Verizon Is One of the Major Telecommunications Research Paper

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Verizon is one of the major telecommunications in the United States. It operates both wireless and wireline services, which have an approximately 63.3% - 36.7% split of the revenues. In FY2011 the company recorded revenues of $110.8 billion dollars, from which it earned $2.4 billion in profit. The wireless industry, which is the key driver of growth in the United States, has oligopolistic conditions, with four companies holding nearly 95% of the market. Verizon has 108.7 million wireless subscribers, making it the market leader in wireless. Second-place AT&T had 100.7 million subscribers, with Sprint and T-Mobile trailing (Jordan, 2011). This report will outline the performance of Verizon over the past five years using both financial and strategic analysis. There will also be recommendations for Verizon to be more successful in the future.

Benchmark

An important aspect when evaluating a company's performance is to understand the industry conditions and attempt to gauge what the company's potential was. For basic financials, Verizon still lags AT&T in terms of revenue, net profit and most importantly in terms of net margin. Verizon's net margin was 2.2% in 2011 while AT&T's was 3.1%. Verizon should at least perform to the standard of AT&T as the companies have a similar history, similar business, similar size and scope as well. The tight margins for both of these firms and the relatively slow growth that they both have seen indicate that there are constraints on profitability in the industry, and that while there are growth opportunities, the U.S. market is becoming saturated and declines in wireline business are offsetting gains in wireless to some extent.

Financial Analysis

The first technique that can be used to analyze Verizon's finances is the trend analysis. The past five years saw the onset of recession in 2008, followed by the introduction of the iPhone in 2007. The iPhone essentially revolutionized the smartphone industry by bringing smartphones to everyday consumers in a way that earlier products like the Blackberry and the Palm were unable to do. A rush of new competitors entered the market, smartphone ownership became standard for consumers and usage patterns changed significantly. Demand for wireline service declined significantly. Revenue and profit figures for the past five years likely reflect the company's ability to compete in the wireless market.

In FY2007, Verizon recorded revenue of $93.4 billion and profit of $5.5 billion. Since then, the company's revenues have grown a total of 18.6%. There was a decline in revenue in 2010, but a rebound in 2011. Verizon recorded a loss in FY2008 due to $15.8 billion in writedowns -- its gross profit was up for the year. Overall, though, Verizon's profitability has declined since FY2007. That year, the net margin was 5.9% compared with 2.2% last year. The cost of revenue has increased 22.1% in the past five years, which is faster than the rate of growth in revenue. The company has been forced to slow the rate of growth in other expenses to maintain profitability.

It is worth noting that cash from operating activities has grown at a slower rate than revenues, only 10.9% in five years. Operating cash flow declined in FY2011 after four years of growth. The company has maintained a steady rate of capital expenditure over the past five years, but this rate (around $16-17 billion) is high relative to operating cash flows. The constant cycle of new infrastructure development has a significant effect on profitability in the industry.

A trend analysis of the company's balance sheet shows improved liquidity. Verizon's current assets have increased 65% in the past five years while current liabilities have increased 24%. Most of the increase in current assets is with cash, which is positive for the company. An increase in receivables or inventory could have indicated slowing business conditions. One negative on the liabilities side is that Verizon has seen its long-term debt increase 78% in the past five years. In the same time period, equity has decreased by 29%. This shift in the firm's capital structure indicates a greater reliance on debt. The decision to take on more debt could have been strategic, however, as interest rates on debt have been very low for the past four years, and Verizon could simply be seeking to lower its cost of capital. However, given that one of the primary functions of management is to increase shareholder wealth, this decline in the book value of equity is alarming. Retained earnings were $17.8 billion in 2007 and were just $1.1 billion at the end of FY2011.

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This decline indicates that the change in capital structure might not be deliberate so much as necessity, especially given the need for constant investment in infrastructure upgrade and development.

Strategic Analysis

Verizon has become of the major players in wireless in the United States. Today wireless is more than 2/3 of the company's business and almost all of its growth. Because competition in the industry is intense, Verizon utilizes a number of different strategies. It must compete to some extent on price, but for the most part adopts a differentiated strategy. It is difficult to compete on price because of the high costs associated with infrastructure. Thus, Verizon spends billions on advertising in order to differentiate itself from the competition. There are a number of ways that the company does this. It focuses on offering better service than its competitors (not a very high bar to leap over), on building superior brand recognition, improving its distribution networks and also with its product/service offerings. A key driver of success in wireless is to have the most popular devices available on your network. Verizon was an early loser with the iPhone, but later acquired access to that product. Samsung is another major manufacturer of smartphones (now the market leader) and it has made a point to have its products available on all major networks, so Verizon does not gain competitive advantage there.

Verizon's profitability has declined in recent years despite its revenue growth. Part of this lies with the fact that cost of revenue has increased at a faster rate than the revenue did. In addition, the company has needed to continue high levels of infrastructure investment, and high levels of marketing expense, in order to remain competitive. Its size gives it a competitive advantage in both infrastructure and marketing spending over all competitors save AT&T, and Verizon has attempted to leverage this advantage in recent years. The company's revenue increases have been significant since mid-2011 when it gained access to the iPhone following AT&T's four-year exclusivity period. Trailing 12-month revenues are $114.2 billion, higher than the FY2011 figure, and the Q4 revenue figure for 2012 is expected to be higher than it was for Q4 2011. This indicates that Verizon is continuing to grow its business. It is expected to gain more market share for the iPhone 5 in the latter half of 2012. Perhaps even more encouraging is the improved profit outlook, with Verizon recording $5.1 billion in net income in the first three quarters of 2012. The caveat is that Q4 advertising expense is usually significantly higher than in other quarters. Last year the company lost money in Q4, and if that happens again this year the profit figures could be more in line with last year, despite being significantly improved in 2012 over the first three quarters. There have also been improvements in the balance sheet as well. Verizon's debt has declined $3.7 billion since the end of FY2011 and the retained earnings have increased by $800 million.

Recommendations

Verizon needs to play the long game. At present, it is expected that wireless will continue to be the dominant platform in the industry for years to come. Additionally, the Department of Justice is unlikely to tolerate further consolidation in the industry. As a result, the terms of competition in the wireless industry are not likely to change for the foreseeable future. Verizon therefore should seek to maximize market share. The reason for this is simple. This is a low margin industry with high capital requirements. The only way to pay for the necessary infrastructure is to spread the cost over as many customers as possible. Firms that have larger customer bases will be able to offer better service at a lower price than firms with smaller customer bases. Thus, once a firm in this industry hits a certain size advantage over its competitors, that advantage begins a positive feedback loop. The company will be cheaper and better, and that will allow it to attract more customers. Eventually, the winning company will have the best technology in the industry and still be price competitive.

At present, AT&T and Verizon are the two companies in wireless who are best-positioned to compete on this basis. It is expected that both companies will seek to exploit their size advantages to increase market share and start this feedback loop. In time, it would not be surprising to see each have.....

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