Will FiOS Ever Pay Off for Verizon?

Exhaustion of the older revenue models and products means firms such as Verizon increasingly will rely on new services to drive revenue growth in the future, Verizon CFO seems to agree.

With the caveat that AT&T arguably is far more exposed to consumer revenues in it fixed network segment, Verizon’s earnings from its fixed networks show why Verizon was not keen to expand its FiOS deployment.

About 40 percent of fixed network  revenue comes from the residential market, notes Michael Hodel, Morningstar analyst. So an important observation is that Verizon makes its money in the fixed network segment from business customers.

The reason Verizon only earns 40 percent from consumers is that it faces ferocious and successful competition from cable operators. “We estimate Verizon now serves less than 40 percent of the households in its territory, down from nearly 60 percent five years ago,” Hodel says.

In other words, where it has built FiOS networks, 60 percent of the access investment is stranded and does not earn a return. That also means full recovery of invested capital has to be carried by the 40 percent of actual customers.

“We believe that losing customers will make it difficult for Verizon to earn a solid return on FiOS network spending or justify network upgrade spending beyond where FiOS already exists,” Hodel argues.

Verizon's network is future-proof. “But returns on this investment have been poor, as we calculate fixed-line asset turnover and margins trail most peers,” said Hodel.

On the other hand, Verizon generates about 70 percent of its total revenue from its mobile segment.

Verizon Wireless of course is working on new sources of revenue, “but the revenue opportunity in these areas may not prove adequate to maintain the current rate of growth across the industry,” Hodel said.

Irrational pricing by Sprint or T-Mobile US or both could threaten Verizon’s mobile cash flow, as could heavy new spending on spectrum.

If consumer revenue growth stalls or if the enterprise market continues to struggle, Verizon may have trouble expanding fixed-line margins as planned.

And Verizon’s cash flow is not what it once was.  Free cash flow of $13 billion in 2014 was 36.5 percent less than in 2013.

Since the $130 billion acquisition of Wireless from Vodafone in 2013, Verizon's debt has more than doubled to $113 billion, while its shares outstanding has increased almost 40 percent.

That limits both borrowing and equity issuance as avenues to raise capital. For that reason, some might doubt Verizon has the ability to buy Dish Network’s spectrum, and Verizon likely has no interest in acquiring Dish Network’s video business.

Might Verizon be better able to augment its spectrum position by buying excess Sprint spectrum? That might seem more reasonable.