Barron's Streetwise - The Problem with Verizon

Episode Date: August 5, 2022

A top telecom analyst explains how T-Mobile is beating Verizon at its own game. Plus, are earnings estimates safe? Learn more about your ad choices. Visit megaphone.fm/adchoices

With record levels of dry powder available for investment, find out what's in store for private markets in 2025 and beyond. Listen to Crafting Capital in partnership with UBS at partners.wsj.com slash UBS, Spotify and Apple Podcasts. Mid-band spectrum is really what makes 5G networks faster than 4G networks. And so T-Mobile has been able to race out ahead of both Verizon and AT&T with high-speed nationwide 5G service. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Brett Feldman. He's a telecom analyst at Goldman

Sachs. And you did hear correctly, there will be some talk about mid-band spectrum coming up. The old 1 gigahertz to 5 gigahertz frequency range, really some of my favorite gigahertz is right in there. In a moment, why the U.S. wireless industry is still growing strong, and why Verizon, for now, is not. And of course, what to make of the shares. Gigahertz is not a word? Not even close. Hmm.

Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack. Two more opportunities because I'm taking off another couple of weeks. I know it seems like I'm having a lazy August and I am, but only because a lot of other people are having lazy August too. So I feel like I don't stand out. Now, note number two is that I'll be filling in as host of the Barron's Roundtable TV show this week and next. If you've never seen that show, it's kind of like this one, except there are more

commercials and you have to look at my face. But my colleagues on the show say a lot of smart things and Paramount CEO Bob Backish will join us this week. Airtimes are 10 a.m. and 1130 a.m. ish Eastern on both Saturday and Sunday on the Fox Business Network. Check your local whatever. Now then, before we come to telecom, let's say a quick word about corporate earnings and why they aren't worse. We are most of the way through second quarter reporting season for big companies, and we're trending toward earnings growth of more than 8% versus a year ago. That's solidly higher than what was projected.

It's not as good as revenue growth, which is running closer to 13%, but that's just what you'd expect during a period of elevated inflation. Rising prices mean higher dollar amounts are changing hands, and at the same time, rising costs are cutting into margins. But the net result isn't so bad. What seems a little unusual is that earnings estimates for future quarters have been holding up so well. You'd think that higher prices would be taking a toll on consumers. After all, that's what the rising stock market has been whispering since mid-June. Investors seem to be saying that all this interest rate hiking by the Federal Reserve will dampen economic activity, which will cause the Fed to eventually pause its rate hikes and even reverse them next year. But if it's true that the economy is weakening,

should I be concerned that projections for next year's earnings growth for the S&P 500 index have only fallen by a couple of points from a 10% growth projection last May to around an 8% projection now. Does that mean earnings estimates have further to fall or that the economy will hold up better than expected? So my view is that there's really two phases to this market headwind. The first phase we've lived through, and that was a decline in valuations. That's Brad Newman. He's the director of market strategy at Alger, the money manager. And he points out that when stock prices fell during the first half of this year, earnings kept rising.

So stocks became cheaper relative to earnings. He says the next phase will be a drop in earnings. When you have a recession, you have a decline in earnings and in corporate profits. And if inflation is high, then the decline in earnings may be a little bit less in dollar terms. But in general, you know, it's something on the order of 15, 20 percent typically in a recession. If inflation is robust, maybe in nominal terms, it could be closer to high single digits or 10%.

But I would say that's the next phase. And we're already seeing earnings estimates being revised down more than normal. Brad says earnings estimates have only begun to come down. They have further to fall. And in his view, the stock market hasn't priced that in yet. I asked if that means that investors should reduce their stock holdings. And he said long-term investors should be fine based on the historical record. 74, 75 was a very difficult recession. Truthfully, I was just born around that time,

