Verizon's financial performance and competitive position analysis

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. 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.

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 a 40% share and the other two firms start to fall by the wayside or become deep discounters offering inferior technology at very slim margins. Verizon should therefore pursue this course. The evidence shows that over the past few years Verizon has adopted this strategy. It has taken out significant amounts of debt in order to help build out its infrastructure, and thus far the result is that Verizon is winning market share. It now has the largest customer base in the industry, and earns more of its money from wireless than AT&T does. If Verizon continues to pursue this strategy, the process of establishing a dominant market share and duopoly in the industry is likely to take several years and perhaps multiple iterations of wireless technology. However, over time the advantages will become so significant that customers will switch to the company at an increasing rate.

Internally, Verizon's approach has increased leverage and decreased shareholder equity. AT&T has adopted much the same strategy, but without taking on nearly so much debt nor eroding its shareholder equity. This implies that Verizon can do better. Verizon should focus on paying down some of the debt it has acquired in the past few years, in part because there is a risk that interest rates increase, but also because this debt is eroding shareholder value. Verizon is generally on a sound strategic path, but needs to take shareholder value into account a little bit more in the future, avoiding debt and perhaps cutting the dividend in order to free up more money to plow back into the company. It will not beat AT&T any time soon, but an aggressive strategy to leverage its size advantage should allow it to push the 40% level on market share and create sustainable separation from Sprint and T-Mobile.

Works Cited:

Jordan, A. (2011). Verizon gained market share with iPhone while other carriers lost. iSource. Retrieved November 14, 2012 from http://isource.com/2011/05/09/verizon-gained-market-share-with-iPhone-as-other-carriers-lost/

MSN Moneycentral (2012)Verizon. Retrieved November 14, 2012 from http://investing.money.msn.com/investments/stock-price?symbol=VZ&ocid=qbes

Verizon 2011 Annual Report. Retrieved November 14, 2012 from http://www22.verizon.com/idc/groups/public/documents/adacct/vz_ar_final_2011.pdf