AOL Acquisition, Partnerships and Innovation Position Company For Future Growth, Dividend Increases

AOL acquisition will advance video advertisement technology, boost free cash flow

4% increase in quarterly dividends gives the company a dividend yield of 4.4%

Operating income up 11% as company continues to improve profit margins

Verizon Communications Inc. (NYSE: VZ) is a leading global telecommunications company that operates two segments: Wireless and Wireline. The Wireless segment offers high-speed mobile Internet, voice, messaging and data services. The Wireline segment offers wireline Internet access (DSL, FiOS), television, cloud, security, and voice telephone services. Verizon’s solutions are used by consumers, businesses and government agencies. Verizon has operations in 150 countries with 200 data centers, about 110 wireless retail connections, over 1,700 retail sites and 12.4 million FIOS video and Internet subscribers combined. The company is ranked 16th on Fortune’s list of 500 largest companies with about $32 billion in operating revenues.


Verizon Acquires AOL for $4.4 Billion to Improve Video Content and Advertisements

On May 12, 2015, Verizon acquired online media company AOL (AOL) for $4.4 billion, or $50 per share, in an all-cash deal at a 17% premium to AOL’s closing price of $42.59 on May 11, 2015. The acquisition gives Verizon access to AOL’s video technology which should help Verizon capture a larger share of the growing online and mobile video content marketplace. As the mobile revolution continues to explode, organizations are expected to spend over $12.3 billion on digital video advertisements by 2018, with 20% compounded annual growth, making this an attractive growth segment that the AOL acquisition can help with to monetize digital content through advertisements.


In response to the acquisition, credit rating company Moody’s Investors Service noted that the transaction was slightly credit negative for Verizon’s balance sheet but supported its long-term goal of monetizing mobile video. Moody’s commented that Verizon’s wireless and network assets, when combined with AOL, will give the merged company a comparative advantage in pricing power over the competition. In parallel, Verizon sold its wireline assets in California, Florida and Texas to landline operator Frontier Communications Corporation (FTR) for $10.54 billion in cash and leased Verizon cell phone towers to American Tower Corporation (AMT) for about $5 billion to strengthen its balance sheet and focus on core markets.

AOL Acquisition at Opportune Moment

AOL currently has the fourth largest audience for online video advertisements in the United States, with a reach of 42%. As AOL lost out to popular brands such as Google and Yahoo, the company quietly reworked its portfolio and sharpened its focus on video technology in 2010 through acquisitions of video company 5min Media and advertising company adap.tv. This refocusing happened shortly after AOL was spunoff from Time Warner Cable (TWC) in December 2009, and as the chart below shows, after an initial dip, analysts saw the power of AOL’s online video advertisement potential which drove up shares from near $11 per share in 2011 to over $40 per share in 2015.


And while AOL no longer enjoyed its erstwhile popularity, its smart refocusing has delivered solid results, with revenues most recently up 7% year-over-year to $625.1 million through strong 12% global revenue growth in video, mobile and program advertising.

Moreover, as its Q1 2015 income statement (below) shows, the company has strong quarterly operating cash flow of $55.7 million that was up 137% over the year-ago quarter, so Verizon is acquiring a healthy and growing franchise.


Verizon Shares Up 6% YTD with 14% Upside Potential

As of May 15, 2015, Verizon shares closed at $49.79, giving the company a market capitalization of $203.07 billion. Shares were trading in the middle of the company’s 52-week range of $45.09 – $53.66 and in-line with their 50-day moving average of $49.60 and 200-day moving average of $48.82, with a stock beta of 0.41 which reflects significantly lower risk than the broader market which carries a beta of 1.0. Year-to-date, Verizon shares are up about 6%, and are up about 90% over the last 5 years. At $49.79 and with earnings of $2.38 per share, Verizon has a price to earnings ratio of 20.9x.


After Verizon reported its latest earnings, investment bank Jefferies maintained a Buy rating with a $54 price target while British bank Barclays (BCS) maintained an Equal-weight rating with a $52 price target, suggesting upside of 4% to 8%. Bullish analysts have a $57 price target for Verizon which gives shares 14% potential upside.

Cash Flow Positive AOL Will Help Verizon Maintain Dividend Increases

Verizon most recently paid a quarterly dividend of $0.55 per share, annualized at $2.20, on May 1, 2015, a 4% year-over-year increase and a solid dividend yield of 4.4%. The company has paid consecutive quarterly dividends since May 1, 1984 (prior to July 3, 2000, shares traded under the Bell Atlantic name). Verizon has also consistently raised dividends (brown line in graph below) and analysts expect the cash flow positive AOL acquisition to help maintain future dividend increases.


Consistent Innovation Helps Verizon Maintain Industry Leadership

Verizon continues to stay ahead of the innovation game. For example, its Enterprise Solutions division offers memory, storage and network uptime enhancements for its cloud solutions in Hong Kong, China, Melbourne, Australia, Singapore and Malaysia. Customers in these cities also have access to Secure Cloud Interconnect and Cloud Marketplace. The division is also expanding its Unified Communications & Collaboration as a Service (UCCaaS) in Europe and the Asia Pacific region.

