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Too early to hang up on Verizon?
Stock Spotlight: The stock has been struggling but investors may do well if they're patient.
October 21, 2005: 12:59 PM EDT
By Jessica Seid, CNN/Money staff writer
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NEW YORK (CNN/Money) - The entire telecom industry has taken a hit this year but Baby Bell Verizon Communications has really taken it on the chin.

Shares of the New York-based telecommunications giant have tumbled 28 percent this year, making Verizon (Research) the second worst performing stock in the Dow industrials.

Verizon is plagued by slow growth in its traditional land line phone business and fears of increased competition from cable companies.

But investors are also worried about high capital spending as Verizon gets set to launch its own video service to better compete against cable. Some also think Verizon overpaid for long-distance firm MCI. Yet Verizon also has what is arguably the healthiest wireless phone business in the country.

So with third-quarter earnings due shortly, will strong wireless results offset sluggish revenue growth elsewhere and concerns about the MCI merger?

Has Verizon stopped working for you?

Verizon plans to boost its capital spending 15 percent this year to launch a bundled package of voice, Internet and TV services called FiOS.

This new fiber-optic network will let TV viewers do things like get a live look at traffic on local roads, e-mail pictures to their televisions so they can watch slide shows or keep track of their fantasy football leagues on the screen while watching the Monday night NFL game.

Since FiOS launched in Keller, Texas, a month ago, Verizon has won approval to deploy the service in parts of New York, Massachusetts, Washington, D.C., Florida and California. And the company is expected to make agreements with more cities and towns in 2006.

In the meantime, the telecommunications company is actively signing up programming deals with content providers like Walt Disney (Research), Viacom (Research) and Time Warner (Research), which owns CNN/Money and other properties.

But it's going to take a while before FiOS is widely available to Verizon customers. The company needs regulatory approval for video franchises from various city and state governments, which means it could be months, if not years, before FiOS is rolled out nationwide.

For this reason, William Power, an analyst at Robert W. Baird & Co., suggests that the returns on Verizon's investment in fiber optics may be years away.

Also worrying investors is the steep price Verizon paid for MCI (Research). Verizon was forced to raise its offer several times to top a rival bid from Qwest (Research) in a contentious takeover battle earlier this year. Verizon wound up winning with an $8.4 billion, about 25 percent higher than its original bid.

Verizon said it needed MCI's roster of large business clients and global network and analysts seem to agree with that strategy, despite the rich price. That's because fellow Baby Bell SBC (Research) agreed to buy MCI competitor AT&T earlier this year.

"For Verizon to be competitive with SBC, they needed MCI's customers," said Jeff Halpern, an analyst at Bernstein & Co.

Can you hear me now?

Even though some are worried about Verizon's spending spree, investors should be pleased by the results from Verizon's wireless arm, a joint venture of Verizon and Vodafone (Research). Verizon owns the majority stake.

Verizon Wireless accounted for nearly half of the company's revenues and operating profits in the second quarter. And sales jumped nearly 15 percent in the quarter, more than three times the growth rate for the entire company.

Although Verizon Wireless is no longer the biggest cell phone service provider -- Cingular overtook Verizon Wireless after it bought AT&T Wireless -- many analysts think Verizon Wireless is in the best financial shape.

Subscriber growth has been booming and analysts expect the company to report that Verizon Wireless added nearly 2 million customers in the third quarter, which will put it near 50 million.

Customer turnover is among the lowest in the industry. Churn -- which measures the percentage of subscribers who cancel their service -- was 1.2 percent for the second quarter and is expected to remain around that level in the third quarter.

But even with the strength in wireless, Verizon is expected to report third-quarter earnings of 64 cents a share, according to Thomson/First Call, down a bit from 65 cents a share a year earlier. Sales are expected to rise just 4 percent. With that in mind, some think Verizon should focus even more on the faster growing wireless unit.

"Verizon's commitment to reinvesting in and reinventing its wire line business has separated it from wire line peers and the stock's performance has reflected market skepticism regarding the investment merit of this strategy," David Barden, an analyst with Bank of America Securities, wrote in a recent report.

A long-distance value

The slide in Verizon's stock does create an attractive buying opportunity for investors, some analysts said. The stock trades at about 11 times 2006 earnings estimates, a discount to its competitors. SBC and BellSouth (Research) both have P/E ratios of about 13 times next year's estimates while Sprint Nextel (Research) trades at 14 times.

What's more, Verizon pays a lofty dividend, which also makes it a safer bet compared to most of its competitors and the rest of the market. The company pays an annual dividend of $1.62 a share, for a yield of 5.5 percent.

That ranks Verizon as one of the top 25 yielding stocks in the S&P 500, and outpaces the 10-year Treasury yield, now about 4.4 percent. And most analysts said that Verizon's balance sheet is strong enough to support the dividend, even with the increased spending plans.

Still, investors will have to be patient. Concerns about competition will probably continue to make for some bad reception with the stock.

In addition to cable companies like Comcast Corp (Research), which has rolled out a digital phone service, other firms like Internet phone companies Vonage and Skype, now owned by eBay (Research), pose a threat. But investors that buy the stock now should reap long-term returns, and they'll paid a handsome dividend while they wait.

None of the analysts mentioned in this story own stock in Verizon nor do their firms have banking relationships with the company.


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