Verizon Risks Profit Betting It Will Win TV, Internet Customers
July 28 (Bloomberg) -- From his 39th-floor office, Verizon Communications Inc. Chief Executive Officer Ivan Seidenberg looks through cables draping his building and holding up scaffolding, marring his view of the Manhattan skyline.
``It's 30 years old,'' Seidenberg explains with a shrug as he sits at the table in his corner office with views of Central Park and the East River. ``It needed refurbishing.''
The marble-and-glass facade of the company's headquarters, at the corner of Sixth Avenue and 42nd Street, isn't the only Verizon structure needing an upgrade. Verizon, formed in 2000 by the $71 billion acquisition of GTE Corp. by Bell Atlantic Corp., runs a century-old network of copper-wire phone lines that transmit calls for 27 million homes from Maine to California.
Verizon's sole CEO since April 2002, when co-CEO Charles Lee ended his tenure, Seidenberg, 57, wants to offer cable television and Internet services along with its telephone package. He plans to extend fiber-optic cables directly to people's homes, a project that Merrill Lynch & Co. analysts say would cost as much as $30 billion over 15 years.
The company has lost subscribers to long-distance phone companies like AT&T Corp., mobile phone carriers such as Cingular Wireless LLC and upstarts such as Vonage Holdings Corp. that are using technology that sends calls more conveniently for customers and at a lower cost to consumers and companies.
Bundles of glass strands as thin as human hair can deliver the gamut of residential communications -- phone calls, e-mail, Internet access and television channels -- in the time it takes the existing network to carry a single call, says Seidenberg.
Cable Competition
``We have to reconstruct the revenue streams around which we generate our growth and, therefore, our earnings,'' says Seidenberg, sitting with one leg crossed over the other and moving his foot in time with the cadence of his speech. ``The goal for us is to provide a very high-speed network to bring large volumes of data so we can re-create new industries.''
John Krause, who helps manage $62.4 billion at Thrivent Financial for Lutherans, which holds 1.1 million Verizon shares, says the biggest threat to Verizon's 25 percent share of the $128.2 billion U.S. local telephone market is from cable television companies.
Comcast Corp. and Cablevision Systems Corp., for example, are advertising their own versions of phone service, packaged with high-speed Internet access and TV channels.
Seidenberg started in telecommunications four decades ago at Verizon predecessor New York Telephone Co. by splicing the wires he's now racing to replace.
The Wireless Advantage
A Bronx, New York, native, Seidenberg is making the upgrade, ripping up sidewalks to lay cable, so Verizon can be the first local phone carrier to add television and to offer Internet access at speeds 20 times faster than it can now provide.
The overhaul would help Seidenberg match TV services sold by cable companies, which have invested more than $80 billion in the past five years so they can deliver phone calls and the Internet along with video. Seidenberg says he would still have an advantage over competitors because he sells wireless calling, which cable companies don't offer.
Verizon yesterday said second-quarter profit surged more than five-fold, led by a 25 percent gain in wireless sales.
Craig Nedbalski, who helps manage $49.9 billion at Cleveland- based Victory Capital Management Inc., says the fiber-optic installation may not come fast or cheaply enough to overcome the cable challenge.
Cable companies lead Verizon and other phone carriers in luring high-speed Internet subscribers, and they've nabbed almost 3 million phone customers in the past three years.
`The Upper Hand'
Cable providers will keep making inroads, putting pressure on phone prices, because it's easier and cheaper to equip a cable system to carry calls than it is to make a phone network capable of delivering TV, Nedbalski says.
``Have you seen any video over your phone line yet,'' says Nedbalski, whose employer's parent, KeyCorp, owns 6.8 million Verizon shares. ``I need to see it work, and I need to see it adopted. Cable guys have the upper hand.''
In the past year, Nedbalski's firm added cable stocks such as Comcast, the largest U.S. cable television provider, to its funds. KeyCorp holds 4.9 million Comcast shares.
Under Seidenberg, who took night classes to earn his bachelor's degree in math from City University of New York, Verizon's stock declined 23 percent in the past two years, to $35.40 on July 13 from $46.10 on March 28, 2002, the last trading day before he became sole CEO.
The 11-member Standard & Poor's 500 Telecommunication Services Index declined 21 percent, while Comcast's stock dropped 17 percent in the same period.
