Diving into 5G: The Future of Network Connectivity

5G is a game-changing proposition for the communication services industry. People are demanding faster and faster network speeds, and 5G offers a combination of that speed, as well as “capacity, reliability, and ultra-low latency required for mission critical services and the growth of massive IoT.” 5G surrounds the idea of connecting devices and creating smart cities with applications to healthcare, retail, and utilities among others

Verizon (NYSE:VZ) was the “first” service provider in the US to truly tap the 5G market. 5G is currently a $21.5B market, and is expected to reach $85B by the end of 2023, increasing at a CAGR of 31.9%. Verizon has strong growth prospects if they can realize this growth, and are currently undervalued according to my calculations.

The ability to get into 5G is currently hindered by a lack of devices and lack of infrastructure able to support it. Even though Apple (NASDAQ:AAPL) has patched things up with Qualcomm (NASDAQ:QCOM), they aren’t expected to offer a 5G iPhone until halfway through 2020. Samsung (OTC:SSNLF), Huawei, and LG (OTC:LGEAF) are all set to release their 5G devices, which will help Verizon continue to expand out their 5G network. However, due to the time lag, 5G benefits won’t be realized until 2021.

However, the world infrastructure, despite people’s demands, really isn’t ready for 5G. The faster data speeds, quicker response times, and increased connectivity are all benefits, but applying the technology across different industries will require time and effort. Building out the number of cell sites, as well as the cost investment in the spectrum are both hindrances to streamlined development of 5G.

Crown Castle International (NYSE:CCI) is on the front lines of infrastructure development, and has promising growth prospects as the wireless carriers, like Verizon, look for fiber-fed small cell sites to fuel the 5G evolution. The company has strong revenue growth, and stands to benefit greatly from building out new communication sites.

Source: Business Wire

The Nuances Of The Technology: What Is 5G?

However, the Utilities Technology Council is warning that rolling out the 5G network without ensuring that the underlying electronic grid can handle the technology will be harmful. Right now, there isn’t a 5G government policy. And there are a host of issues with the technology, including the aforementioned lack of infrastructure of spectrum provision for both utilities and communications, and health concerns due to the increased frequency of the microwave bands.

Source: Financial Times

There are also issues of backhaul, or connecting cell towers to a core network, which will make the 5G cells more expensive due to the sheer number of them. Finding space for the sites is problematic, and the cost of maintaining power sources to provide electricity is high. Obtaining local permits to actually build the base stations is expensive both in terms of dollar cost and time cost. Considering that local and muni governments have zoning authority over both cell towers and base stations, the carriers might have a hard time getting the necessary infrastructure built out for 5G.

Source: UTC

There is also an inherent trade-off in 5G. You cannot have both high capacity and high coverage. 5G operates throughout the entire radio spectrum, and requires access to all of the available bands. 700MHz is required for the more rural areas, as it can travel well over terrain and other obstructions. 3.4-3.8 GHz is mid-range, can carry a higher amount of traffic and serve smartphones and smartwatches. High-band, 24.25-27.5 GHz require several small cells in a localized area to work, as they are easily blocked by obstructions and do not travel far.

Source: UTC

Verizon relies exclusively on high-band mmWave technology. That puts them at a key disadvantage compared to T-Mobile (NASDAQ:TMUS), which uses all spectrum bands. However, T-Mobile, is relying on Sprint (NYSE:S) to access the mid-band spectrum, and the likelihood of that merger getting approved is low.

Also, T-Mobile delayed their launch until at least Q3 2019 because the phones that are currently available can only use mmWave technology and can’t fully support all of the airwaves that T-Mobile is using. Sprint is planning to launch their 5G service this year, under Google Fi (NASDAQ:GOOG) (NASDAQ:GOOGL). But Sprint does not own licenses to wireless airwaves, so they can’t market millimeter wave coverage. Instead, they are operating on the mid-band spectrum, which is faster than 4G LTE, but really isn’t much to get excited about. AT&T (NYSE:T) has only provided 5G to businesses, compared to Verizon’s regular consumer reach.

So basically, everyone has something, but no one has everything. Verizon was able to roll-out in Minneapolis and Chicago, but they don’t have the coverage necessary to produce at scale. T-Mobile doesn’t have devices to support their plan, or merger approval to move forward. Sprint needs T-Mobile to get the spectrum they need to deploy faster and offer more coverage. AT&T is moving along at a decent clip, but they have headwinds as well.

AT&T vs Verizon: One Has 5G, The Other Pretends it Does

AT&T got in trouble for rebranding their 4G LTE network as 5G Evolution. Sprint sued AT&T for misleading consumers, because 5GE is not 5G despite what 54% of consumers thought. OpenSignal compared users who had 5GE versus those who didn’t and found that:

“AT&T users with 5G E-capable smartphones receive a better experience than AT&T users with less capable smartphone models but AT&T users with a 5G E-capable smartphone receive similar speeds to users on other carriers with the same smartphone models that AT&T calls 5G E.”

