AT&T and Verizon Financial statement analysis

AT&T and Verizon
Background
Both AT&T and Verizon have their roots as Baby Bells, large telecom companies that arose after the breakup of Bell. These are two of the largest telecom companies in the United States. At the time of the breakup, telecom was a highly stable business based on landline telecommunications, but the industry has transformed and is now strongly driven by wireless. As wireless technology continues to improve, being a player in wireless means having a high level of investment in fixed infrastructure assets, something that is evident on the balance sheets of both of these companies.
However, these companies differ significantly on how they are structured. Their businesses are very similar, but AT&T has kept a relatively low debt level, and sought growth through expansion. The massive amount of goodwill on its balance sheet and relatively small amount of long-term debt indicate this. Verizon, by contrast, has not been a player in M&A to nearly the same degree that AT&T has been, and instead has taken on debt in order to finance its infrastructure buildout. The analysis of the finances of these two companies shows that while they have similar businesses in terms of operations, they have very different approaches to these businesses from a financial perspective, and that these differences have a significant impact on the shareholders of these two companies.
The common size income statements for AT&T and Verizon for the past two years are as follows:
Income Statement
Raw
CS
Raw
CS
2016
2015
Revenue
163786
100.00%
146801
100.00%
Cost of Service
76884
46.94%
67046
45.67%
Gross Income
86902
53.06%
79755
54.33%
SGA Exp
36347
22.19%
32919
22.42%
Impairments
361
0.22%
35
0.02%
Depreciation
25847
15.78%
22016
15.00%
Operating Income
24347
14.87%
24785
16.88%
Net Income
13333
8.14%
13345
9.09%
Verizon
Income Statement
Raw
CS
Raw
CS
2016
2015
Revenue
125980
100.00%
131620
100.00%
Cost of Service
51424
40.82%
52557
39.93%
Gross Income
74556
59.18%
79063
60.07%
SGA Exp
31569
25.06%
29986
22.78%
Impairments
0
0.00%
0
0.00%
Depreciation
15928
12.64%
16017
12.17%
Operating Income
27059
21.48%
33060
25.12%
Net Income
13608
10.80%
18375
13.96%
The common size statements allow for easier comparison of the two companies. There are a couple of things that stand out from this analysis. The first is that AT&T has a much higher cost of service than does Verizon. As a consequence, AT&T ends up with lower operating and net margins. Both companies have roughly the same selling, general and administrative expenses, though Verizon's increased in 2016. It is worth noting that Verizon's raw number only increased by a couple of million dollars, but the revenue figures decreased, which made SGA expense, which is generally viewed as a fixed cost, a much greater percentage of revenues. It was probably targeted to be more at 22% again, but went higher when revenue failed to reach 2015 levels. The cost of service increased slightly as well. The operating expense took a hit at a result.
While Verizon saw its revenues decrease, AT&T saw a significant increase in expenses. As with Verizon, AT&T saw the cost of service increase slightly, but its SGA expense was held around the same. The company has a higher depreciation expense to begin with, and that actually increased despite the increased revenues. AT&T saw its profit increase in terms of raw number but the profit margin diminished.
Comparing the performance of the two companies on their common size income statements, AT&T had a better year in 2016 in a lot of respects, but still performs more poorly in terms of its margins and cost structure than Verizon does.
AT&T
Balance Sheet
Raw
CS
Raw
CS
2016
2015
Cash
5788
1.44%
5121
1.27%
Accounts Rec
16794
4.16%
16532
4.11%
Current Assets
38369
9.51%
35992
8.94%
PPE
124899
30.97%
124450
30.91%
Goodwill
105207
26.09%
104568
25.97%
Fixed Assets
364912
90.49%
366680
91.06%
Total Assets
403281
100.00%
402672
100.00%
Accounts Payable
31138
7.72%
30372
7.54%
Current Liabilities
50576
12.54%
47816
11.87%
Long Term Debt
113681
28.19%
118515
29.43%
Shareholders' Eq
124110
30.78%
123640
30.70%
Verizon
Balance Sheet
Raw
CS
Raw
CS
2016
2015
Cash
2880
1.18%
4470
1.83%
Accounts Rec
17513
7.17%
13457
5.51%
Current Assets
26395
10.81%
22365
9.16%
PPE
232215
95.10%
83541
34.21%
Goodwill
27205
11.14%
25331
10.37%
Fixed Assets
217785
89.19%
221810
90.84%
Total Assets
244180
100.00%
244175
100.00%
Accounts Payable
19593
8.02%
19362
7.93%
Current Liabilities
30340
12.43%
35052
14.36%
Long Term Debt
105433
43.18%
103240
42.28%
Shareholders' Eq
24032
9.84%
17842
7.31%
Analysis of the common size balance sheets shows that Verizon has higher accounts receivable as a percentage of total assets – in fact in 2016 it had a higher number period, when we know that A&T did more sales. This highlights an issue for Verizon – inability to collect on its accounts receivable, indicating that perhaps its buyers have poor credit quality, consistently, than AT&T buyers.
Of particular note on the balance sheet is just how much of AT&T`s balance sheet is in goodwill, which is usually the result of merger & acquisition activity. AT&T has clearly done much more of this than Verizon has, given the outsized percentage of that on the balance sheet. But AT&T also has much more shareholders` equity on the balance sheet than Verizon does as well. The difference between the two companies is that Verizon has a much greater percentage of long-term debt. It does not seem to be an outsized percentage, but it is much larger than that of AT&T.
Financial Ratios
Ratios
AT&T
Verizon
2016
2015
2016
2015
Cash Ratio
0.11
0.11
0.09
0.13
Current Ratio
0.76
0.75
0.87
0.64
LTD / Equity
0.92
0.96
4.39
5.79
Gross Margin
53.06%
54.33%
59.18%
60.07%
Operating Margin
14.87%
16.88%
21.48%
25.12%
Net Margin
8.14%
9.09%
10.80%
13.96%
x Interest Earned
3.1
3.0
5.8
6.7