so I don't recall the recession. I was three years old, but I remember it being, it was a tough three years old. Diapers cost a lot of money back then. But there are certainly investors who can recall this. And as I said, it was a deep recession. The S&P 500 before that recession was about 100, if you can believe that, not 4,100, but 100. And the recession was so deep that it fell 40%. But that 40% was only 40 points. That 40 points, we routinely move in a day or a week today. So my point is that recessions, while they seem terrible and they can be extremely painful, particularly if you're close to retirement, they're really small in the grand arc of history because productivity continues to

advance and productivity drives earnings over time and earnings ultimately drive stock prices. Brad says that a recession flywheel has already been set in motion, but that we might not technically get a recession until the second half of this year. That has actually been a topic of lively debate over the past couple of weeks. Recessions are sometimes characterized by two consecutive quarters of negative economic growth, which we've just had based on early estimates for second quarter growth. But that's not a hard and fast rule. Here's Brad. And just to prove that it doesn't have to be two quarters in the pandemic of 2020, it was only two months. So it certainly doesn't have to be two quarters, in the pandemic of 2020, it was only two months. So it certainly doesn't have to be two quarters. Could be more, could be less.

So I think in the first quarter, you know, we certainly weren't in a recession. There's just too much strength in other parts of the economy. Even though GDP was negative, final demand consumption was strong. Second quarter, real consumer spending still grew, even though GDP was negative. Inventories took a couple points off. But things were clearly weak. I don't think we were in a recession in the second quarter. These days, I think we're getting close to a recession.

I think that a recession probably will hit the U.S. So how do we know when we're in a recession if negative GDP growth doesn't tell us? It's pretty simple. There's a 102-year-old group in Cambridge, Massachusetts called the National Bureau of Economic Research, and its Business Cycle Dating Committee is in charge of figuring out after the fact when recessions started or ended. It defines a recession as, quote, a significant decline in economic activity that has spread across the economy and lasts more than a few months.

Apparently one of those hasn't happened yet, or it has, and the NBER, Business Cycle Dating Committee, hasn't told anyone yet. And if you're wondering why it gets to decide, I think it's just because it's been doing it for so long. If you want to challenge the NBER for that job, go ahead. Set up your own business cycle dating operation. Start declaring recessions. I mean, not willy-nilly, only when you're sure.

But if enough people begin citing you as proof that we're in a recession, I think you've got the job. Jackson, are we in a recession? I'm not sure yet. I haven't seen what the groundhog has said. I think you're thinking of winter, right? With the winters ended. I'm pretty sure he does recessions, too. Ironically, that kind of dual revenue stream, assuming he's being paid for the job, will serve him well if we are in a recession. I'll tell you what's showing little sign of slowing. The U.S. wireless phone business.

That's next after this quick break. Calling all sellers. Salesforce is hiring account executives to join us on the cutting edge of technology. Here, innovation isn't a buzzword. It's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. Welcome back.

In the endlessly quotable 1987 movie, Wall Street, Michael Douglas plays Gordon Gekko, who has a memorable phone call from the beach. Astonish me, pal. New info. I don't care where or how you get it. Just get it. What stands out about that call is that it was made using a handheld cellular telephone, which was new. I was in high school at the time and most of my calls were at home on a wall-mounted rotary AT&T phone in the kitchen where if you wanted privacy, you stretched the cord as far as it would go, and you

crouched down on the other side of the kitchen counter and you talked quietly. The phone Gecko used was called a Motorola Dynatac, although most people who remember it call it by a name that roughly evokes its size, weight, and appearance, the brick phone. My family did not have a brick phone, and I didn't know anyone who did, but about seven years later, I bought what might have been history's least necessary cell phone. It was dramatically smaller than the Dynatac, with a little part at the end that flipped down. The Motorola Microtac. I had just gotten my first career-type job as a stockbroker, I had almost no clients, and there was zero chance of me needing to field an important

business call from the beach. Mostly, I just made the occasional call to a friend after hours while in conspicuous view of others, but not too often because calls cost 45 cents a minute on top of the flat monthly fee for service. All of which is to say, somewhere between when I was in high school and when I started working as a stockbroker, handheld cellular phones had already gone from being reserved for the Gordon Gekko's of the world to being used by any ordinary nobody McNo clients. And now, nearly 30 years later, smartphones seem as ubiquitous as mouths. How can the U.S. wireless industry possibly still be a growth market. And yet, the post-paid phone subscriber base in the U.S. has grown faster than the pace of population growth for 20 consecutive quarters.

