capital ‐3.03 ‐3.47 ‐7.92 ‐4.63 ‐4.60 ‐4.53 ‐4.49 ‐4.45
Plus: Net PPE 88.96 89.95 83.54 87.38 90.77 93.86 96.75 99.54 Other Operating Assets PV of Operating Leases 11.30 13.32 16.65 17.42 18.09 18.71 19.29 19.84
Net Intangible Assets (non‐Goodwill) 5.80 5.73 8.34 6.64 5.15 3.84 2.76 1.95 Wireless Licenses 75.75 75.34 86.58 87.44 88.32 89.20 90.09 90.99 Other Assets 4.54 6.63 7.51 7.51 7.51 7.51 7.51 7.51 Plus: Other Operating Assets 97.38 101.02 119.08 119.01 119.07 119.26 119.65 120.30 Less: Other Operating Liabilities 5.65 5.57 11.64 11.64 11.64 11.64 11.64 11.64 Invested Capital 177.65 181.92 183.06 190.12 193.60 196.94 200.27 203.75
ROIC NOPLAT 29.40 28.20 25.44 19.13 19.22 19.61 19.90 20.17 Beginning Invested Capital 179.44 177.65 181.92 183.06 190.12 193.60 196.94 200.27 ROIC 16.38% 15.87% 13.99% 10.45% 10.11% 10.13% 10.10% 10.07%
FCF NOPLAT 29.40 28.20 25.44 19.13 19.22 19.61 19.90 20.17 Ending Invested Capital 177.65 181.92 183.06 190.12 193.60 196.94 200.27 203.75 Beginning Invested Capital 179.44 177.65 181.92 183.06 190.12 193.60 196.94 200.27 FCF 31.19 23.93 24.31 12.06 15.75 16.26 16.57 16.70
EP Beginning Invested Capital 179.44 177.65 181.92 183.06 190.12 193.60 196.94 200.27 ROIC 16.38% 15.87% 13.99% 10.45% 10.11% 10.13% 10.10% 10.07% WACC 5.52% 5.52% 5.52% 5.12% 5.16% 5.47% 5.51% 5.51% EP 19.49 18.40 15.40 9.76 9.41 9.03 9.06 9.14 Verizon Communications, Inc. Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models Key Inputs: CV Growth 1.39% CV ROIC 10.07% Fiscal Year Ending Dec. 31 2016 2017 2018 2019 2020 WACC 5.12% 5.16% 5.47% 5.51% 5.51% Cost of Equity 6.37% 6.37% 6.71% 6.71% 6.71%
DCF Model Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E NOPLAT 19.13 19.22 19.61 19.90 20.17 Change in Invested Capital 7.06 3.47 3.35 3.33 3.48 FCF 12.06 15.75 16.26 16.57 16.70 CV 422.21 Discount Factor 1.05 1.11 1.17 1.23 1.23 Present Value of Cash Flows 11.48 14.24 13.95 13.47 343.24 Value of Operations 396.38 Excess Cash 0.96 Investments in Unconsolidated Businesses 0.80 Short Term Investments 0.35 Long Term Debt 103.71 Short Term Debt 6.49 Underfunded Pension Plan 5.89 PV of Operating Leases 16.65 Employee Stock Option Plans 0.47 Net Assets Held for Sale 9.64 Value of Equity 274.91 Shares Outstanding 4.24 Implied Share Price 64.81 Adjusted Price 65.23
EP Model Fiscal Years Ending Dec. 31 2016 2016E 2017E 2018 2019E 2020E Invested Capital 183.06 Economic Profit 9.76 9.41 9.03 9.06 9.14 CV 221.94 Discount Factor 1.05 1.11 1.17 1.23 1.23 PV of Economic Profit 9.28 8.51 7.74 7.36 180.43 Value of Operations 396.38 Excess Cash 0.96 Investments in Unconsolidated Businesses 0.80 Short Term Investments 0.35 Long Term Debt 103.71 Short Term Debt 6.49 Underfunded Pension Plan 5.89 PV of Operating Leases 16.65 Employee Stock Option Plans 0.47 Net Assets Held for Sale 9.64 Value of Equity 274.91 Shares Outstanding 4.24 Implied Share Price 64.81 Adjusted Price 65.23 Verizon Communications, Inc. Fundamental P/E Dividend Discount Model (DDM) Fiscal Years Ending Dec. 31 2016E 2017E 2018E 2019E 2020E
