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Morningstar | Verizon's Network Focus Should Drive Strategic Gains; Raising FVE to $58

After reviewing our Verizon estimates, we’re increasing our fair value estimate to $58 from $52. We’ve also maintained our narrow economic moat rating and stable moat trend rating. We believe Verizon shares are roughly fairly valued at current prices, making them unattractive for new investment at current prices. Still, we expect Verizon’s continued network focus will enable it to outperform its rivals in the wireless industry.

Verizon’s recent strategic choices haven’t been flawless, but the firm has largely remained on the right track, in our view. With the vast majority of its efforts focused on network quality, we believe Verizon has protected its core competitive advantages while maintaining solid returns on capital, especially in the wireless business. In short, we like Verizon’s telecom focus, which should maximize its strengths in the areas it can control while limiting exposure to the rapid changes across the media landscape.

Verizon’s moat stems from cost advantages in its wireless business and the industry’s efficient scale characteristics. Verizon and AT&T dominate the U.S. wireless market, claiming 40% and 30%, respectively, of the postpaid phone market between them. Providing solid nationwide coverage requires heavy fixed investments in wireless spectrum and network infrastructure. While a larger customer base does require incremental investment in network capacity, a significant portion of costs are either fixed or more efficiently absorbed as network utilization reaches optimal levels in more locations. In addition, Verizon’s relatively straightforward corporate history and consistently strong financial position have enabled it to deploy its network in a highly coordinated manner over the past 15 years, making it more efficient on average than its rivals.

We believe the benefits of fixed-cost leverage and the difficulty of providing a differentiated wireless offering create an efficient scale advantage in the wireless industry. The massive consolidation across the industry over the past 15 years and the inability of several interested parties, including Dish Network and Comcast, to effectively enter the market provide evidence of efficient scale. The benefits of efficient scale could become even more apparent if T-Mobile and Sprint complete their merger.

Verizon’s fixed-line operations are challenged on a stand-alone basis, in our view. Verizon has deployed Fios, its fiber-optic cable network, to about three fourths of this territory, eliminating the gap in network capabilities versus cable companies like Comcast. Despite this network improvement, however, Verizon's ability to win customers hasn’t been impressive. About 40% of homes served by Fios take Verizon Internet access service, a figure that hasn’t moved much over the past five years and likely leaves the firm slightly trailing the cable companies in these markets. We suspect the high cost of deploying Fios has hampered the ability to use aggressive price promotions to attract new customers.

While Verizon has avoided large-scale acquisitions, it has still succumbed to the notion that telecom firms need a presence in the media business, a view we don’t share. The firm has used acquisitions to form Oath, an online content and advertising technology firm that hopes to challenge Google and Facebook for share in the digital advertising market. Verizon is reportedly already wrestling with Oath’s future direction, and long-time AOL/Oath CEO Tim Armstrong recently announced his departure. Apparently, Verizon is struggling to determine what information tied to its wireless customers it can share with Oath to better target advertising. This struggle, which we expect will continue as consumers and regulators sort out privacy issues, is the key reason we aren’t fond of Verizon’s foray into media. While we don’t begrudge firms taking calculated risks in search of growth, we aren’t fond of moves that potentially threaten core competitive advantages, in this case Verizon’s brand reputation.