Verizon (VZ, Financial) is one of the largest telecom providers in the world, and the largest wireless carrier in the U.S. The company is poised to benefit from many 5G industry tailwinds, but due in part to the capital-intensive nature of the business and the oligopoly in which it operates, analysts don't tend to be bullish on it. Yet, Oppenheimer Research has upgraded the stock to "Outperform" after two years of negative ratings as Verizon has scored a massive $1.58 billion contract to modernize U.S. embassies in a landmark deal.
Core business
Verizon has over 90 million phone customers which are split across its three main segments; Consumer, Business and Government. Verizon also has a legacy fixed-line phone service in the northeast of the United States which generates approximately 12% of revenue.
5G tailwinds
The 5G industry was worth $64.5 billion in 2021 and is forecasted to grow at a blistering compounded annual growth rate (CAGR) of over 44% between 2022 and 2030 according to estimates from Precedence Research. By the end of this period, the industry is expected to be worth a staggering $1.87 trillion. Verizon’s large market position means the company is poised to become the backbone of the 5G industry in the U.S.
Verizon has also announced its "Network as a Service" strategy, which laid out bold plans for the 5G network. As part of this new strategy, Verizon acquired the 5G mid-band frequency spectrum and aims to provide 5G to over 50 million households by 2025. The speed of 5G means it could eventually disrupt fixed-line home broadband and create a true wireless experience whether at home, work or outdoors.
In September, Verizon even won a $11.5 million contract from the U.S. Department of Defense to construct a private and secure 5G network for an aircraft hangar at Joint Base Pearl Harbor Hickam (JBPHH) military base. This network will be used for various maintenance-based experiments and could open the door to larger defence contracts in the future.
Verizon is also working on multi-edge computing with partners such as Cisco (CSCO, Financial). This state-of-the-art technology aims to bring the power of the data center closer to your device. As a simple example, let's say a company has created an AI-powered app that uses your mobile camera for image recognition. An app like this would need access to a vast database and need the ability to run machine learning or AI algorithms on the images, usually at a data center. This is fine, but often the data center is not close and thus latency in the application would be embedded. However, with MEC, this latency will be removed, which opens up a whole host of possibilities from 3D video streaming to the Metaverse.
More recently, Verizon has scored a $1.58 billion task order to modify U.S. embassies with new IT services in a lucrative 10-year contract. The gradual stabilization of the company’s subscriber base has also caused Oppenheimer Research to upgrade the stock to “Outperform” after two years of negative ratings.
M&A activity
In 2015, Verizon went on a shopping spree and acquired internet giant AOL for $4.4 billion. The company also acquired Yahoo for $4.5 billion in 2017. These made up Verizon's Media brand, but in 2021 the business sold off these assets to private equity firm Apollo Global Management (APO, Financial) for a measly $5 billion, which was less than half what Verizon originally acquired them for. Despite the poor acquisition track record, Verizon is continually reinventing itself and thus it is probably for the best the business has sold off unrelated units.
Financials
Verizon announced solid financial results for the second quarter of 2022. Revenue was $33.8 billion, which beat analyst estimates by $11.57 million. This was driven by higher than expected wireless equipment revenue, offset mostly by wireline declines. Wireless service revenue popped by a tremendous 9.1% year over year. This was driven by the acquisition of TracFone in the fourth quarter of 2021. However, Service revenue did decline by 3.9%, which was driven by losses related to the sale of Verizon Media.
The company generated net income of $5.3 billion in the second quarter, which declined by 10.7% year over year. This was again driven by the sale of Verizon Media and aggressive marketing investments for its wireless service. Therefore I don’t deem this to be a major issue in the long term.
Cash flow from operations was a staggering $17.7 billion in the first half of 2022, which was down slightly from the $20.4 billion generated in the first half of 2021. However, this was mainly due to higher inventory and lower working capital, which is not a major issue as inventory can be worked through.
Verizon’s balance sheet consists of $1.98 billion in cash and short-term investments. In addition, the business has a monstrous amount of unsecured debt with $130.6 billion reported. The good news is management has been paying down this debt balance and reduced it by $5 billion in the second quarter.
Healthy dividend
Verizon pays a healthy forward dividend yield of 6.62%, which has grown at a pace of 2% per year over the past five years. In addition, this dividend has grow consistently over the past 18 years, making it a strong option for dividend reliability.
Valuation
In order to value Verizon, I have plugged the latest financials into my advanced valuation model, which uses the discounted cash flow method of valuation. I have forecasted a conservative 5% revenue growth for next year and then 6% per year over the next two to five years.
I have also forecasted the business to increase its operating margin slightly to 20% over the next eight years, which is also conservative in my view.
Given these factors, I get a fair value estimate of $53 per share. The stock is trading at ~$40 per share at the time of writing and thus offers a significant margin of safety of ~30%.
Verizon is trading at a price-earnings ratio of 7.6, which is 32% cheaper than its five-year average.
Final thoughts
Verizon is a legacy telecom company that still has growth potential due to technological advancements even as it operates mainly in a closed and saturated market. The company does have high debt, but it has managed debt well historically, and it looks undervalued relative to historic multiples at the time of writing.