EPS$ 4.23 $ 4.67 $ 4.76 $ 4.80 $ 4.86
Key Assumptions CV growth 1.20% CV ROE 36.04% Cost of Equity 6.37%
Future Cash Flows Dividends Per Share 2.30 2.37 2.44 2.51 2.59 CV 90.91 Discount Factor 1.06 1.13 1.20 1.28 1.36 Discounted Dividends 2.16 2.09 2.02 1.96 66.76
Intrinsic Value 72.84 Adjusted Intrinsic Value 73.32 Verizon Communications, Inc. Relative Valuation Models Sales in Billions Sales Sales Ticker Company Price 2016E 2017E P/S 16 P/S 17 T AT&T $38.64 166.9 170.5 0.23 0.23 S Sprint $3.59 32.4 33.2 0.11 0.11 TMUS T‐Mobile $39.10 35.1 37.5 1.11 1.04 Average 0.49 0.46
VZ Verizon Wireless $53.52 132.77 133.81 0.403 0.400
Implied Value: Relative P/S (Sales16) 64.45 Relative P/S (Sales17) 61.44 Verizon Communications, Inc. Key Management Ratios Fiscal Years Ending Dec. 31 2013 2014 2015 2016E 2017E 2018E 2019E CV (2020) Liquidity Ratios Current Ratio Current Assets / Current Liabilities 2.62 1.06 0.64 0.83 0.82 0.84 0.85 0.88
(Cash and Cash equivalents + A/R, net + Short Term Investments) / Current Quick Ratio Liabilities 2.59 1.01 0.60 0.79 0.78 0.81 0.81 0.84 Operating Cash Flow Ratio Cash Flow From Operations / Current Liabilities 1.44 1.09 1.11 0.81 1.04 0.97 1.02 0.95
Activity or Asset‐Management Ratios Fixed Asset Turnover Ratio Revenue / PPE 1.36 1.41 1.58 1.52 1.47 1.45 1.42 1.39 Asset Turnover Ratio Revenue / Total Assets 0.44 0.55 0.54 0.55 0.55 0.54 0.55 0.54 Receivables Turnover Ratio Revenue / Average Accounts Receivable 9.64 9.62 9.59 9.61 9.40 9.44 9.42 9.41
Financial Leverage Ratios Interest Coverage EBITA / Interest Expense 11.98 4.11 6.74 6.61 16.55 17.98 18.47 19.84 Debt/Total Assets Total Debt / Total Assets 0.34 0.49 0.45 0.43 0.40 0.38 0.36 0.34 Debt/Equity Total Debt / Total Equity 0.98 8.28 6.18 4.02 2.73 2.11 1.63 1.38
Profitability Ratios ROE Net Income / Average Total Equity 26.03% 21.92% 116.60% 81.11% 63.61% 49.26% 40.21% 34.22% ROA Net Income / Average Total Assets 9.43% 4.72% 7.70% 7.31% 8.10% 8.13% 8.08% 8.03% Profit Margin Net Income / Revenue 19.53% 9.41% 13.96% 13.42% 14.72% 14.74% 14.73% 14.76% Gross margin (Revenue‐COGS) / Revenue 62.76% 60.71% 60.07% 60.00% 60.00% 60.00% 60.00% 60.00%
Payout Policy Ratios Dividend Payout Ratio Dividends Per Share / Earnings Per Share 52.17% 89.09% 51.01% 54.35% 50.65% 51.23% 52.25% 53.18% Retention Ratio 1 ‐ (Dividends Per Share / Earnings Per Share) 47.83% 10.91% 48.99% 45.65% 49.35% 48.77% 47.75% 46.82% Dividend Coverage Ratio Earnings Per Share / Dividends Per Share 1.92 1.12 1.96 1.84 1.97 1.95 1.91 1.88 Present Value of Operating Lease Obligations (2015) Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013) Present Value of Operating Lease Obligations (2012)
