The Case for Verizon -- Part 1

[BRIEFING.COM - Robert V. Green] Verizon Communications (VZ) has been a long-term growth pick on our Current Stock list since December 2005.  In today's column, we reiterate the investment premise for Verizon. At current price levels, and with a strong proof of demand for the FiOS service that is key to our premise, we believe additional investment or new positions in Verizon are very attractive.

The Verizon Investment Premise

We have frequently summarized the Verizon investment premise in the following way:

How quickly is Verizon approaching true convergence of all digital telecom services onto a single network?

We have long believed that the future of the telecom industry centers around the development of "single-source" telecom vendors. This term describes a vendor that is able to deliver all of the available telecom services over a single technical infrastructure, with true convergence of functionality.

Before detailing Verizon's position in the telecom industry today -- and their progress made so far toward fulfilling our investment premise -- it is helpful to look at some history of the telecom industry.

Convergence And The Internet 2.0 Vision

Our premise for Verizon is based upon their ability to truly "converge" telecom services onto a single network platform.

The term convergence has been around for a long time. In fact, at the height of the Internet bubble in early 2000, the "big dream" of the next wave of the Internet was convergence of video onto the then (and still) primarily text-based world-wide-web.

Called "Internet 2.0" (not to be confused with "Web 2.0"), this vision of the "next-wave" of the Internet revolution never really happened. Video simply required more bandwidth than was possible at the time, even though the industry suffered from a fiber-optic glut, at the "middle level" of the network.

Venture capitalists had raced to build networks that would service the thousands of end-user providers. This type of infrastructure was viewed as "selling pick-axes to the miners." Global Crossing, Frontier, and Qwest, were all based upon the idea of owing a key part of the Internet 2 infrastructure -- with the potential to charge tolls to all travelers.

The Qwest Commercial

This vision was nicely encapsulated in a Qwest commercial that was widely broadcast in late 1999 and early 2000.

A weary business traveler pulls into a dreary looking hotel in the middle of a desert. He asks the bored desk clerk if the hotel rooms have TVs. Without looking up from her magazine, her droll response was "we have every movie ever made, in every language, available on demand, at any time."

This any-movie-any-time pay-per-view vision was the core idea behind Internet 2.0, but when it became clear that this vision would not materialize overnight -- like the text based Internet had -- the entire Internet bubble investment era began to unravel.

The Lack Of Broadband

The real problem, however, was that there were few homes that had broadband Internet access. The wave of predicted broadband services never developed, because few homes in 1999 and 2000 could receive broadband Internet. This problem came to be known as "the last mile" problem.

What was really needed to fulfill the vision of "Internet 2.0" was an infrastructure capable of delivering broadband services directly to the home.

To build such a network, the cable companies began converting their analog systems to digital cable, with integrated Internet service. Once Internet service was available, integrating telephone service using VOIP became possible.

The cable companies were the first to address the "last mile" problem. They were initially extremely successful in delivering Internet services to homes, particularly to homes that were already TV customers.

In the years from 2000 through 2005, Verizon's response (along with the other RBOCs) was DSL service. DSL service, while functional, was technically inferior to cable-based Internet access, however.

It would not be until Verizon began to roll-out their fiber-based network -- completely independent of and separate from the copper-based telephone network -- that Verizon would be able to offer a truly competitive broadband product.

However, Verizon's FiOS product was positioned not as a broadband Internet product, but as a network for bundled services.

What Is Bundling?

The current term used for multiple telecom services sold as a single package is "bundling."

This misleading term should not be confused with what we are calling "single-source" telecom providers.

Bundling simply refers to the delivery and billing of separate telecom services from a single vendor. For example, a bundled "triple-play" from Comcast includes Internet service, "land line" phone service, and digital cable television.

However, there is no integration between these services from any vendor, currently. Each product is separate, with no integration of  functionality. The only thing that is truly bundled is the billing invoice.

Triple-plays from cable companies and from RBOCs such as Verizon and AT&T are all currently "bundled" products. There is very little integration of functionality between the services, even though they may be delivered over the same wires.

The Vision Of Integrated Telecom Services

The vision of integrated telecom services, however, is much different. On an integrated telecom service network, cross functionality between services becomes possible.

