Verizon Must Think Long Term on Wind Mobile

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According to recent reports, Verizon (NYSE: VZ) wants to acquire Canadian wireless telecommunications company, Wind Mobile. The company seeks to make an entry into the Canadian telecommunications industry by acquiring one of its struggling domestic players.AT&T (NYSE: T) and Britain’s Vodafone are also reported to be interested in venturing in the Canadian market. If Verizon seals the deal with Wind Mobile, this will be a return to the country following its initial spell as a majority shareholder of Telus Mobility, which ended in 2004.

 

The opportunity

 

The acquisition of Wind Mobile would result in some revenue for the U.S.’s second-largest telecommunications company. However, the significance of the benefits compared to the amount of capital, effort, and time devoted to the process may raise some questions.

 

Apparently, Canada will only allow a foreign company to acquire a domestic company if the domestic company accounts for less than 10% of the market share in the industry in which it operates. Wind Mobile’s market share in the Canadian mobile telecommunications industry is well below that threshold at just 2.23%, which paves way for bidders to place their offers.

 

Wind Mobile has only 601,719 subscribers, as compared to Verizon’s 100 million. The company’s average revenue per user stands well below that of the three heavyweights at just $27.60 per month as reported for 1Q13. Based on the 601,719 subscribers, that would translate to revenue of just $49.83 million for the most recent quarter. When compared to Verizon’s $20 billion plus, this is nothing more than a balancing figure.

 

According to analysts, Verizon would spend at least $2 billion for spectrum purchases, network upgrades, and consolidation costs. Assuming constant revenue throughout the next three quarters, Wind Mobile would report just under $200 million for the year. This means that, based on the current figures, it would take ages for Verizon to recoup its investment.

 

However, Verizon’s acquisition may also mean giving Wind Mobile some muscle to compete with the domestic elite. The company’s LTE network could be a key factor in boosting Wind Mobile’s monthly ARPU and subscriber base. This is the only window of opportunity for Verizon. Otherwise, there is no immediate gain. A Verizon spokesperson told Bloomberg that Wind Mobile is just one of the various options the company has for an investment.

 

“Wind Mobile is ‘one of many’ options under consideration, Bob Varettoni, a spokesman for Verizon, said in an e-mail. ‘We constantly evaluate a wide variety of business opportunities.’ “

This, therefore, means that in as much as the interest remains real, chances of placing a bid for Wind Mobile will depend on a cost-versus-benefit assessment of the available options. Meanwhile, Verizon remains strong fundamentally, with wide margins and double-digit earnings growth rates.

 

Competition

 

Verizon is one of three U.S. telecommunications companies, and is the leading mobile phone service provider with more than 100 million subscribers. It faces competition from AT&T, which is another company interested in entering the Canadian market. AT&T recently launched 4G LTE in Florence-Muscle Shoals and is the largest, in terms of market cap, in the telecommunications industry, while Sprint Nextel (NYSE: S) is the smallest. Therefore, Verizon is sandwiched in between, although not too far behind, AT&T.

 

Sprint Nextel has been in the news in the recent past regarding bids from Japanese carrier, SoftBank, and Dish Network. Sprint Nextel has also been in a bidding war with Dish Network, in the chase to acquire another U.S. carrier, Clearwire. Sprint was counting on the proceeds from its prospective buyer to boost its cash positions as well as avail funds to acquire Clearwire.

 

However, following Dish’s withdrawal from the bidding war to acquire Sprint Nextel, it now means that it is up to SoftBank to complete the acquisition. Following Dish Network’s decision, Kevin Smithen, an analyst from Macquarie, downgraded Sprint from “buy” to “neutral,” citing impending spending that could result in negative cash flows. So, Sprint has quite a number of problems at the moment, and, therefore, may not be a serious threat to Verizon for now.

 

Performance and valuation

 

Verizon’s most recent quarterly earnings grew by 15.8% year-over-year, which trumps AT&T’s 3.2%, while Sprint Nextel reported a loss. In terms of margins, Verizon is the most impressive with 61% gross margin, compared to AT&T’s 57% and Sprint Nextel’s 42%. Its operating margins are equally superior, standing at 13% for the trailing 12-months (TTM), compared to AT&T’s 10%, while Sprint Nextel lags behind with just 2%.

 

However, AT&T is more profitable with EPS of $1.29 TTM, compared to Verizon’s $0.40 EPS, while Sprint Nextel stands at a loss of $1.37 per share. Nonetheless, all the three companies are below the industry average of $1.75 EPS.

 

Assessing the P/E ratio indicates that Verizon is the most expensive, but when we factor in the estimated earnings growth rate for the next five years, Verizon is actually the cheapest among the three companies. Verizon’s P/E ratio stands at 128.02 times, while its PEG ratio TTM is pegged at 1.76 times. This compares to AT&T’s 27.73 and 2.30, respectively.

 

The bottom line

 

Verizon’s attempt to acquire Wind Mobile may seem like a lucrative opportunity, but apparently, there will not be any immediate benefits. However, if the company manages to penetrate some of its products and services into the Canadian market via Wind Mobile, then there could be a huge upside, especially considering the fact that only 27 million Canadians are subscribed to wireless communications services. As the market grows, Verizon could position itself well to capitalize on that. Otherwise, the company’s fundamentals look very strong, as the stock is not as expensive as it seems.

 

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