TMRK Terremark Worldwide, Inc. (MM)

The largest U.S. mobile service provider Verizon Communications (VZ) is slated to release its first quarter 2011 earnings results on April 21, before the opening bell. The current Zacks Consensus Estimate for the first quarter is 51 cents, representing a 9.79% decline year over year.

Verizon had a 1.82% average positive earnings surprise in the last four quarters. We expect first quarter earnings to be slightly dampened by higher handset subsidies, partially offset by iPhone sales and solid 4G services.

Verizon started selling Apple Inc.'s (AAPL) iPhonefrom February 10, ending the exclusivity that its largest competitor AT&T Inc. (T) enjoyed since 2007. Verizon’siPhone is gaining traction and has been adopting by customers well.

Further, Verizon’s first 4G handset “ThunderBolt”, launched in mid-March, will enjoy the first-mover advantage of the company’s latest Long-Term Evolution (LTE) network. This is expected to increase profitability throughout 2011. The company’s 4G services cover approximately 38 markets with around 110 million people at year-end 2010. Verizon plans to expand its 4G LTE network in 140 additional markets by the end of 2011and cover virtually its entire nationwide 3G footprint by the end of 2013.

We believe all these developments along with increased smartphone adoption will make it more competitive against Sprint Nextel Corp. (S) and AT&T. Further, 4G networks and iPhone sales will boost Verizon’s earnings and revenue going forward.

Moreover, Verizon has positioned itself for growth in cloud services in 2011. The company recently acquired the information technology service company Terremark Worldwide Inc. (TMRK). Verizon seeks to expand its cloud business to offset declining revenues from traditional fixed lines.

On its fourth quarter conference call, Verizon had not released any financial forecast for the first quarter.

Fourth Quarter Flashback

Verizon’s fourth quarter earnings had missed the Zacks Consensus Estimate by a penny due to higher discounts on Verizon’s family and unlimited plans. But earnings improved year over year on the back of continued strength in Wireless, FiOS and strategic business services.

Revenues improved slightly driven by wireless revenue on lower churn (customer switch) and higher data revenues. However, Verizon’s subscriber growth plunged as it struggled to compete with AT&T in the smartphone market.

Wireline revenue remained under pressure due to persistent erosion of access lines. FiOS services remained strong across all markets with the penetration rate of both FiOS Internet and FiOS TV reaching approximately 31.9% and 28%, respectively.

Agreement of Analysts

Estimates for the first quarter have been trending downward over the last 7 and 30 days. Out of 25 analysts, 5 have made downward revisions in the last 7 days and 8 moved in the same direction in the last 30 days. None of the analysts made positive revisions for the first quarter.

For fiscal 2011, out of 30 analysts, 3 revised their estimates downward over the last 7 days while none moved in the opposite direction. Over the last 30 days, 5 analysts have made downward revisions while one revised the estimate upward.

The analysts are concerned about persistent erosion in access line, slowdown in post-paid subscriber growth as well as high promotional expenses, which may drag near-term earnings.

Though Verizon Wireless is the largest U.S. wireless carrier with 94.1 million subscribers at the end of December 2010, it was losing its market share to AT&T’s iPhone exclusivity till early February.

The sale of the iPhone strengthens Verizon’s competitive position in the highly coveted smartphone market. Verizon’s iPhone is expected to add 2.1 million net new subscribers in 2011 outpacing AT&T for the first time since 2008. However, the iPhone carries risks to Verizon. The company might have to spend $3 billion to $5 billion to subsidize the device in 2011 based on the expected $400 per iPhone subsidy that Verizon will absorb. These handset subsidies are expected to be a drag on profits.

Magnitude — Consensus Estimate Trend

The magnitude of revisions for first quarter and fiscal 2011 has been static at 51 cents and $2.22 respectively, over the last 7 as well as 30 days. The Zacks Consensus Estimate for 2011 reflects an annual increase of 21.28%.

Although Verizon continues to expand its 3G wireless and wireline FiOS network footprints, returns from investments in these businesses are uncertain. Further, AT&T threatens customer retention initiatives across all the segments of Verizon.

Our Analysis

We believe Verizon’s continued investments in its upgraded broadband network,strong wireless and FiOS services, 4G LTE mobile broadband networks, higher smartphones penetration, cloud computing business, and other data devices will lead to revenue growth. The offerings, including smartphones that support 4G network would strengthen Verizon’s position relative to its peers. Further, a healthy balance sheet and strong commitment to shareholders’ return make the stock more attractive for income-oriented investors.

Driven by iPhone as well as new LTE handsets, smartphone penetration is expected to increase from the current 26% to more than 50% by the end of 2011. We expect increased penetration of smartphone and other integrated devices to boost data revenue.

However, the 4G infrastructure may be an obstacle if other service providers shift to different generation technologies. Additionally, upgrading to 4G services as well as Verizon’s iPhone might increase operating costs of the company. Further, intense competition from cable companies and other alternative services providers may provide downside risk to the stock.

We currently have a long-term Neutral rating on Verizon supported by the Zacks # 3 (Hold) Rank.

 
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