Local Call Leader
Verizon, which in April replaced former parent AT&T in the Dow Jones Industrial Average, has hemorrhaged 8 million lines since mid-2000.
Sales rose to $67.8 billion last year from $64.7 billion in 2000 as gains at Verizon's burgeoning wireless company -- the biggest in the U.S. -- outweighed declines in its telecom unit, which serves customers in 29 states and Washington, D.C.
Verizon ranks first for local calling, with 55 million lines, and is fourth in consumer long-distance sales, after AT&T, SBC Communications Inc. and MCI Inc.
Before Verizon was formed, Seidenberg was CEO of Bell Atlantic, one of seven companies spawned by the 1984 breakup of AT&T. Seidenberg had been CEO of Nynex Corp., which Bell Atlantic acquired in 1997. Four of the original so-called Baby Bells remain.
Losses to E-Mail
``Verizon is one of a bunch of former monopolies facing all kinds of competitive pressure,'' says Mark Hesse-Withbroe, an analyst at U.S. Bancorp Asset Management, whose Minneapolis-based parent, U.S. Bancorp, owns 6.6 million Verizon shares.
Like customers of fellow Bell companies BellSouth Corp., Qwest Communications International Inc. and SBC, some Verizon clients have departed because they're relying more on e-mail.
Others have flocked to wireless service plans featuring limitless local and interstate calls for a flat fee, while some disconnected lines devoted to dial-up Internet access in favor of cable modems or digital subscriber lines that offer Web surfing at higher speeds.
Long-distance companies AT&T and MCI and other recent entrants to the local phone market have also nabbed 15.2 million subscribers under U.S. Federal Communications Commission rules designed to foster competition, according to the FCC.
More Regulations
The regulations forced Verizon and other regional carriers to lease networks at rates set by state regulators. Seidenberg and his counterparts will probably start winning back subscribers who switched to AT&T and MCI now that a federal court has scrapped the network-leasing rules. AT&T on July 22 said it would stop trying to add residential subscribers.
A U.S. appeals court said in March the rules were illegal under the Telecommunications Act of 1996. In June, the U.S. solicitor general and the FCC chose not to ask the Supreme Court to review the decision.
Seidenberg's losses to cable companies have only just started, says Krause at Minneapolis-based Thrivent. ``Cable companies are the real threat,'' he says. ``They have a really robust plant that can offer voice.''
What's more, Verizon remains subject to other rules, such as FCC and state regulations that let the government determine how much providers can charge to carry each other's phone calls, while cable companies run largely free of regulation, Krause says.
And unlike employees of its cable rivals, most of Verizon's workers are represented by unions, increasing the company's labor costs and reducing flexibility in moving and firing workers. ``They are cost and opportunity disadvantaged,'' Krause says.
Reducing Debt
Seidenberg, who served as an Army sergeant in Vietnam, says Verizon is prepared for the cable onslaught. ``They do have good architecture; they do have less regulation,'' he says of cable companies. ``The trade-offs are, we have more cash, more concentration and, I think, better-trained people.''
Verizon has less debt, compared with earnings before interest, taxes, depreciation and amortization, than Comcast. Verizon's debt-to-Ebitda ratio at the end of March was 1.77 compared with 3.89 for Comcast, according to data compiled by Bloomberg.
Chief Financial Officer Doreen Toben, 54, has used cash and asset sales to slash $18.9 billion from Verizon's debt in two years.
Seidenberg rejects the suggestion that telecommunication and cable companies are at war. He says both Verizon and cable providers can gain. ``I view them as a competitor, but I also view them as a responsible partner in expanding the capacity of our industries to grow,'' he says.
`Drive-by Shootings'
Verizon and its cable competitors, Seidenberg says, will be survivors in an industry that in the past three years has seen bankruptcies for WorldCom Inc. and Global Crossing Ltd.
Seidenberg gives his deputies wide latitude in running their units and keeps himself abreast of developments through informal conversations he terms drive-by meetings, says Robert Ingalls, 49, Verizon's president of retail markets. ``I've heard that term differently, as `drive-by shootings,''' Ingalls says.
``He knows how to get you in a discussion and to motivate you to focus on the right stuff by asking a lot of questions,'' he says.