Operating Operating Operating Operating Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Dec. 31 Leases #REF! Leases Fiscal Years Ending Leases 2016 2.744 2015 2.499 2014 2.255 2013 2.038 2017 2.486 2016 2.245 2015 2.02 2014 1.84 2018 2.211 2017 1.960 2016 1.703 2015 1.572 2019 1.939 2018 1.660 2017 1.379 2016 1.28 2020 1.536 2019 1.369 2018 1.085 2017 0.992 Thereafter 7.297 Thereafter 4.670 Thereafter 3.748 Thereafter 4.119 Total Minimum Payments 18.213 Total Minimum Payments 14.403 Total Minimum Payments 12.19 Total Minimum Payments 11.841 Less: Interest 1.56 Less: Interest 1.083 Less: Interest 0.893 Less: Interest 0.93 PV of Minimum Payments 16.65 PV of Minimum Payments 13.32 PV of Minimum Payments 11.30 PV of Minimum Payments 10.91
Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases
Pre‐Tax Cost of Debt 1.92% Pre‐Tax Cost of Debt 1.92% Pre‐Tax Cost of Debt 1.92% Pre‐Tax Cost of Debt 1.92% Number Years Implied by Year 6 Payment 4.8 Number Years Implied by Year 6 Payment 3.4 Number Years Implied by Year 6 Payment 3.5 Number Years Implied by Year 6 Payment 4.2
Lease PV Lease Lease PV Lease Lease PV Lease Lease PV Lease Year Commitment Payment Year Commitment Payment Year Commitment Payment Year Commitment Payment 1 2.744 2.7 1 2.499 2.5 1 2.255 2.2 1 2.038 2.0 2 2.486 2.4 2 2.245 2.2 2 2.02 1.9 2 1.84 1.8 3 2.211 2.1 3 1.96 1.9 3 1.703 1.6 3 1.572 1.5 4 1.939 1.8 4 1.66 1.5 4 1.379 1.3 4 1.28 1.2 5 1.536 1.4 5 1.369 1.2 5 1.085 1.0 5 0.992 0.9 6 & beyond 1.536 6.3 6 & beyond 1.369 4.1 6 & beyond 1.085 3.3 6 & beyond 0.992 3.6 PV of Minimum Payments 16.65 PV of Minimum Payments 13.32 PV of Minimum Payments 11.30 PV of Minimum Payments 10.91 Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding
Number of Options Outstanding (shares): 0.031 Average Time to Maturity (years): 2.000 Expected Annual Number of Options Exercised: 0.0155
Current Average Strike Price:$ 48.15 Cost of Equity: 6.37% Current Stock Price: $53.52
2016E 2017E 2018E 2019E 2020E Increase in Shares Outstanding: 0.0155 0.0155 0.0155 0.0155 0.0155 Average Strike Price:$ 48.15 $ 48.15 $ 48.15 $ 48.15 $ 48.15 Increase in Common Stock Account: 0.7463 0.7463 0.7463 0.7463 0.7463
Shares Outstanding (beginning of the year) 4.2420 4.2575 4.2730 4.2885 4.3040 Plus: Shares Issued Through ESOP 0.0155 0.0155 0.0155 0.0155 0.0155 Less: Shares Repurchased in Treasury ‐ ‐ ‐ ‐ ‐ Shares Outstanding (end of the year) 4.26 4.27 4.29 4.30 4.32 VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol VZ Current Stock Price $53.52 Risk Free Rate 2.66% Current Dividend Yield 0.00% Annualized St. Dev. of Stock Returns 38.80%
