Verizon Communications Inc.which led to 2018’s massive write-down.
On September 14, Verizon announced a $6.9 billion deal to acquire Tracfone, the largest nationwide American prepaid wireless virtual network operator (MVNO), from Mexican telecom America Movil. (MVNOs rent network capacity from facilities-based wireless network operators like Verizon.) Verizon expects to pay $3.125 billion in cash and $3.125 billion in stock for Tracfone, with an additional $650 million to be paid in the two years after the closing if Tracfone meets certain performance requirements. Verizon has had a longstanding relationship with Tracfone as a wholesale supplier of network services, so the deal is not a total surprise. Tracfone has 21 million subscribers, of which 13 million already use Verizon’s network in a wholesale capacity. Tracfone also has 90,000 retail locations nationwide, including in Walmart stores. Tracfone operates a portfolio of prepaid wireless brands, including the eponymous brand, Straight Talk, SIMPLE Mobile, Total Wireless, and others.
The acquisition, which should bolster Verizon’s prepaid business, marks another step in the consolidation of the U.S. telecom industry, with T-Mobile’s acquisition of Sprint earlier this year as the most notable recent merger. One aspect of the Tracfone deal is that Verizon will acquire the 8 million subscribers it does not already serve on an MVNO basis. In effect, Verizon will deny these customers to Tracfone’s other wholesale suppliers and, not incidentally, to competitors AT&T, T-Mobile, and U.S. Cellular.
Verizon has traditionally focused more on its high-value postpaid subscriber base. However, evolving industry dynamics, including the prevalence of unlimited data plans, a strengthened T-Mobile in the wake of the Sprint acquisition, the entrance of cable company MVNOs from Comcast, Charter, and Altice, and a possible new entrant in Dish Network, may have led Verizon to reconsider the prepaid or ‘value-oriented’ end of the U.S. wireless market. Verizon CEO Hans Vestberg also intends to reap the back office and distribution synergies from the addition of 21 million Tracfone subscribers. Adding the 8 million subscribers not already on the existing Verizon network, thereby increasing its usage, will also help to lower costs per subscriber as a larger number of subscribers are spread over the existing network. This synergy is underscored by Verizon’s statement that it does not plan to increase capital expenditures as a result of the Tracfone acquisition.
The deal is, of course, subject to regulatory approval, which is not entirely certain given Verizon’s incumbency as the wireless industry leader. However, if regulators segment the market into prepaid wireless versus overall wireless services, the transaction may have a smoother path to approval as Verizon lags in the prepaid segment. Verizon expects to complete the acquisition in 2H20.
We are maintaining our 2020 adjusted EPS estimate of $4.78. Our 2020 estimate is below the midpoint of management’s reaffirmed guidance range, which calls for adjusted EPS to be up 2% to down 2% this year, but $0.03 above consensus. Our estimates imply 1.6% EPS growth over the next two years, below our long-term forecast of 4%.
Telecom companies are highly susceptible to disruptive technological change. Verizon has been a technology leader and this leadership has continued with its 4G and now 5G rollout. Verizon’s businesses are also highly regulated and dependent on a benign regulatory environment. While AT&T has for years been the Pepsi to Verizon’s Coke, i.e., a close competitor in what is essentially a wireless telecom duopoly, a rejuvenated T-Mobile has been gaining ground, and, with the Sprint merger, may have finally gained the scale (and spectrum assets) to seriously challenge Verizon’s industry leadership.
We note that the wireless telecom sector, despite its sustained growth, is also highly competitive and at full penetration in the U.S.
Verizon is a leader in the U.S. telecommunications industry. The company was created in July 2000 when Bell Atlantic and GTE merged.
Verizon shares are flat year-to-date on a total-return basis, compared to a 9% gain for the S&P Telecommunication Services Industry Group Index and a 6.6%. Verizon’s lagging enterprise value/EBITDA ratio of 7.9 is just above the high end of the five-year average range of 7.0-7.8. The forward enterprise value/EBITDA multiple of 7.4.