Ingalls recalls one instance, before the merger, when he was Bell Atlantic's vice president of consumer marketing and the company had just begun losing lines in New York.
Seidenberg's Advice
``It was probably one of the more intense meetings,'' he says. ``I was a little bit on the hot seat. He subtly called me into his office, and he gave me a lot of very specific messages about, `It's good to have passion about what you do.' He reinforced for me the things I should do to try to solve the problem.''
Seidenberg emphasized that Ingalls should focus on what he can change -- such as marketing -- and not worry about what he doesn't control. Ingalls says he followed the advice by introducing more-flexible service plans.
Half a decade later, the competition is heating up again.
Philadelphia-based Comcast plans to make phone service available to almost all of its 21.5 million subscribers by the end of 2006, the company said in May.
Like other cable companies, Comcast delivers calls using circuit-switched technology, which can convey only a single conversation over a given circuit at a time and is the same method used by the Baby Bells.
Comcast and its counterparts are quickly adopting Voice over Internet Protocol, which cuts carriers' costs by as much as half, according to Atlanta-based Cox Communications Inc.
`I Love It'
Comcast, Cox and other cable providers will probably have 9.6 million phone customers by the end of 2008, up from 2.6 million at the end of 2003, Lehman Brothers Holdings Inc. analyst Vijay Jayant says.
By the end of 2008, gains by cable companies and other sellers of phone service based on VoIP will probably cost Verizon and the other local phone companies $7.3 billion in annual sales, Fitch Ratings analyst Michael Weaver says.
Jeff Parsons, a 33-year-old radio disc jockey from Portland, Maine, says switching to the VoIP product sold by Time Warner Inc.'s cable division has cut his phone bill by two-thirds. ``I absolutely love it,'' says Parsons, who made the switch from Verizon last year. ``The amount of money you save is incredible.''
Home State Competition
Parsons says he pays Time Warner $39.95 a month for unlimited local and long-distance calling compared with an average of $120 he paid Verizon. A plan that includes unlimited local and long-distance calling for $54.95 a month is available in Parson's area, according to Verizon's Web site.
Time Warner Cable, the second-largest U.S. cable television company, had 14,000 telephone subscribers at the end of March and intends to make VoIP calling available to all of its 10.9 million subscribers by the end of the year.
Verizon's competitive challenges may be most acute in the company's home state of New York. Moody's Investors Service in April cut the rating on debt issued by the company's New York unit by three levels to Baa2, Moody's second-lowest investment- grade credit rating, citing rapidly expanding competition from cable companies.
Two months after the credit rating cut, Cablevision, the biggest cable service provider in the New York area, introduced a product that groups TV, phone and Web access at an introductory rate of $90 a month, 30 percent less than the same bundle of services from Verizon.
And now, for the first time, Verizon finds itself having to grapple with other providers for a five-year contract to sell as much as $200 million in annual services to New York City.
Power Failure
New technologies are letting the city, like other customers, choose from a broader range of service providers rather than depend on what used to be a monopoly phone company. Previously, only data services were bid upon.
Gino Menchini, commissioner of the city Department of Information Technology and Telecommunications, praises Verizon's efforts to restore phone service to lower Manhattan after the Sept. 11 attacks, including its role in getting the New York Stock Exchange running six days later. ``They did a great job,'' he says.
Verizon didn't do as well during the power failure in August 2003, the largest blackout in North American history, Menchini says. ``We had central offices that failed because generators weren't adequately maintained,'' he says. ``I'm working very closely to ensure that doesn't happen again.''
Seidenberg says he's confident Verizon can compete. ``They've laid out a fair challenge,'' he says. ``And we think we have new technology and new skills to offer.''
`Focus On Growth'
Seidenberg, who earlier in his career handled federal regulatory affairs for AT&T and Nynex, says he spent too much time in 2003 calling the attention of investors and lawmakers to laws he considers outdated or unfair.
Those include the rules that forced him to lease parts of Verizon's network at rates determined by states rather than the market.
``It's more important to get focused on growth and opportunity than it is to get focused on what government is or isn't doing,'' Seidenberg says. He says he let complaints about laws get in the way of his plans to transform Verizon.
``We allowed the issues to dominate our psychology too much,'' he says. ``They became too much a part of our public persona.''
