Verizon must slash $375M in costs to stay on even keel following Frontier sale, Jefferies says

Verizon (NYSE: VZ) completed its sale of wireline properties in three states to Frontier last Friday, leaving it with a wireline footprint concentrated in the Northeast U.S. market. However, financial analyst firm Jefferies says the deal creates headwinds that could affect earnings.

Specifically, Verizon could see earnings per share (EPS) fall by 6 cents in 2016.

"Guidance for EPS to 'plateau' in 2016 embeds the divestiture and assumes the impact can be mitigated through operational efficiencies, at the consolidated company," Jefferies said in a research note. "Management has proven adept at reducing costs, particularly in Wireless, where SG&A declined on an absolute basis in 2015 and on a percentage of revenue basis in each of the last two years; we expect further declines on both measures in 2016."

Jefferies added that "the ability to further reduce costs to offset the lost EBITDA represents the most significant threat to guidance and consensus in our view, with management needing to remove ~$375mn in costs to ensure the transaction is EPS neutral."

By selling the wireline assets, which were in former GTE territories of California, Florida and Texas, Verizon shed 3.3 million voice connections, 2.1 million broadband subscribers, and 1.2 million video subscribers. Within the broadband subscriber numbers, there are an estimated 1.5 million FiOS subscribers representing over 21 percent of Verizon's fourth-quarter FiOS Internet base.

Although Verizon's FiOS footprint is now relegated to the Northeast, the service provider continues to transition more of its customer base off of copper plant and onto fiber.

Jefferies said that this transition and the fiber-based nature of FiOS "could drive faster growth in the consumer business."

Jefferies said that while Verizon has set a path for future growth, the telco will have overcome a "few hurdles as 2016 progresses, including continued ARPA degradation, slowing subscriber gains, an uncertain path to EPS stability post the FTR property sale, an unproven video strategy, and the risk of continued 'Millennial'-oriented acquisition activity."

As a result, Jefferies downgraded Verizon's rating from "Buy" to "Hold," while maintaining its $53 price target.

Another issue is the tapering off of FiOS video and broadband growth.

While Verizon added 99,000 new FiOS Internet subscribers in the fourth quarter, the number was much lower than the 145,000 subscribers it added in the same period a year ago. Much of this could be attributed to two factors: the growing maturity of its existing markets and the fact that it has no plans to expand into other areas outside of where it has established franchise agreements with local towns and cities.

Regardless of the slowing growth, Verizon reported that the growth of FiOS broadband and video drove fourth quarter wireline consumer wireline revenues of $4.1 billion, an increase of 2.6 percent compared with fourth-quarter 2014. 

Verizon has passed 20 million homes with FiOS, surpassing its 18 million goal. 

To entice existing and new subscribers away from its cable competitors, Verizon has been running a TV ad campaign highlighting the difference between its FTTH network and cable. The telco talks about how it can deliver symmetrical speeds from 50 Mbps up to 500 Mbps. 

Even though Verizon has not followed fellow ILEC AT&T into the 1 Gbps arena, the ability to provide symmetrical speeds within 50-500 Mbps means the telco can stay competitive against cable in the markets where it offers FiOS.

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