Average Average B‐S Value Range of Number Exercise Remaining Option of Options Outstanding Options of Shares Price Life (yrs) Price Granted RSU (restricted units) 13,903 48.15 2.00 $ 15.09 $ 209,755 PSU (performance units) 17,203 48.15 2.00 $ 15.09 $ 259,542 Total 31,106$ 48.15 2.00$ 15.09 $ 469,297 Market Risk Premium COGS as % of Revenue $64.81 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% $64.81 37.00% 38.00% 39.00% 40.00% 41.00% 42.00% 43.00% 0.40$ 121.41 $ 113.96 $ 107.21 $ 101.07 $ 95.45 $ 90.30 $ 85.55 ‐0.50% $76.83 $72.35 $67.84 $63.33 $58.79 $54.23 $49.65 0.50$ 108.84 $101.07 $94.12 $87.88 $82.23 $77.10$ 72.42 0.00% $77.36 $72.86 $68.35 $63.82 $59.27 $54.70 $50.10 0.60$ 98.20 $90.30 $83.32 $77.10 $71.54 $66.52$ 61.98 Wireless Service 0.50% $77.90 $73.38 $68.86 $64.31 $59.75 $55.17 $50.55 Beta 0.74$ 85.62 $77.73 $70.86 $64.81 $59.44 $54.66$ 50.36 Revenue Growth 1.00% $78.43 $73.90 $69.36 $64.81 $60.23 $55.63 $51.01 0.80$ 81.17 $73.33 $66.52 $60.56 $55.30 $50.61$ 46.42 1.50% $78.96 $74.42 $69.87 $65.30 $60.71 $56.10 $51.46 0.90$ 74.25 $66.52 $59.87 $54.07 $48.99 $44.48$ 40.46 2.00% $79.49 $74.94 $70.38 $65.79 $61.19 $56.57 $51.92 1.00$ 68.14 $ 60.56 $ 54.07 $ 48.46 $ 43.55 $ 39.22 $ 35.37 2.50% $80.03 $75.46 $70.88 $66.29 $61.67 $57.04 $52.37
CV ROIC Default Spread $64.81 8.50% 9.00% 9.50% 10.07% 10.50% 11.00% 11.50% $64.81 0.40% 0.90% 1.40% 1.92% 2.40% 2.90% 3.40% 0.80% $58.28 $58.70 $59.09 $59.48 $59.75 $60.03 $60.29 1.00% $74.22 $71.85 $69.60 $67.39 $65.44 $63.51 $61.67 1.00% $59.56 $60.12 $60.62 $61.13 $61.48 $61.85 $62.19 1.50% $73.37 $71.02 $68.79 $66.60 $64.67 $62.76 $60.93 CV 1.20% $60.96 $61.66 $62.29 $62.94 $63.37 $63.84 $64.26 2.00% $72.53 $70.20 $68.00 $65.82 $63.91 $62.01 $60.20 NOPLAT G 1.39% $62.41 $63.26 $64.02 $64.81 $65.33 $65.90 $66.41 Risk Free Rate 2.66% $71.44 $69.14 $66.96 $64.81 $62.92 $61.04 $59.26 1.60% $64.19 $65.22 $66.15 $67.10 $67.74 $68.42 $69.05 3.00% $70.88 $68.60 $66.43 $64.29 $62.41 $60.55 $58.77 1.80% $66.07 $67.29 $68.39 $69.52 $70.27 $71.08 $71.83 3.50% $70.07 $67.81 $65.66 $63.54 $61.68 $59.83 $58.07 2.00% $68.16 $69.60 $70.89 $72.21 $73.10 $74.05 $74.92 4.00% $69.27 $67.03 $64.90 $62.80 $60.96 $59.13 $57.38
COGS as % of Sales Marginal Tax Rate $64.81 37.00% 38.00% 39.00% 40.00% 41.00% 42.00% 43.00% $64.81 34.10% 35.10% 36.10% 37.10% 38.10% 39.10% 40.10% 20.00% $91.93 $87.44 $82.94 $78.43 $73.90 $69.36 $64.81 1.30% $71.69 $70.27 $68.83 $67.38 $65.92 $64.45 $62.97 21.00% $87.44 $82.94 $78.43 $73.90 $69.36 $64.81 $60.23 1.50% $70.76 $69.36 $67.95 $66.53 $65.10 $63.66 $62.21 SG&A as 22.00% $82.94 $78.43 $73.90 $69.36 $64.81 $60.23 $55.63 1.70% $69.84 $68.47 $67.09 $65.70 $64.30 $62.89 $61.46 % of Sales 23.00% $78.43 $73.90 $69.36 $64.81 $60.23 $55.63 $51.01 Default Spread 1.92% $68.85 $67.51 $66.17 $64.81 $63.44 $62.05 $60.66 24.00% $73.90 $69.36 $64.81 $60.23 $55.63 $51.01 $46.35 2.10% $68.06 $66.75 $65.42 $64.09 $62.74 $61.39 $60.02 25.00% $69.36 $64.81 $60.23 $55.63 $51.01 $46.35 $41.66 2.30% $67.19 $65.91 $64.61 $63.30 $61.99 $60.66 $59.32 26.00% $64.81 $60.23 $55.63 $51.01 $46.35 $41.66 $36.93 2.50% $66.34 $65.09 $63.82 $62.54 $61.25 $59.94 $58.63