What Warren Buffett Sees in Verizon

If you’re a regular Investing Daily reader, you likely know that every three months, we update you on the stocks some of America’s best-known investors are buying and selling. We do that by carefully parsing their 13F filings.

Here’s how it works: within 45 days of the end of each quarter, institutional money managers with assets of at least $100 million must report their stock holdings to the SEC via Form 13F. At the end of the 45-day period, the SEC makes these filings available to the public on its website.

We released our latest analysis of the 13F forms of four superstar investors—Warren Buffett, Seth Klarman, Daniel Loeb and David Einhorn—just last week. (Click here to read that article.)

One thing to keep in mind: these 13F filings are often out of date before they’re even released, and they likely don’t paint an up-to-the minute picture of each investor’s holdings.

Nonetheless, they’re worth paying attention to—particularly when two or more of these investors zero in on the same stock, as was the case in the first quarter.

Calling Verizon

The quarter saw two of our four investment gurus—Buffett and Loeb—take significant new positions in telecom giant Verizon Communications (NYSE: VZ), a long-time holding of our Utility Forecaster advisory’s Growth Portfolio.

Buffett’s Berkshire Hathaway (NYSE: BRK.A, BRK.B) bought 11 million Verizon shares in Q1, valued at about $524 million as of the end of March, while Loeb, head of the Third Point hedge fund firm, bought 3.5 million shares, worth about $166 million as of quarter-end. Meanwhile, fellow hedge fund honcho John Paulson added 8.7 million Verizon shares (with a value of about $415 million).

The big news surrounding Verizon in Q1 was the closure of its $130-billion deal to buy Vodafone Group’s (NasdaqGS: VOD) 45% stake in its Verizon Wireless business on February 21. The company said the move would immediately lift its earnings per share by 10%.

Buying Vodafone’s interest significantly increased Verizon’s debt, but it now has access to all of Verizon Wireless’s substantial free cash flow (or operating cash flow minus capital expenditures), which will help it pay down that debt and keep raising its $2.12 annual dividend (4.3% yield).

At the same time, the company has been making huge investments in its wireless and wireline networks in the past few years, to the tune of around $4 billion a quarter. Verizon has now completed the rollout of its high-speed 4G LTE wireless network, and now offers 4G LTE service to 97% of the nation.

Dividend, “Economic Moat” Likely Caught Berkshire’s Eye

Due to its relatively small size (in Berkshire terms), the Verizon investment was likely made by one of Buffett’s portfolio managers, Ted Weschler or Todd Combs. But it’s entirely in keeping with the Oracle of Omaha’s investment style.

For one, even though Buffett remains opposed to Berkshire Hathaway paying a dividend itself, he’s long been a fan of dividend-paying stocks like Verizon. Blue chips with above-average yields, such as IBM (NYSE: IBM), General Electric (NYSE: GE) and Coca-Cola (NYSE: KO), continue to make up the bulk of Berkshire’s holdings.

Aside from having one of the highest yields in the S&P 500, Verizon has paid dividends consistently since 1984 and has raised its payout every year since 2005.

Verizon also enjoys what Buffett calls an “economic moat”: in other words, it possesses key advantages that make it tough for competitors to lure away customers (much like a physical moat protects a castle from invasion). These include its newly rolled-out 4G LTE wireless network, its enduring brand, the ability to bundle Internet, phone and TV services and, of course, two-year wireless contracts.

The company’s churn rate, or the average percentage of wireless contract customers who left for another carrier, came in at 1.07% in the first quarter, equal to that of main rival AT&T (NYSE: T).

3 Long-Term Trends Working in Verizon’s Favor

Here’s a closer look at three trends Verizon is well-positioned to capitalize on in the years ahead: 

  • Mobile video’s next act: In the wake of AT&T’s $48.5-billion acquisition of satellite operator DirecTV (NYSE: DTV), rumors flew that Verizon was in talks to buy rival satellite firm DISH Network (NasdaqGS: DISH). But Verizon CEO Lowell McAdam quickly shot that down. “I don’t feel that owning a satellite company is something I find intriguing at this point,” he said.

    Instead, the company is focusing on rising demand for mobile data as more consumers watch video on their smartphones and tablets. Total U.S. mobile data revenue hit $90 billion in 2013 and is expected to rise above $100 billion this year, according to technology consulting firm Chetan Sharma.

    Last weekend, the company tested its LTE Multicast service by broadcasting the Indy 500 over its 4G LTE network. Using multicasting, video is broadcast to numerous devices at once over a designated channel of spectrum. That puts less pressure on the network than “unicasting,” or streaming video to smartphones and tablets individually.
  • The growth of the cloud: The company continues to develop its OnCue Internet TV platform, which it recently purchased from Intel Corp. (NYSE: INTC). Verizon hasn’t yet launched OnCue, but McAdam recently gave a hint of its future when he referred to it as a virtual video “jukebox” that would let consumers access a wide range of content from the cloud. Unlike cable, OnCue would offer transactional video-on-demand (where the customer pays for each individual program) and subscription functionality.

    “I think that’s a very attractive model for us. But it can’t be the bundled 10 channels together and force users to take it over-the-top, the way they have done in their current linear model,” said McAdam, speaking at the J.P. Morgan Global Technology, Media and Telecom conference on May 20.
  • A spreading ’net: Another factor that’s likely to increase demand for wireless services is the continued growth of the Internet of Things, which refers to the web’s spread beyond computers and mobile devices to things like thermostats, industrial sensors, cars and even kitchen appliances—refrigerators, for example.

    Tech research firm IDC recently predicted 30 billion “autonomously connected endpoints” and $8.9 trillion in revenue from the Internet of Things by 2020.

    That creates an opportunity for wireless carriers like Verizon: according to figures from tech market research firm Ovum, machine-to-machine wireless revenue will jump to $44 billion by 2018 from $13 billion in 2012. Importantly, that estimate only includes industrial usage, not consumer devices.

Meantime, most major Wall Street analysts agree with the Oracle of Omaha’s Verizon buy: 9 currently rate the stock a strong buy, while 14 give it a buy recommendation. There are no sells. Nine analysts rate the shares a hold.

Verizon currently trades at 14.0 times its forecast 2014 earnings, just a touch above AT&T, at 13.7, but below the S&P 500’s forward p/e ratio of 16.0. The stock also offers low volatility, with a beta rating of just 0.36. (Stocks with a beta of 1 are as volatile as the market, while those below are less volatile.)

You can get immediate access to all our analysis of Verizon—including our carefully selected buy-under target on the stock—when you take a no-risk trial to Utility Forecaster today. Simply click here to join now.

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