Confronting Cable
As part of the effort to make up for lost time, he's announced plans to spend about $800 million installing fiber- optic cables to 1 million homes in California, Florida, Texas and six other states this year. He says he'll double the number of homes next year and reach customers who generate half of the company's revenue in the next five years.
The effort will cost $1,000-$1,200 a home, totaling as much as $30 billion over 15 years, says Merrill Lynch analyst Jessica Reif Cohen.
Besides cutting the cost of delivering traditional calling, having fiber-optic connections to homes means consumers will be able to download songs, documents and other information at speeds 20 times faster than now possible over DSL.
Ultimately, Verizon plans to use the connections to transmit video and television, confronting cable providers on their home turf, Seidenberg says.
He's made a good start by expanding what Verizon calls its other growth divisions, including DSL and its Verizon Wireless mobile phone unit -- 55 percent of which is owned by Verizon, with 45 percent owned by Vodafone Group Plc -- says analyst Tim Gilbert of Des Moines, Iowa-based Principal Global Investors, which manages $122 billion, including Verizon bonds.
Reducing Costs
Customers who buy a bundle of products that includes local and long distance or fast Web access are about 70 percent less likely to disconnect local lines and generate an average of $5 more in monthly revenue than those buying a single service, Verizon Vice Chairman Lawrence Babbio, 59, says.
In the first quarter, 50 percent of Verizon's $17.1 billion in revenue came from areas such as wireless, DSL and long distance, compared with 45 percent a year earlier.
``We have focused on the things it's going to take first and foremost to keep our customers and, secondly, to continue to drive our revenue,'' retail markets head Ingalls says of Verizon's efforts to sell a broader range of products.
In the first quarter, phone companies such as Verizon added more high-speed Internet customers than cable companies did for the first time, say UBS AG analysts John Hodulik and Aryeh Bourkoff.
Top Wireless Company
Seidenberg is investing more than $1 billion in two years on VoIP equipment so he too can reduce costs, says Albert Lin, an analyst at American Technology Research in San Francisco.
He's started selling satellite television through an agreement with DirecTV Group Inc., the largest U.S. satellite TV company, for customers who want to buy phone, Web access and TV services from the same vendor.
Seidenberg's most attractive division is one cable companies lack: Verizon Wireless, Victory Capital's Nedbalski says. The Bedminster, New Jersey-based company outranks other U.S. mobile phone carriers in terms of subscribers, sales and spending on network upgrades.
Run by Dennis Strigl, 58, Verizon Wireless lifted revenue 21 percent to $6.2 billion in the first quarter and was the only one of Verizon's four units with a sales gain.
Verizon Wireless ranked highest in customer satisfaction in each of the 12 markets covered by a survey conducted last year of more than 31,000 users of the Consumer Reports Web site, showing why it has the lowest client turnover in the industry.
Small Acquisitions
Seidenberg missed an opportunity to own all of Verizon Wireless earlier this year, when Vodafone failed to acquire AT&T Wireless Services Inc. The purchase would have required Vodafone to sell its $20 billion Verizon Wireless stake to Verizon.
Seidenberg and Strigl say the relationship was unharmed by Vodafone's interest in exiting the partnership and that Vodafone was justified in not overpaying for AT&T Wireless. ``If anything, my first reaction was, I was pleased Vodafone was in the game to drive the price up,'' Strigl says.
SBC and BellSouth, parents of Cingular Wireless, acquired AT&T Wireless for $41 billion.
Seidenberg makes clear he's eager to own all of Verizon Wireless. ``Would we like to own 100 percent of the business? Sure,'' Seidenberg says.
Hard Hat
He's had to settle for expanding the wireless unit through smaller purchases, such as the July 1 acquisition of Qwest's mobile phone assets for $418 million.
Seidenberg keeps in a desk drawer the shears he used to splice cables when he started in the phone industry. He rifles through the closet of an otherwise uncluttered office to show he's also got a hard hat and a raincoat for use in the field, in case of hurricanes, floods or other catastrophes.
``You've got to keep them,'' he says. ``You've got to use them.''
Such preparation helped Verizon weather the telecommunications meltdown that sent WorldCom and Global Crossing into bankruptcy. Seidenberg is spending $30 billion to protect against what may be the hardest challenge yet.
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