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Verizon, AOL, And What You Need To Know

May. 27, 2015 11:14 AM • vz

  • Verizon’s acquisition of AOL has largely received mixed reviews in the investment community.
  • While the mismatched (by market cap) purchase will not wildly enhance Verizon’s bottom line on its own, future synergies have the potential to produce.
  • Look for continuing guidance as Verizon rolls out their OTT entertainment package, along with consumer response to it.

With the acquisition of AOL (NYSE:AOL ), Verizon (NYSE:VZ ) is embarking on an untried path. The overall market reaction has been tepid as watchers wait to see whether the deal will be a $4B blunder, or signal a new era in the rapidly evolving technological revolution. While there is some question as to whether a blue in the wool telecom can blend business with the ponytail programming crowd, there is no question that the two businesses have overlapping interests.

Verizon has been playing around with various forms of TV-streaming services for some time. They have had a deal with the NFL for the past several years to provide games on cellular devices (the most current deal is worth $1B over 4-years ) and are on track to lay out an OTT by the summer that will largely attempt to monetize viewers through ad-placement.

Verizon Wireless will employ an advertising-based model for its planned over-the-top mobile video service, which a top executive at the carrier predicted could become a multibillion-dollar business over time. And that's the major reason why Verizon Communications just spent $4.4 billion to buy AOL.

While current viewing of online video content dips strongly into a cell phone user's data bucket, Verizon envisions a scenario where ad-based revenues will allow the carrier to largely offset the data costs of transmission. In other words, customers will be able to access the OTT service over the air without continually banging into overhead data caps. The ability to provide targeted advertising for the particular viewer will be a key in producing the ad revenues that will be needed to cover the cost of programming offerings and cellular data streams.

This is where the synergies can begin to build up between the typical "focused-advertising" (which has become the tried and true revenue source for search engines) and cellular services: the phone company knows where your cellular device is at all times, which means that they know where you are and where you tend to go. Add all of that to the template of data profiling that proliferates everything web, and Verizon/AOL may well be able to enhance their ad-services in order to produce, as stated by Verizon. "a multibillion-dollar business for us from an advertising standpoint."

And while some content may be promoted by allowing viewing without dipping into user's data buckets, the overall strategy is likely to blend some form of subscription service on the OTT while appealing to the data-intensive streaming crowd, and then topping it off with ad-driven revenues. The goal, as always, will be to increase ARPU while maintaining (or increasing) net post paid customers.

Small cell networks

On the tail-end of Sprint (NYSE:S ) CEO Marcelo Claure's journey to Japan to discuss raising funds from parent SoftBank to build out small cell sites, Verizon has suggested that they may follow the same approach. The record setting spectrum auction from last year is convincing cellular network providers that better economies of scale may be found with fewer airwave assets, replaced by a denser network of small cell sites.

Currently, Verizon is focused on the top 50 U.S. markets for small cell deployments, with a special focus on the top 10. Shammo said.

And while Sprint has indicated that it may or may not bid in the upcoming

spectrum auction as a result of the intense prices that cellular spectrum is fetching, you can bet that all the carriers will be interested in grabbing some of the lower frequency spectrum that is coming available: it will likely be the last opportunity for quite some time to gain the long range, building piercing spectrum that is necessary to build out a cellular network satisfactorily. The spectrum auction slated to occur in 2016 is sure to bring all comers.

AT&T (NYSE:T ) has recently been making inroads at grabbing up some loose 700MHz spectrum, and will clearly be interested in the 600MHz spectrum in the 2016 auction. And while the lower frequency spectrum is not ideal for data heavy applications, it is required for truly nationwide coverage. The bidding war very well may cool presuming that DISH (NASDAQ:DISH ) has had their fill of spectrum (which is a real possibility) and Sprint and company are relegated to minor players. Still, the auction cannot come fast enough, as debt costs are looking more and more like they are on the upswing on the likelihood of federal interest rate hikes.

Verizon by the book

Like AT&T, Verizon has a long history of increasing dividend payments. And while the increases have been a bit more sporadic over time for Verizon, the past decade has seen a 36% increase in dividend payments to shareholders. In that time the payout ratio has varied wildly; needless to say it is high, in an industry that typically maintains high payout rates. Verizon is certainly not afraid to consume debt in order to maintain payments to investors.

And unlike the AT&T mega-merger with DirecTV, the AOL acquisition should not produce too steep of a balance sheet tick. While AOL will largely be allowed to operate independently (while in conjunction) with Verizon from a business perspective, it seems likely that any complementary features will be sought out and exploited. ROI on the AOL asset itself will initially be marginal, but if the build out of ad revenues on the OTT offering produce, the return could be quite positive down the road.

Although the market has been somewhat tepid in regards to the news of this acquisition, the upside appears to be good, while the downside (at $4B) is relatively minor. As a return on investment vehicle, Verizon has been making many moves towards delivering not simply a cellular network for their customers, but a content driven engine to draw data hungry media viewers into their skirt. It remains to be seen whether Verizon will be able to produce on this promise, but the AOL deal is a good one considering the direction that big red was heading.

AOL has been improving their ad services and has a few media content assets to boot. Though rumors are that Verizon is considering spinning off those assets, do not be surprised if they remain in the AOL portfolio. Given the vastly different skill set that is needed to manage a telecom verses an internet content provider, it is a smart decision for Verizon to allow AOL managers breathing room to do their thing. Still, no synergies can be gained if they do not find common ground. Although Verizon has acquired AOL, the ability for AOL to be useful to Verizon's bottom line will probably be influenced more by the direction and innovation of the AOL camp, as they find ways to utilize the Verizon information bag on consumers to round out their advertising product.

Disclosure: The author is long S, T.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Category: Forex

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