ROFA
3.65%
3.64%
6.25%
8.28%

ROE
10.74%
10.79%
56.62%
102.99%

Receivables Turn
9.75
8.88
7.19
9.78



There are some interesting findings in the financial ratios as well. Some ratios are less exciting – both companies have a decent current ratio, and Verizon`s spiked in 2016, but that is mostly accounts receivable, so that is not actually a good thing. The company might be more liquid on paper, but the receivables turnover dropped from 9.78 to 7.19, which is not a good thing. AT&T by contrast tightened its receivables.
As noted earlier, AT&T relies a lot less on debt, and that is reflected in the stark difference between the two companies in terms of their LT debt to equity ratios, which are quite high for Verizon but relatively low for AT&T. The huge difference in capital structure is definitely one of the stories between the two companies.
Given the difference in capital structure, ROE is not a great way to compare the two companies necessarily. Verizon would be expected to have a much higher ROE and it does. The return on fixed assets is a better measure for these two companies, given the difference in capital structure and the fact that their businesses rely heavily on fixed asset infrastructure. On that measure, Verizon still outperforms AT&T, an indicator in part that its balance sheet has a lot less in the way of goodwill. Verizon does more with less than AT&T, something that is supported in the prior analysis that shows a more efficient SGA expense. Verizon also has a much better times interest earned, which is surprising considering how much more highly leveraged it is; one would expect it to perform poorly on that measure but it actually does well. It has more debt, but seems to have financed this debt at lower cost than AT&T.

Recent M&A Activity
During the time period covered, AT&T announced a merger with Time Warner, valued at $85.4 billion (Elsea, 2017). This merger had not been finalized at the time of the financial statements studied in this analysis. There were no major mergers or acquisitions for either of these firms that were finalized during the period studied.
Overall Assessment
AT&T and Verizon have both sought to maximize shareholder value while competing in an industry characterized by high fixed costs, and intense competition that thins margins. Both companies have performed reasonably well during the past couple of years. The difference in their respective capital structures is highlights the trade-off between risk and return between similar companies. The biggest single difference between them is not the operating performance. Verizon has enjoyed superior operating performance over the past couple of years, while AT&T is the larger of the two companies. The difference is actually in the risk.
Verizon has delivered very strong return on equity figures, and this is because Verizon has a large amount of long-term debt on its balance sheet. There is not a lot of equity value on the balance sheet of Verizon, so shareholders are able to enjoy more of the returns, relatively, than AT&T shareholders. Both companies have stable businesses, and both can expect to be profitable for the foreseeable future. The fact that Verizon has chosen the path of high leverage reflects that management of Verizon is confident that it can continue to meet debt obligations. Indeed, it can. The times interest earned for Verizon is lower than that of AT&T, despite the company having a much higher debt to equity ratio. This means that Verizon has taken on a lot of debt, but that this debt is financed at a much lower level. This is what allows Verizon to return more to its shareholders per share than AT&T can afford to do. So Verizon shareholders get the upside benefit of substantial leverage, but without the high cost of debt. AT&T shareholders, with a higher cost of debt, are in a position where they see weaker return on equity, which is to be expected because the book value of equity is much higher for AT&T, but they also pay a higher cost of debt.
In terms of balancing the risks of leverage with the rewards, it seems that the Verizon approach is better for shareholders. A highly leveraged capital structure is typically acceptable for businesses with stable, repeatable cash flows, and both of these companies qualify. AT&T prefers to maintain a stronger balance sheet – presumably so it can make large deals like the proposed deal for Time Warner, while Verizon prefers to accept its position in the market and return more of its earnings back to shareholders.


References

2016 AT&T Annual Report. Retrieved December 11, 2017 from https://investors.att.com/~/media/Files/A/ATT-IR/financial-reports/annual-reports/2016/att-ar2016-completeannualreport.pdf

2016 Verizon Annual Report. Retrieved December 11, 2017 from https://www.verizon.com/about/sites/default/files/annual_reports/2016/downloads/Verizon-AnnualReport2016_financial.pdf

Elsea, Z. (2017). AT&T's acquisition of Time Warner could be in trouble. Forbes. Retrieved December 12, 2017 from https://www.forbes.com/sites/legalentertainment/2017/11/02/atts-acquisition-of-time-warner-could-be-in-jeopardy/#e24c42876cae

NetMBA (2010) Common size financial statements. NetMNBA. Retrieved December 11, 2017 from http://www.netmba.com/finance/statements/common-size/