Verizon Communications Inc. (VZ): Seeking Organic As Well As Inorganic Growth In Trying Times
That Verizon Communications Inc. (NYSE:VZ) is looking for new growth is not in doubt. What has been doubted by some is whether the company will be able to achieve that growth and how fast that could happen. To begin with, Verizon is not trying to put together a business plan to help it move to the next level like it may be happening elsewhere. The company has already mapped out its strengths and weaknesses and knows exactly what to do to get things moving in the right direction.
Verizon is trying a multipronged approach to unlock new growth, but there is more to its strategy than just new revenue avenues. The company is also working to diversify into areas of higher growth and where revenue is less cyclical. The question at this juncture is whether Verizon stands any chance of luck in its endeavors. The simple answer is “Yes”, but that requires elaboration.
What Verizon Communications Inc. (NYSE:VZ) is trying to do is growing organically and also through strategic acquisitions. In the recent move, the company announced a deal to buyout AOL, Inc. (NYSE:AOL) for $4.4 billion, meaning $50 for every share of AOL, which represents more than 17% premium for AOL shareholders. The fact that Verizon is willing to pay a premium for AOL alone speaks volumes, which is where the story begins.
AOL acquisition and its implication
The $4.4 billion buyout amount for AOL, Inc. (NYSE:AOL) is palatable for Verizon whose market cap is more than $202 billion. The company reported roughly $13.4 billion of free cash flow in 2014. If need be, Verizon also has the opportunity to supplement its cash on hand with debt, especially given the cheap borrowing environment, to fund AOL acquisition.
Closing the deal will enable Verizon to add a great technology at a relatively low price.
Buying a revenue-generating business:
In reaching out for AOL, Verizon will be adding an asset that already generates revenue and whose growth is generally in an upward trend. AOL operates in a number of segments that include the legacy subscription business and what is called Third Party Properties, which is an ad-placement service. Last year, AOL’s revenue rose 9% thanks to strong performance in the Third Party Properties segment. The revenue improvement trend continued in 1Q2015 whereby total revenue rose 7% to more than $625 million at a time when Third Party Properties revenue jumped 19% to $232 million.
Verizon will benefit from immediate boost to its top-line by simply bringing AOL under the fold even before it starts any major reorganization.
The whole story about Verizon Communications Inc. (NYSE:VZ) acquiring AOL has much to do with the AOL’s advertising technology than anything else. It is the ad technology that has been driving growth in AOL at a time when Internet business is fading.
The acquisition of AOL looks aimed at supporting Verizon’s video initiatives. Verizon is working on an over-the-top (OTT) mobile video service that currently doesn’t have a name but is expected to launch this summer.
As Verizon’s wirelines business continues to fade while wireless market matures, the company is turning focus to media and content, which is where services like mobile video and the whole OTT story come in.
With AOL’s technology, Verizon will be able to strengthen its mobile advertising platform and maximize revenue on that front. Verizon hopes that mobile advertising will at some point in the future become a meaningful source of revenue, possibly being able to offset declines in traditional voice and text business.
There is huge revenue opportunity in digital ad market with predictions that the global online video ad market alone will reach $19 billion by 2017, rising exponentially from $11 billion in 2014. Mobile is expected to drive the growth of digital advertising with AOL’s CEO, Tim Armstrong, stating that the coming years will see mobile accounting for 80% of media consumption. That explains why anyone looking for growth in online ad market needs a stronger mobile presence, and of course, the right ad technology. With its own rich mobile population and technology from AOL, Verizon is poised to get both.
Upselling AOL subscribers:
AOL reported having nearly 2.2 million subscribers on its dial-up Internet service. The company further stated that average revenue per user in its dial-up service is $20.83. Verizon Communications Inc. (NYSE:VZ) can transition the dial-up subscribers to its mobile broadband or FiOS and squeeze more revenue from them, boosting its overall top-line.
A wiser move
Verizon’s bid for AOL seems to be a more sensible move compared to what AT&T Inc. (NYSE:T) is trying to achieve through combination with satellite television provider DIRECTV (NASDAQ:DTV). The reason AT&T-DTV combination looks risky is that satellite TV, like cable, is in secular decline given the attack from streaming TV services.
Verizon’s native growth efforts
Beyond the expected technology and audience boost from the acquisition of AOL, Verizon Communications Inc. (NYSE:VZ) has been busy trying to drive new growth in-house.
Verizon recently came up with a repackaged TV service called Custom TV. The video service offers slimmed down television programming with an entry-level price of $55. The idea behind Custom TV is that Verizon wants to give its customers more freedom to choose what they want to watch and possibly pay less in the process. Custom TV provides Verizon with an opportunity to squeeze more revenue from pay-TV offering even as it knows very well that the future is in streaming video.
Verizon’s Custom TV has not been received well everywhere with content creators like Walt Disney Co (NYSE:DIS) questioning the move. But Verizon has promised to solder on, banking on public goodwill on the matter of more choice for television viewers.
Verizon is shifting its focus away from wireless service revenue to more wireless equipment revenue. Under its so-called Edge plan, the company will be able to record equipment (handset) revenue upfront, have lower SG&A expenses and enjoy higher profit margins. Edge will have a drag on wireless service revenue and perhaps overall revenue for some time, but in the long-term Verizon will be able to significantly boost its EBITDA through the strategy shift.
Edge adoption is tracking nicely and is expected to reach 50% this year.
Risk areas for Verizon
Slowdown in wireless growth:
Wireless market is saturated and growth has slowed down. Competition has also heightened as players resort to new strategies like stealing subscribers from rivals to fuel their growth. Aggressive pricing war is being waged, especially by smaller carriers like Sprint Corp (NYSE:S) and T-Mobile US Inc (NYSE:TMUS), and the strategy is not healthy for the bottom-line story.
Beyond teleco competition, Verizon Communications Inc. (NYSE:VZ)’s push into OTT sees it join a crowding race to lure cord cutters. The company will have to battle it out with the likes of DISH Network Corp (NASDAQ:DISH) that has Sling TV, Sony Corp (ADR) (NYSE:SNE), which has Vue TV, and Apple Inc. (NASDAQ:AAPL), which is said to be working on a streaming video service, which could launch alongside its anticipated Apple TV streaming hardware.
The other challenge is the cost of content, especially so as content creators are seen launching their own streaming services like HBO coming up with HBO Now. Verizon’s move to unbundle sports in its Custom TV offerings may also strain the company’s relationship with content providers even for its upcoming mobile video service.
Many things can be said about Verizon Communications Inc. (NYSE:VZ)’s move to acquire AOL, including that the company is desperate given that the likes of Yahoo! Inc. (NASDAQ:YHOO) were resistant to buying the asset despite recommendations by some shareholders. However, you don’t really see desperation in Verizon because the company is actually tapping powerful ad technology at a discount. Additionally, for any company in the position of Verizon that plays in a market that has matured, failure to seek new growth can’t be far from mismanagement, which is why acquisition of AOL makes plenty of sense. Whether Verizon will be able to extract value from AOL remains to be seen, but the acquisition came at a cost Verizon can easily afford.
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