Monday, March 1, 2021

Verizon Communications Inc. ($VZ)

The Berkshire Hathaway 2020 Annual Report was released on Saturday morning. One thing I saw is that Buffett has been buying Verizon Communications Inc. (VZ). 

A comment on Twitter: "I think $VZ is a long-term inflation bet. Buffett agrees with you and wants a biz with upfront capex now (next 3-5 yrs) and oligopoly pricing power once inflation picks up (5+ yrs). Consistent with his ‘77 fortune article too." [“How Inflation Swindles the Equity Investor”]

We like industry concentration and oligopolies. The cellular business in the U.S. is down to four companies: AT&T (T) is biggest, VZ is second biggest. Those top two wireless providers have something like 70% market share. That is almost as concentrated as the tobacco duopoly in the U.S. (of MO and BTI). 

Importantly, AT&T and Verizon own most of the low frequency spectrum. John Hempton wrote a physics-based explanation for the competitive advantage this gives:

AT&T and Verizon have the lion's share of low frequency spectrum in the US. [Both Sprint and T-Mobile have narrow slices.] These large holdings of low-frequency spectrum mean that Verizon and AT&T can offer better coverage at lower capital cost than their competitors. The low frequency spectrum however still has limited capacity. If you want lots of capacity you have to use high frequency spectrum (simply because there is much more of it). If you have low frequency spectrum you advertise yourself on network reliability ("Can you hear me now") but you offer limited and often small data plans. If you have a high-frequency network your reliability is going to suck (sorry Sprint) but you can offer very large (even unlimited) data plans.

Better coverage at lower capital cost because low frequency radio waves penetrate through obstacles better, so you do not need as much infrastructure to provide the same amount of service.

I see that VZ trades for ~14.5 times earnings if you adjust earnings lower by substituting last year's capital expenditures for last year's depreciation charge. (See the 2020 10-K for VZ.) Otherwise 12.9x if you take reported net income. They have had remarkably steady dividend growth and the shares have consistently traded at a 4%ish dividend yield.

As we are putting on a value vs growth trade, we are interested in big capitalization public companies in concentrated industries that return cash to shareholders. Lists of oligopolistic industries are a good starting point. Factors to consider:

  • Valuation - Search engine market is concentrated (a monopoly) but it’s not cheap.
  • Recurring revenue - something like tobacco or cell phone service has less volatile revenue than capital equipment like airliners (duopoly industry) or heavy trucks.

Businesses with recurring revenue seem to do a lot better over time than ones that sell product in fits and starts. 

A related concept is customer stickiness. Somehow, the good industry structure of car tires hasn’t translated into consistent profitability for Goodyear. Perhaps the answer is: people are loyal enough to Marlboros that the operating margin is 40%; people are indifferent enough about tires that the operating margin is 5-10%.

No comments: