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Wednesday, July 26, 2006

Verizon's Losing Hand

Stocks: (VZ)(T)(VOD)

Verizon is staking much of its future on the prospect that fiber-to-the-home will be a good bet. It won't be.

Verizon has a number of legs on its table. Cellular is going well. The Verizon Wireless business, that the company owns with Vodafone, is doing fine. In the last quarter, it added 1.5 million customers. With 52.6 million retail customers, it claims to be No.1 in that business.

Verizon still has a very strong wireline business for local and long distance, but it is shrinking. VoIP, cell users, and cable company phone offers are cutting into the company's cash cow.

Verizon's numbers have been going up at a slow but steady pace. In the period ending March 30, revenue was $22.743 billion, up 25% from the same quarter a year before. But, operating income dropped 7% to $1.632 billion.

According to Morningstar, Verizon has a hefty$34.6 billion in long-term debt. Capital expenditures in the last twelve months have totalled over $15.7 billion.

The Cap Ex is the crux of the matter. A faster network from fiber optic installations can increase broadband speed by 20x or greater, and allow services line online television. But, who wants it?

Broadband penetration of US internet households in now at 72% according to Nielsen. But, in an interview with Investor's Business Daily, and analyst for Nielsen said that this growth was "flattening off".

For the Verizon investment in ultra-fast broadband to work, investor have to make make several assumptions. One is that people will pay more for faster internet to allow Verizon to get a return on its Cap Ex. Another is that people will want to switch from cable to Verizon's product for faster speeds of broader programming offer. The last is that people care about faster speeds. In other words, consumers know how fast their broadband is and want something with much more bandwidth. It is not self-evident that any of these views of the future is a sure thing.

Verizon's stock is at $33. In late 2004, it was at over $40. It has very significantly underperformed the Dow and S&P of the last two years. According to Yahoo!Finance, Verizon has a price to sales multiple of 1.2. Smaller rival Qwest, which does not have Verizon's balance sheet or revenue, trades at 1.1. The premium should be much larger for Verizon.

Wireless and a shrinking fixed-line business is not going to pull Verizon's stock out of the mud if the early returns from its fast internet products are not steller. And, the odds are long there.

Douglas A. McIntyre can be reached at He does not own securities in companies that he writes about.

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