To boost broadband, Verizon plans to launch a 100G metro network that will incorporate networking leader Cisco Systems’ (CSCO) Network Convergence System with the metro-optimized 6500 packet optical technology of telecommunications company Ciena Corporation (CIEN).

Verizon’s Digital Media Services division recently acquired digital channel management software – Translate – from The Walt Disney Company (DIS). Verizon will integrate Translate with its Video Lifecycle solution to allow broadcasters to insert digital advertisements and offer live digital simulcasts. The Digital Media Services division also partnered with Irish Internet service provider Imagine Communications to use their Zenium software to give broadcasters the ability to offer over-the-top video streaming. Verizon also has content collaboration agreements with Nickelodeon’s sketch-comedy show AwesomenessTV and DreamWorks Studios (DWA) to develop original content.


As mobile broadband offerings and demand grows, Verizon’s Wireless division announced 4G LTE enhancements in Alabama, California, Florida, Georgia, Louisiana, Massachusetts, Mississippi, New Hampshire, Rhode Island, Texas and Vermont.

Partnerships Help Verizon Leverage Technology and Lower Customer Acquisition Costs

Verizon leverages industry partnerships across the supply chain to fill gaps in its offerings and stay on top of consumer trends, preferences and cutting edge technology. For example, the company entered into a long-term bilateral commercial interconnection agreement with Internet service provider Cogent Communications (CCOI) that allows users to efficiently exchange data across the two networks at high-performance speeds. With both companies expecting increased traffic demand in the future, this synergistic agreement allows them to leverage each other’s advanced technologies while avoiding duplication and saving on capital expenditures.


As part of Verizon’s content acquisition plan, the company signed agreements with Atlantic Coast Conference Digital Network, Campus Insiders, CBS Sports, ESPN and 120 Sports. These college sports programs are expected to attract younger, mobile device users in the 18 – 24 age range – the ideal growth target.

Through a partnership with online transportation company Lyft, Verizon plans to preload Lyft’s mobile application on mobile phones bought through Verizon. The partnership will allow Lyft to reduce its marketing costs while acquiring more customers, and benefit Verizon customers by offering a 15% discount on mobile phone bills that use Lyft. Verizon lost over 138,000 mobile phone customers in the first four months of 2015 and partnerships are aimed at stemming customer churn as competitors such as Sprint and T-Mobile offer compelling plans at lower price points. However, Lyft currently has the same agreement with AT&T (T), Verizon’s biggest competitor. Verizon also recently announced that it will not preload three mobile applications from Microsoft (MSFT) on its flagship Samsung S6 mobile phone.


Seasoned Management Oriented to Innovation, Growth and Shareholder Returns

Lowell McAdam was named Chief Executive Officer in 2011 and Chairman in 2012. Mr. McAdam previously held the positions of Chief Operating Officer and Chief Information Officer with the company as well as President of the Wireless division. He is a highly experienced, technology-savvy executive.


Francis Shammo has served as Executive VP and Chief Financial Officer since November 2010, after being promoted from CEO of Verizon Telecom and Business. Before that, Mr. Shammo was President of Verizon Business and President – West for the Wireless division. He joined the company in 1989 when it was still called Bell Atlantic Mobile.


Roger Gurnani is Executive VP and Chief Information and Technology Architect, responsible the company’s technology strategy. Mr. Gurnani plays an integral part in the evolution of the company’s digital platform. He was promoted from Chief Information Officer in January 2015.

Q1 2015 Operating Income Up 11%, Net Income Down 28% Due to Income Taxes, Loss for Unconsolidated Businesses

For the three months ended March 31, 2015, Verizon reported operating revenues of $31.98 billion (up 3.8%), operating income of $7.96 billion (11%) and net income of $4.34 billion (down 28%), or $1.02 per share.


Wireless operating revenues increased 7% with 35% operating income margin while Wireline operating revenues increased 2% with 4% operating income margin.


As of March 31, 2015, Verizon had $4.39 billion in cash and cash equivalents, $108.95 billion in long-term debt and $10.76 billion in total equity.

Summary

Verizon is a leader in its space, with revenue diversification by segment and geography, steady and rising dividends and a commitment to long-term growth and industry leadership. Its recent AOL acquisition shows that management understands industry dynamics and disruptions posed by Internet and mobile offerings, and has the appetite to make bold but affordable investments to position itself for participation in the growing online video advertising sector. Investors should view Verizon as a core long-term telecom holding for steady and growing dividends and modest capital appreciation upside. The company has a seasoned management team, a robust balance sheet and an enviable portfolio of consumer and enterprise customers, complemented by a compelling array of fiber and wireless technology and services. While shares may appear a little rich on valuation, investors should not hesitate to buy on dips.

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