Source: OpenSignal

Basically, AT&T was overstating the truth, lableing their advanced 4G LTE network as 5G. They have 19 cities with 5G service, but no phones that can use it yet. If you create a pen, but you don’t have any ink for it, did you create a pen at all?

Verizon is currently the only carrier to have a 5G network. They recently released limited 5G service to Chicago and Minneapolis, offering the service through the moto z3 phone with a 5G mod add-on for $10 a month. Those services are expected to average 450 Mbps per second, peaking at 1 gigabit per second. The average is 15x the current speed of ~30 Mbps, and if they can achieve 1 Gbps, that would be 33x faster. Verizon plans expand to plan to 28 more cities by the end of 2019.

Source: Open Signal

But 5G still has a long way to go. Without getting into the nuances of the technology, the below graphic details the issues that current 5G hotspots have. They can’t scale. The 5G network relies on mmWaves, whereas 4G LTE uses MHz. As T-Mobile’s CTO Neville Ray writes

“Millimeter wave (mmWave) spectrum has great potential in terms of speed and capacity, but it doesn’t travel far from the cell site and doesn’t penetrate materials at all. It will never materially scale beyond small pockets of 5G hotspots in dense urban environments.”

Source: T-Mobile

Source: ARS Technica

5G networks require millimeter waves to reach their highest speeds, but millimeter waves don’t travel far, and they are blocked by walls and other opaque objects, as shown in the above graphic.

The wireless carriers are investing a collective $275B into building out the networks, with Accenture (NYSE:ACN) estimating that there will be 3M jobs created from the endeavor. When it came to fruition, 4G contributed $100B to the economy, primarily because the US was a market leader in the roll-out. In 2017, 4G carried 72% of total mile traffic, which is expected to decline to 71% by 2022. 5G is expected to carry 12% of mobile traffic by that same year.

Source: Cisco

Winning The 5G Race: China

China has a 5G network that is growing quickly, primarily because they treat 5G as a government initiative. The Asia-Pacific area currently dominates 5G adoption, primarily due to Huawei, the world’s largest maker of telecommunications equipment. China was preparing for 5G as early as 2013, and they already have 2 million cell sites, with 5.3 sites for every 10 square miles. The US has about 200,000 sites, and 0.4 sites per square mile.

Source: Statista

The US has been back and forth with Huawei over the past several months, arresting their Chief Financial Officer, and potentially banning US suppliers from working with the company, stating “It is the United States’ position that putting Huawei or any other untrustworthy vendor in any part of the 5G telecommunications network is a risk.” The UK is planning to deploy Huawei equipment into their 5G network, despite warnings from the US.

But China doesn’t need the US on this move forward. They already have trials underway for integrated 5G, layered on a 4G network, and are investing billions to develop a stand-alone network, putting them light years ahead of any other country. They are expected to account for 40% of global 5G connections by 2025.

Source: Financial Times

Huawei comes with its own security concerns that are beyond the scope of this article, but the most important point is that despite Verzion and AT&T’s best efforts, they are still far behind China. Huawei signed 40 commerical contracts for 5G with global carriers, and has more than 700,000 5G stations around the world.

China also outspent the US by $24B on wireless communication infrastructure since 2015, with another $400B planned for the next five years. Deloitte writes that being first to this market could give China “more than a decade of competitive advantage”.

Source: GSMA Intelligence

China Tower is leading in building out the network, owning 96% of the macro towers and cell sites, and has invested almost $18B in capital since 2015. It’s not so much the existing infrastructure, but the speed at which China is moving at this point. They added 460 new sites per day in 2017, adding more sites over a three month time span than the US did over three years.

Source: Deloitte

How The US Government Is Responding to 5G

Newt Gingrich, Brad Parscale, among others, are creating “a plan for the government to share 5G airwaves, via a third-party operator, with wireless companies on a wholesale basis”, according to Fortune. Rivada Networks would potentially be a part of that operation. They claim that this plan would provide services to rural areas, and create more affordable options for those outside of the biggest cities

Trump tweeted about his views on 5G, stating that American companies, presumably service providers, must step up their efforts if they want to be successful. It’s evolved into a multibillion-dollar debate, with Gingrich most recently saying “we are losing to Huawei” and called out the White House for lack of leadership on the subject.

Source: Twitter

The issue that the US has with 5G is that we currently have more high-frequency airwaves, rather than lower-frequency, which carries signals farther. It’s a tradeoff between speed and coverage, and the US has been primarily focused on speed. The FCC has a 5G FAST Plan, which involves auctioning off different bands of frequency.

They auctioned off 28 GHz earlier this year, and plan to auction off 37 GHz, 39 Ghz, and 47 GHz. Right now, the US focuses more on high band, but has plans to roll out mid-band and low-band deployment as well. But that will take time, especially because the FCC still needs to review and approve small cell infrastructure.