I think if you had asked anyone 20 quarters ago whether that was possible, they would have said no way. That's Brett Feldman. He's a telecom analyst at Goldman Sachs, and when he talks about post-paid phone subscribers, he means those of us who pay a regular amount for wireless service each month, as opposed to those who pay in advance for a certain number of minutes. Those are prepaid customers. But how can wireless subscriptions at this point still be growing faster than the population. Brett says one reason is that postpaid plans have become better deals with discounts on phones and unlimited data and perks like Netflix service thrown in and access to hotspots for internet. And so essentially

consumers just showed a willingness to pay a little more to get a lot more. More recently, the pandemic has probably had a positive impact on the growth rate of the industry for a couple of reasons. One, you had a lot of stimulus last year. So to the extent anyone may have had difficulty paying their bill and would have dropped out for a little bit, that didn't happen. It certainly looks like kids started getting phones earlier as they just became more connected. And that's a trend that we think is still unfolding. Brett also says that businesses have been buying more cell phones for their workers. One thing that stands out about recent wireless results is that even though industry trends have been strong, Verizon has been lagging behind. I asked why. That's a great question. And

it's a question that investors have been increasingly debating. And I think part of it requires just remembering what Verizon has been for most of its operating history, which is that for most of the last two decades, it has been far and away perceived to be the leader in network quality. And that's because they did have the best network. Verizon had a lot of historical advantages around technology choices, around the spectrum resources that it had. And it used that very effectively to convince consumers that they did indeed have the best network. You probably remember their famous Can You Hear Me Now campaign. All of us remember the Can You Hear Me Now guy, right? Can you hear me now? Can you hear me now? Can you hear me now? Good.

Can you hear me now? Can you hear me now? Can you hear me now? Good. That's an actor named Paul Marcorelli, who was arguably the face of Verizon for more than a decade, starting in 2004. In 2016, Paul defected to Sprint commercials, and to make sure Verizon wouldn't accuse him of taking his Can You Hear Me Now character with him,

he was careful to use his real name in the commercials. Hey, I'm Paul, and I used to use his real name in the commercials. Hey, I'm Paul. And I used to ask if you could hear me now with Verizon. Not anymore. I'm with Sprint now. Because guess what? Sprint merged with T-Mobile in 2020. But I'm getting ahead of Brett at Goldman, who was explaining how Verizon was starting to lag behind. So they really conditioned consumers over the last two decades to look at maps and to use maps to determine who had the best service and the service they should be willing to pay the most money for. The challenge that Verizon now has is that T-Mobile actually had an early mover advantage in terms of deploying 5G coverage relative to Verizon and relative to AT&T. 5G coverage relative to Verizon and relative to AT&T. And the reason is that when they acquired Sprint, the principal resource that they acquired in that acquisition was a treasure trove of mid-band spectrum that Sprint had held but had not deployed because they didn't have the financial resources

to do it on their own. And so T-Mobile has been able to race out ahead of both Verizon and AT&T with high-speed nationwide 5G service. And guess what they've been doing in their commercials? They've been showing the map because they know that consumers have been trained to look at maps and to see that as a signal as to whose coverage is better. And so I think that maybe Verizon has lost a little bit of that brand identity. that brand identity. Brett says that Verizon still scores well on most network quality tests, but customers might not view it as the clear network leader they once did,

which means they might not be as willing as they once were to pay a premium price for Verizon service. I asked how Verizon can fix that. These large wireless carriers tend to be like battleships, which is to say it's hard to turn their direction quickly. So when things are going well, that momentum tends to carry through for a sustained period of time. But when that momentum begins to slow, it can be difficult for them to turn the businesses around and start growing at a faster rate. at a faster rate. In the case of Verizon, the good news is that they were able to acquire a substantial amount of mid-band spectrum in a government auction last year, and they're deploying that very quickly. Brett says that by the end of 2023, Verizon should have its new mid-band spectrum deployed nearly nationwide, and its network should be at least as good as those of its rivals. But what about between now and then? In the near term, what they're probably going to have to do would just be more promotional in order to make sure that they're able to continue to add some

