On December 8, one of our holdings in the Crabtree Technology portfolio, Verizon (VZ), provided a mid-quarter update on its business. The company noted some distinctly positive developments, like continued growth in its post-paid wireless business.
However, it also indicated that aggressive promotions from Sprint (S) and T-Mobile (TMUS) were causing operating profit margins to be lower than expected. Moreover, the company’s “churn” rate has risen recently as it gains and loses customers more frequently.
Dollar share
Verizon’s stock declined about 4% on this news, which is understandable.
Sprint and T-Mobile are desperate to maintain relevance and while neither is profitable, both are growing more quickly than AT&T (T) and Verizon and taking incremental market share from the two larger competitors.
We estimate that the U.S. telecommunications services market is about $400 billion annually; Verizon and AT&T each have about 30% market share, based on their current revenue run-rates. Sprint and T-Mobile have about 9% and 7% respectively.
At our firm, we really like companies that grow market share, or perhaps merely hold on to share in an industry that is growing quickly. Which begs the question: why are we holding on to our Verizon position when they are probably losing market share?
The answer lies in the difference between market share and what I call, “dollar” share. Market share is easily defined: the proportion of revenue from a distinct industry or sector that belongs to an individual company.
Steady performance
Google (GOOG), for example, has about 65% market share in the on-line search business; the balance is held by Microsoft (MSFT), Yahoo (YHOO) and some much smaller firms.
Yet Google’s market share has remained roughly steady for several years.
The 20-25% revenue growth rate they’ve sustained over that same time frame has occurred because online advertising in general (and search in particular) is itself taking dollar share from other areas of advertising, like television, radio and newspapers.
And while that helps boost Google’s top-line, the search engine giant is losing some dollar share to Facebook (FB) and other social media sites, the content of which Google generally can’t index and therefore can’t search. It’s never easy.
Back to Verizon. Verizon’s growth top-line growth rate (and that of its wireless business – both about 5% year-over-year in its most recent quarter) roughly matches U.S. and worldwide telecom service growth.
And as noted earlier, they’re on track to lose 1-2% points of telecom services market share this year in the U.S.
Video revenue
But telecom services growth itself is being driven by immense amounts of data – particularly video – that is migrating away from traditional media channels. And that video stream contains advertising.
This year, $50 billion will be spent in the U.S. on all forms of online advertising. Of this, 6%, or $3 billion will be video ads (e.g., those pre-ads you get before watching a YouTube video).
In short, the second screen in your hand or your lap is becoming the primary screen for many people.
Back when Verizon and its predecessors were phone companies, all they carried was voices. And they weren’t paid by the syllable.
Now they carry bits. And while Net Neutrality rules limits their ability to charge by the bit, Verizon’s average revenue per customer account is rising as they and their telecom competitors capture dollar share.
Real deal
It would be great if Verizon were gaining market share, but for that to happen, Sprint and T-Mobile will need to stop their price war. How might that come about? Both of the smaller players are losing money.
Thus, it might eventually occur to regulators that it would be better for the two of them to merge into a third, well capitalized competitor (something Sprint tried to bring about earlier this year).
This would surely be preferable than to have both wither and potentially fade, losing money and market share and leaving the U.S. with Verizon-AT&T duopoly.
Or T-Mobile or Sprint’s foreign overlords, Deutsche Telekom (DTEGY) and Softbank (SFTBY) respectively, might discreetly nudge their subsidiaries to revert to a rational pricing model and operate profitably in an unspoken but convenient collusion.
For now, we’re content to hold on to our stake in Verizon. We get direct exposure to the mega-trend of wireless communications.
Cash flow
Prodigious operating cash flow is meeting debt service and providing a 4.7% yield, although dividends reflect past performance and there is no guarantee they will continue to be paid.
And the larger company serves as a nice counterweight to the more volatile names in the Crabtree Technology portfolio.
Hey, if the wait drags on, we can always entertain ourselves with some online cat videos, delivered via our smart phones.
Photo credit: Mike Mozart via Flickr Creative Commons
DISCLAIMER: The investments discussed are held in client accounts as of November 30, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
