Simplifying Verizon's Acquisition Strategy

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Verizon has been in the news with various merger opportunities over the past several months. While it seems there is certainly a lot of activity taking place, one wonders what this all means. The obvious short answer is that Verizon is trying to grow and become more profitable. However, I'd like to offer a simplified perspective. There are two fundamental ways for Verizon to generate revenue -- selling access and selling content/advertisements -- with a third way, selling faster access, potentially on the horizon. Let's break it down.

Revenue Stream Option 1A: Selling Access (Landlines)

The most identifiable revenue generator for Verizon is through the sale of access, i.e. infrastructure. In this case, Verizon sells you the access to the outside world by providing the pathways for you to get to the Internet and/or the PSTN (Public Switched Telephone Network). The primary pathways include traditional landlines, DSL, fiber (Verizon Fios), and cable.

Recently, rumors have circulated that Verizon is weighing the acquisition of Charter Communications, the second largest cable operator in the U.S. If rumors prove to be true and an acquisition takes place, Verizon would essentially be doubling down on high speed access. Verizon Fios covers 14 million households, mostly in the Northeast (New York to Virginia Beach). Charter Communications covers 49 million households, is located in 41 states, and has concentrations in California, Missouri, Texas, and Michigan. Charter itself grew in 2016 through the acquisition of Time Warner Cable and Bright House.

Over the past eight years, Verizon has been selling off its no growth/declining business -- mainly its old landline business -- to Frontier Communications. While profitable, the old business model does not favor the stock market, which values growth over profitability (i.e. Amazon).

Selling high speed access provides Verizon a long term revenue stream. Verizon's expansion of a high speed landline footprint is also part of its wireless strategy, which I dive into below.

Revenue Stream Option 1b: Selling Access (Wireless)

As the largest postpaid wireless provider in the U.S. with 114 million subscribers, Verizon is positioned well in this market. However, Verizon's average revenue per user (ARPU) is at $55, lagging behind T-Mobile and Sprint ($63) and AT&T ($70). With slowing growth in wireless, Verizon is looking for other areas in which to grow.

Part of the rationale behind a Charter Communications acquisition is also geared toward wireless. 5G wireless promises gigabytes-per-second speeds. Remember that the 5G wireless antennas needs to be hooked up to a high speed landline fiber network in order to actually connect to the Internet or VPN. Verizon would prefer that this traffic rides on its own fiber network rather than paying another party to use its network.

Wireless is, and will continue to be, an important part of Verizon's revenue mix. While wireless revenue has stabilized, there will be a growth spurt when 5G wireless technology comes to market.

Revenue Stream Option 2: Selling Content/Advertisements

The other major deal in the news is Verizon's Yahoo acquisition. Despite the concerns about several massive hackings at Yahoo, most analysts expect Verizon to go through with the purchase. Verizon's motivation for this deal is to gain scale for a high growth market: digital advertising on mobile devices. Just look at Facebook's revenue and stock price as an example of the importance of this market.

In 2015, Verizon acquired AOL. While some remember AOL from the old days of its dial-up service, AOL has expanded to become a content provider (Huffington Post, TechCrunch) and has sophisticated technology for advertising media (trailing only Google and Facebook). Yahoo double downs on the content/advertisement business. Meanwhile, Verizon's primary competitors are already heavily invested in becoming content providers -- Comcast with its acquisition of NBCUniversal and AT&T with the pending acquisition of Time Warner.

(Possible) Revenue Stream Option 3: Selling Faster Access

Selling fast-lane access is currently prohibited by Net neutrality regulations, the principle that all providers treat data the same so that there is no discrimination or different charges based on content, platform, user, application, etc. In short, a provider cannot give higher priority to someone who is willing to pay more (i.e. fast lanes).

However, there are already fast lanes and slow lanes. In wireless, your data can travel over fast lanes (4G), moderate lanes (3G) or slow lanes (2G). [Note: Verizon announced it will be shutting down its 2G network by December 31, 2019, and AT&T shut down its 2G network on January 1, 2017.] Sprint, on the other hand, still uses 2G technology. With Sprint's "no overage" data plans, once you reach your data threshold, Sprint will continue to provide unlimited data, but at 2G speeds.

But can a vendor price discriminate by speed? Yes, up until 2015 Republic Wireless (a Sprint & T-Mobile MVNO) sold different user experiences (speeds). Republic Wireless charged $25/month for unlimited 3G data and $40/month for unlimited 4G data.

At some point in the future, the carriers would like to see Net neutrality regulations changed. The Internet providers (Verizon, Comcast, AT&T) would like to charge the content providers to ensure a better user experience (i.e. give priority to their content/application). Current Net neutrality rules prohibit "double dipping," the scenario where Internet providers receive payment from both consumers (for Internet access) and the content providers.

With the new administration in the U.S., comes a change in the Federal Communication Commission. Tom Wheeler is out as FCC chairman, and Ajit Pai is in. In general, a Republican administration historically tends to be more sympathetic to "owner rights," in this case the Internet providers. And while it is way too early to predict the future, do not be surprised if Net neutrality rules are relaxed moving forward.

In Sum

By taking a simplified view of Verizon's business model, we see how the possible acquisitions of Charter Communications (expand access/coverage) and Yahoo (add users/applications/content) fits. Going forward, future acquisitions can guide us in gauging how the company fares in its efforts to expand its access footprint and provide more content.

"SCTC Perspectives" is written by members of the Society of Communications Technology Consultants, an international organization of independent information and communications technology professionals serving clients in all business sectors and government worldwide.

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