Verizon adds 2.2M subs in Q4, but margins shrink amid smartphone surge

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Verizon Wireless (NYSE:VZ) reported a record number of retail postpaid subscriber additions in the fourth quarter but it also posted a drop in margins, as analysts had expected. The carrier followed the familiar pattern of taking a short-term hit on margins by adding a glut of smartphone users in the year-end period in the hopes of reaping long-term financial reward from those contracts.

Verizon added 2.2 million net retail connections in the fourth quarter, including a record-high 2.1 million retail postpaid net additions and 142,000 retail prepaid additions. The company added 5 million net retail postpaid connections in 2012, the most in four years. At the end of 2012, the company counted 98.2 million retail connections--up 6.6 percent year-over-year--including 92.5 million retail postpaid connections.

During the company's earnings conference call, Verizon Communications CFO Fran Shammo said sales of the carrier's Share Everything shared data plans continued to exceed company expectations. New smartphone customers who want a subsidized device need to sign up for the plans. He said that as customers move into the plans they are adding more devices, using more data and moving up in usage tiers, which generates more revenue for Verizon.

"The Share Everything plans allow Verizon to begin to capture a larger portion of connected devices," TBR analyst Eric Costa noted in a research note. "This currently consists of primarily tablets, yet future connected devices will cover multiple different verticals and open up new revenue streams for Verizon."

Here's a breakdown of Verizon's key quarterly metrics:

Financials: Verizon said total wireless revenues were $20 billion in the fourth quarter, up 9.5 percent year over year. The carrier reported that service revenues clocked in at $16.4 billion, up 8.5 percent year-over-year. Retail service revenues grew 8.4 percent from the year-ago period, to $15.8 billion.

ARPA: As it disclosed when it reported its third-quarter 2012 earnings, Verizon noted it is no longer reporting average revenue per user (ARPU) but instead now is reporting average revenue per account (ARPA). The company made the change to account for its Share Everything plans, which let customers add multiple devices to one account. Verizon's retail postpaid ARPA grew 6.6 percent year-over-year to $146.80 per month. The company reported an ARPA of $145.42 per month in the third quarter.

Margins: As expected, Verizon's margins fell in the fourth quarter. The carrier's wireless operating income margin was 24 percent and wireless EBITDA margin was 41.4 percent, down from 42.2 percent in the year-ago period. In the third quarter, Verizon's wireless operating margin was 31.8 percent and EBITDA margin was 50 percent.

Shammo said he expects the company's wireless EBITDA margin to rebound quickly and achieve full-year 2013 levels of around 49 to 50 percent. "If you look at just the fundamentals of the business, our fundamentals are more sound than they were a year ago," he said, explaining his optimism on margin growth. Verizon's full-year wireless EBITDA margin for 2012 was 46.6 percent.

"The carriers have to take additional steps to contain subsidy costs in order for us to get enthusiastic about the group again," wrote New Street analyst Jonathan Chaplin. "We believe T-Mobile's Value Plans may be the answer," he said, adding that Verizon and AT&T Mobility (NYSE:T) "should be able to transition to this type of plan without giving up as much on pricing."

Smartphones: As Verizon had announced earlier, it sold 9.8 million smartphones in the quarter. Verizon disclosed that it sold 6.2 million Apple  (NASDAQ:AAPL) iPhones in the quarter and that around half of those were the LTE-capable iPhone 5. Shammo said there was "steady but slow" adoption of Microsoft (NASDAQ:MSFT) Windows Phones, which Verizon started to promote more heavily during the fourth quarter. 

Around 87 percent of Verizon's postpaid phone sales were smartphones and about 30 percent of smartphone activations were customers who were new to Verizon. At the end of the fourth quarter, smartphones accounted for more than 58 percent of the Verizon's retail postpaid base, up from 53 percent at the end of the third quarter 2012. Verizon said 9 percent of its retail postpaid subscribers upgraded their device's in the fourth quarter.

LTE devices: The carrier activated 7.3 million LTE devices in the fourth quarter, up from 4.5 million LTE devices in third quarter. Verizon now covers 273.5 million POPs with LTE, or roughly 89 percent of the U.S. population. The carrier expects to finish its initial LTE deployment by mid-year.

Churn: Verizon's retail postpaid churn was 0.95 percent in the fourth quarter and total retail churn was 1.24 percent.

For more:
- see this release
- see this Verizon presentation (PDF)
- see this WSJ article (sub. req.)
- see this Bloomberg article

Special Report: Wireless in the fourth quarter of 2012

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