Source: ZDnet

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Trump came out in late April and stated that the US approach to 5G would be “private sector-driven and private sector-led.” That might change in the coming months, but the stakes right now are enormous in this game. The administration will need to seriously consider improving infrastructure and policy to make a private 5G roll-out possible for the wireless carriers. As Josh Rogin stated, it’s akin to “building a Betamax system in a VHS world” or essentially buying a horse-and-buggy in the advent of the automobile.

How To Profit: Network Carriers Or Cell Tower REITs

That was a lot of information about 5G, and a lot of it addressed how the technology works, and the obstacles that are currently in place to mass adoption. Verizon was a market leader in the 5G rollout, and they also demonstrated the best overall performance as a cellphone provider for the first half of 2018, according to Root Metrics. The company won across the board, posting the top performance in network reliability, network speed, data performance, call performance, and tied with AT&T for text performance.

Source: RootMetrics

Verizon also outperformed under a PCMag Speedtest app, under both the new Samsung Phones and the iPhone X. Across the board, download speeds have increased by 10Mbps, peaking between 200Mbps and 300Mbps across the country. Verizon outperformed AT&T, Sprint, and T-Mobile by 9.2Mbps on average. ATT&T and T-Mobile both beat out Verizon by 1% in terms of reliability, but across the board, Verizon has the best download speed and upload speed, and the lowest ping count.

Source: Phone Arena

Verizon Financials: Wireless vs. Wireline

Verizon operates in two main business segments, Wireless and Wireline. Wireless encompasses voice and data services, Internet access, and services for tablets, smartphones, wearables, etc. Wireline is the more traditional circuit network, offering calling services, networking solutions through IP, Ethernet, and WAN, and Internet and TV through FIOS services.

Wireless represents 70% of VZ’s total revenues, and has grown 4.8% Y/Y from 2017 into 2018. Wireline has experienced consistent declines in growth, declining 3% into 2018.

Source: Capital IQ

An issue that the company might run into is their property distribution. They have significant investments in wireline equipment, more than half of their total property holdings. The company is planning to transition their copper-based product line into a fiber-based network system called Intelligent Edge Network, that should support both the wireless and wireline segments.

Source: Verizon 10K

The company benefited greatly from the 2017 tax break, posting a (48.3)% tax rate, totaling a tax benefit of $16.8B. That benefit disappeared in 2018, and Verizon operated under an 18.3% tax rate. That’s why there was such a massive decline in net income. Their Y/Y operating revenue increased by 3.8% despite being hit by their $4.6B Oath impairment.

Source: Verizon 10K

Despite the decline in net income, they were still able to increase their operating cash flow by 41.2%. Oath is being rebranded as Verizon Media Group, and Verizon is refocusing on their network services. Taking on Yahoo and AOL resulted in less of a value-add than the company expected, and returning to their core competencies is a good strategy moving forward. They have demonstrated growth and outperformance in their network segment, winning several awards in the process.

They have a strong balance sheet, especially compared to their competitors, leading the way in operational, solvency, and liquidity ratios. That should provide strength to the company as they continue to commit resources to building out their 5G network.

Key Acquisitions: Trying to Add Value with AOL and Yahoo

Verizon acquired AOL for $4.4B back in 2015, and Yahoo! Inc for $4.5B in 2017. Through their Verizon Media division (previously Oath), which holds Yahoo Sports, they have have a $2B partnership with the NFL and a deal with the NBA to provide video streaming of sports content, as well as the La Liga and Liga MX soccer games. The company hopes to capture the next generation of sports watchers, with “the ambition to own sports in the mind of the consumer” according to Brian Angiolet, VZ’s chief media and content officer.

Source: Variety

The company wrote a $4.5B loss on Oath, and reduced their workforce by 10,000 people. Oath was reduced to $200M in value, which is a massive reduction from it’s previous $4.8B assessment. Oath previously held 4.2% of the digital advertising market, but that number is expected to shrink to 3.3% this year, dominated by Facebook, Amazon, and Google.

Source: Market Realist

Oath is being rebranded as Verizon Media Group, and Verizon is refocusing on their network services. Taking on Yahoo and AOL resulted in less of a value-add than the company expected, and returning to their core competencies is a good strategy moving forward. They have demonstrated growth and outperformance in their network segment, winning several awards in the process.

Based on my DCF calculations, Verizon is currently undervalued, and has a potential upside of 75% at a growth rate of 4.5%. This is with a modest growth rate of 4.5%, calculated from projecting return on invested capital and their retention ratio. The stock has room to the upside, and breaking into the 5G market is a value-add for that.

Source: Author

If you want to target specifically 5G, without getting exposure to a wireless carrier, a cell tower REIT might be a good option. Verizon needs to lease space from tower companies in order to build out their small cells. Crown Castle International Corp focuses specifically on small cells, with over $23B in contracted lease payments, with the Big 4 wireless carriers representing 73% of their site rental revenues. The company specializes in fiber-fed small cells, which will be a huge asset as the carriers continue to build out their networks.