level of customers and more importantly, retain the customers they have. And what that really means is you're probably going to see really great deals on wireless phones from Verizon, particularly as you see new devices come to market over the next couple of months, which is expensive. It's an expensive way to maintain stability in your customer base, but it gives them the ability to preserve that customer base so that as their network starts to get considerably better, they'll hopefully be in a better position to resume a faster rate of growth based on the quality of network and not on the attractiveness of their handset prices. Okay, so there's good potential for discounts ahead, which would be welcomed by consumers. But what about investors?

Are any of these stocks attractive? Brett says his top pick is T-Mobile, which he calls the industry's best grower, stemming from its merger with Sprint. Both Sprint and T-Mobile, which he calls the industry's best grower, stemming from its merger with Sprint. Both Sprint and T-Mobile had relatively low presence in certain markets like rural areas and the business market. And as a result of the significantly better network coverage and capacity they created through the merger, they can now really go and target those customer bases. So they should remain the growth leader and subscribers among the big carriers for a number of years. The merger has also allowed them

to take a lot of costs out of the business and just gain a lot more scale. So they should be able to continue growing margins much faster than their peers, not only because they're growing their subscriber base, but because they're continuing to take costs out of the business. Brett says that T-Mobile is on the verge of generating much more cash flow than it needs

to run the business. The company has said it plans to buy back $60 billion worth of its stock between 2023 and 2025. That's about one third of its market value. Brett has a neutral rating on Verizon. He's bullish on AT&T, even though he calls it a very slow growth business. The company has cut its dividend and sold its entertainment assets, which Brett says could allow it to invest in its 5G business. And even after the dividend cut,

the stock price is so low that the yield is over 6%, which Brett views as attractive. One last question. It's about something called fixed wireless. That's where you install a device from the wireless company in your home to get high-speed internet service. If you've cut the cord with your cable company, in other words, canceled your cable tv bundle and signed up for a handful of streaming services you might still have to pay your cable company 60 to 100 a month for high speed internet service which means you haven't really cut the cord with fixed wireless you can get rid of cable internet service altogether and the wireless company might give you a discount if

you also use them for phone service. It's a relatively new business that's being eyed as a long-term competitive threat to the cable industry. So how's it going? Brett says, better than expected. T-Mobile and Verizon are the two wireless carriers that have really leapt into that market. And they have both had much more success this year with that service. And I think many investors and analysts such as myself might have guessed. Just to put some numbers on that, T-Mobile signed up 560,000 subscribers to their wireless home internet service in the second quarter. Verizon signed up over 250,000 subscribers. That means over 800,000 subscribers signed up for that service in the second quarter. That represents essentially all of the growth in the broadband market. And it's nearly twice as many customers as you would

have typically expected to sign up for a broadband service in the second quarter. That's promising growth. But Brett says that for now, it's coming from what he calls underserved customers, ones who might not have great wired internet options. Maybe they had DSL lines from the phone companies. It helps that fixed wireless is easy to sign up for. There's no cable installer to wait for. You sign up online, plug in a device and go.

But for now, fixed wireless isn't quite a cable killer. The big challenge is that because those services are based on wireless networks and not wireline networks, they don't have nearly the capacity that, say, a fiber optic cable that comes into your house might have. So the real question isn't going to be, can these carriers continue to sign up customers in the near term? It's going to be, can their 5G networks handle all that usage over the long term? Thank you, Brett and Brad, and thank all of you for listening. Jackson Cantrell is our producer. Subscribe to the podcast, rate it, review it, tweet me and TV me and call up 1994 me on my Motorola micro tax so I have someone to talk to we'll pretend we're doing huge deals together see you next week