Introduction

AT&T (T) and Verizon (VZ) are the two largest wireless communications providers in the United States. Together, they hold approximately 70% of the wireless market in the United States. However, they are facing fierce competition from T Mobile (TMUS) and Sprint (S) in the past year. In this post, we will compare both companies and offer our view on which company has better opportunities.

Past Stock Performance

Let us first take a look at AT&T and Verizon’s past performance. I have included in the chart below the share prices of AT&T and Verizon. As can be seen from the chart, an investment in AT&T five years ago would result in a return of 2.35% while an investment on Verizon would result in a loss of -0.39%. Compare to S&P500’s gain of 76.3%, both AT&T and Verizon have done poorly. This reflected the competitive environment that both companies are in. However, we must realize that both telecom giants pay attractive dividends every year. If we calculate its total return (including dividends), AT&T’s total return in the past 5 years was a solid 32.41% whereas Verizon’s total return was 24.87%. The Winner: AT&T.

Source: YCharts

Wireless Metrics

We will take a look at some metrics that evaluates both companies’ wireless segment. For simplicity, we only compare both companies’ postpaid wireless results. Below is the graph that shows AT&T and Verizon’s postpaid ARPU/ARPA. Please note that both companies uses a slightly different metric. AT&T reports in average revenue per user (“ARPU”) while Verizon reports in average revenue per account (“ARPA”). As can be seen from the chart, both companies’ average revenues declined significantly from two years ago. This is due to fierce competition from T Mobile and Sprint.

Source: Created by author, company reports

As we can see from the chart below, Verizon seems to be able to retain its customers better in this wireless battle. Except a net decline in Q1 2017, the company has consistently added more postpaid subscribers. On the other hand, AT&T lost quite a bit of subscribers in the past two years. To be fair, part of this loss was due to management’s decision to focus more on prepaid subscribers.

Source: Created by author, company reports

Let us now take a look at the company’s postpaid churn rate. As can be seen from the chart below, Verizon’s churn rate consistently beat AT&T’s churn rate except for one quarter in the past two years.

Source: Created by author, company reports

Based on these three metrics, Verizon appears to fare much better than AT&T. The Winner: Verizon.

EBITDA Margin

As we can see from the chart below, AT&T led Verizon in EBITDA margin before 2010. However, Verizon is clearly the winner after 2013. In fact, it has an industry leading EBITDA margin in its wireless segment (low-to-mid 40% range in 2017). It is worth noting that T-Mobile and Sprint’s EBITDA margin in its wireless segment is in the range of 20~30%, much lower than Verizon and AT&T. The Winner: Verizon.

Source: Created by author, company reports

Balance Sheet

In order for communications service providers to maintain its competitive position, they have to invest heavily to upgrade and maintain its network and acquire necessary spectrums. Hence, it is important for us to look at both companies’ balance sheet to make sure that they will be able to secure money for their future projects. As the chart below shows, AT&T typically spends about $20 to $22 billions per in capital expenditure while Verizon typically spends about $17 to $18 billions per year. As the industry moves towards 5G wireless systems, both AT&T and Verizon’s capital expenditure is expected to continue to increase from their current levels.

Source: Created by author, company reports

The table below shows selective metrics that will help us evaluate both AT&T and Verizon’s balance sheet strength. As can be seen, AT&T has higher long-term debt than Verizon. This is not surprising given AT&T’s scale. AT&T’s debt to capitalization ratio of 53.6% is much better than Verizon’s 72.4%. Verizon’s purchase of Vodafone’s Verizon Wireless stake in 2014 was one of the main reasons why it has a much higher debt to capitalization ratio. Let us now look at both companies’ net debt to EBITDA ratio. I like to use the general rule of thumb suggested by Pat Dorsey of Morningstar. That is, a ratio much higher than 3 should be approached with caution. Fortunately, both Verizon and AT&T’s net debt to EBITDA ratio are below 3.0x. AT&T’s net debt to EBITDA ratio of 2.2x is better than Verizon’s 2.6x. The Winner: AT&T.

Source: Company reports (as of Dec. 31, 2017)

Dividend Growth and Sustainability

AT&T and Verizon currently pay a quarterly dividend of $0.50 and $0.59 per share respectively. Their dividends are equivalent to dividend yields of 5.32% and 4.86% respectively as of March 16, 2018. As can be seen from the chart below, both companies have consistently raised its dividends in an annual basis.

Source: Created by author, company reports

Although both companies are committed to increase their dividend every year, their dividend growth rates are very modest. As we can see from the chart below, both companies’ annual dividend growth rates were below 4% since 2010.

Source: Created by author, company reports

Let us now look at the company’s dividend sustainability. We evaluate the payout ratio using both companies’ free cash flow instead of EPS as free cash flow better reflect the company’s cash flow position in one single year. As can be seen from the chart below. Verizon’s dividend payout ratio was way above 100% in the past two years while AT&T’s payout ratio remained below 100% in the past decade. To be fair, Verizon’s high payout ratio in 2017 was largely impacted by higher deferred taxes. As the industry moves towards 5G, we expect both companies to invest heavily in capital expenditure. Therefore, we need to continue to monitor both companies’ payout ratio and cash position. The Winner: AT&T.

Source: Created by author, company reports

Future Prospect

Wireless market in the United States appears to be reaching saturation. The eventual adoption of 5G wireless systems will help both companies grow its revenue. However, it is still at least a few quarters to 1~2 years from now before we see any meaningful contribution to both companies’ revenues. In the mean time, both companies are seeking alternative paths to grow their revenues and improve their EBITDA margins.

Verizon has a three-tier strategy: continue to lead the industry with the best wireless network in order to defend its postpaid subscriber base, develop new platforms in digital video (e.g. Yahoo and AOL contents) and the IoT, and focus on development of applications and content that are supported by the first two tiers. On the other hand, AT&T is aiming to vertically integrate its content delivery service (wireless data) with content creation services. AT&T hopes to defend against competition through multiple services, as its wireless revenue is prone to price war. Therefore accessing to contents such as through the Time Warner acquisition will help the company strengthen its competitive edge. In addition, the company is also expanding its business into Mexico and South Africa. This will enable the company to diversify its business.

I like AT&T’s strategy better as the company clearly is aiming at improving its margin and building a moat that its customers will rely on. However, the fate of Time Warner acquisition remains to be seen as the company fights in court to save the acquisition. Verizon also wanted to focus on content, but its acquisition of AOL and Yahoo is a much smaller scale to AT&T’s acquisition of Time Warner. Since there is still uncertainty on AT&T’s Time Warner acquisition, there is no clear winner on this category. Winner: Tied.

Investor Takeaway

AT&T and Verizon operate in a competitive telecommunication industry in the United States. In our analysis, we noted that Verizon has better EBITDA margin than AT&T thanks to its strength in its wireless segment. However, AT&T has a much better balance sheet and a more sustainable dividend. Although it is still unclear about AT&T’s Time Warner acquisition, AT&T has growth opportunities south of the border.