Some examples of cross-functionality are the following:

• Caller-ID of an incoming phone call appears on the television screen, with the capability to pause the TV from the remote control.
• Ability to have an instant message or tagged e-mail or other type of Internet based alert appear on the TV screen.
• Ability to have an instant message or tagged e-mail delivered to a land-line phone screen, as is today done with cell-phones.
• Internet based access of a digital DVR (TiVo) in order to program recording of a program from any location (DirecTV has this functionality now).
• Ability to display IP-based TV delivered from an Internet Web site on your wide-screen HDTV.
• Ability to display a Skype-style video-phone call on your television, using either your cell phone number or your land-line number.
• Having home-phone voicemail messages forwarded as an e-mail message or a text-message to a cell phone.

In addition, once a digital TV is integrated with the Internet, it becomes possible to use the TV screen as the viewing engine for a Web site.

While WebTV has offered this service for years without much success, their problem was trying to "replace" the presence of a computer with a keyboard. With an integrated service, the existing computer simply routes output to the TV.  Since both the computer and the TV are connected to the same, integrated digital service, a truly functioning converged service is possible.

This type of integration has just begun with the iPhone, where Internet services are delivered to a cellular phone. Imagine the wave of new functionality that could be delivered when your TV becomes a giant iPhone, with the remote control being touch screen, as it is now.

Such as service does not require purchase of new television, provided that the TV is digital. All that is required is a digital processing box -- and a single-source telecom network.

At this moment, it becomes possible for true on-demand video of any kind. This was the vision of Internet 2.0 eight years ago that never happened.

With the eventual integration of cellular phone service, examples of cross-functionality become even greater, including:

• Placing a cell-phone in a "home-charger" unit, which automatically forwards incoming cell-phone calls to the existing phones in a house.
• Using an Internet-based "mailing list" to send a single text-message or voice message to multiple cell phones or e-mail addresses (Verizon offers this functionality now.)
• Using a Web-enabled cell phone to perform Internet research, then sending all of the results to either a home-based DVR or computer for storage. In fact, the results could be delivered directly to other devices, not necessarily to the cell phone.

There are, of course, many other potential new features that could be offered, many of which have not been envisioned by anyone yet.

The Pieces That Most Analysts Are Missing

Analysts today generally view Verizon as a traditional phone company that is struggling to survive the changing forces in the industry. Only Verizon's dominance in the cellular industry is viewed as positive, but that market is now viewed as mature.

This perception includes an image of a slowing moving, innovation fearing dinosaur, content to graze on guaranteed profits. Furthermore, the image is diluted with the vision of the POTS (plain-old-telephone-system) as being the essential asset of the company, which is now eroding.

This still-widely held perception tends to hold back multiples on VZ stock. However, we view this out-of-synch market perspective as a buying opportunity.

Since the building of the FiOS system began, Verizon has been remarkably aggressive, both in capital investment and in marketing. We began viewing Verizon as an aggressive innovator when the company first began to rollout the FiOS network. For details, please see the Ahead of the Curve column of 29-Aug-05 "Verizon: Shift From Dividend Focus To Long Term Premise."

Since that time, Verizon has made significant progress towards fulfilling the vision of a single-source network. In fact, we think that the growth rates exhibited by Verizon so far imply much greater potential for the FiOS product than anyone - including ourselves - envisioned two years ago. 

The piece that most analysts are missing, however, is the potential for true convergence that the FiOS network offers.

There is no other network in existence today, including the AT&T fiber network or the cable networks, that can provide true convergence of all four telecom services: home phone, cell phone, video, and Internet. The only network being built today that can converge all of these services is the Verizon FiOS network.

The current focus in the telecom world is on "bundled" products, often called "triple-play" products.  The real shift in the telecom industry will occur when bundling gives way to convergence. After that, when the convergence of cellular service begins to appear, Verizon's true competitive advantage will become apparent.

More To Come

We will take a look in more detail at Verizon's progress toward fulfilling this vision of converged telecom services in an upcoming article.

Comments may be e-mailed to the author, Robert V. Green, at rvgreen@briefing.com

Verizon Communications (VZ):  September 4, 2008, midday: $ 34.57 -1.13 (-3.19%)

Note: In accordance with Briefing.com's Trading Policy, the author has a personal position in Verizon Communications.