Verizon Will Ride New Streaming Service to $43.50

Verizon (NYSE:VZ) is planning to launch a streaming service that doesn’t require an existing cable connection, which pits it more directly against Netflix and could hurt the same cable TV operators with which it has recently struck deals. ^[1] Verizon recently entered into agreements with Comcast (NASDAQ:CMCSA) and Time Warner (NYSE:TWC), the top two cable operators in the U.S., to resell their cable TV service as part of its single, double and triple play bundles to its customers. ^[2] The cable TV operators have seen a drop in pay TV subscriptions in favor of cheaper web-based alternatives, and Verizon’s move will only heighten these concerns.

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FiOS margins should decrease in the longer term

Verizon’s FiOS TV service has about 4 million customers. It provides this service by buying content from studios and distributors that is then packaged and sold to customers, as any other cable company or satellite provider does. However, its scale of operations in this segment is not that big, and the company had decided not to expand into new markets and instead focus on bolstering its existing FiOS network. ^[3]

This has made it tough for Verizon to negotiate favorable terms with content providers who are afraid to antagonize the big cable operators with whom they have had long-standing relationships. The wireless carrier is therefore planning on coming out with a service that will also be available outside Verizon’s FiOS current markets, catering to the needs of about 85 million households. Increasing the scale of operations by growing its number of subscribers will help it negotiate lower fees and decrease costs on a per-subscriber basis, and this will help improve its gross margins for the existing FiOS service as well.

If Verizon manages to draw enough subscribers to its streaming service, this will help it brand and market its wireless services, possibly in a quad-play bundle that will also include its FiOS TV service.

However, for that to happen, it will have to first take on established market players such as Netflix, HBO and Amazon.  And that entails having to take a hit on its margins in the initial few years before it has grown its subscriber base big enough to be able to command favorable terms with content providers.

Our price estimate for Verizon’s stock is $43.50, which is about 15% above market price.

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1. Verizon to take on Netflix with Web service, Reuters, December 6th, 2011 [↩]
2. Comcast, Time Warner Cable, Bright House Networks and Verizon Wireless Enter into New Agreements, Comcast press release, December 2nd, 2011 [↩]
3. Verizon Axes FiOS Expansion, PCMag, March 27th, 2011 [↩]