How did the MCI merger change Verizon's business and financial outlook?

MCI closed on January 6, 2006, giving Verizon one of the largest end-to-end global IP networks and creating Verizon Business to serve medium and large enterprises and government customers. Management expects merger synergies with a net present value of about $8 billion, with annual benefits of $550 million in 2006, $825 million in 2007 and $1.1 billion in 2008. Integration costs are estimated at $400 million, $325 million and $275 million over the same three years, and integration capital spending is $1.6–1.9 billion. The cash consideration included about $779 million in supplemental payments, plus MCI debt redemptions and the Carlos Slim share purchase.

Is Verizon's wireline business shrinking, and can growth offset it?

Yes, the wireline voice business is in structural decline. Domestic Telecom revenues fell 1.1% in 2005 because switched access lines dropped 6.7%, driven by competition, technology substitution and wireless substitution. Growth areas are offsetting part of this: data revenue rose 10.5%, DSL and broadband connections reached 5.1 million, and long distance lines reached 18.4 million. Management says growth-area revenues (wireless, broadband, long distance, business data) were 58% of total revenues in 2005, up from 53% in 2004, and that FiOS fiber deployment is central to the strategy.

What is the key value driver in Verizon's results?

Verizon Wireless, a 55%-owned joint venture with Vodafone holding 45%, is the main driver. Its segment income rose 34.9% to $2.2 billion, and it is the most profitable U.S. wireless carrier by operating income. Because Vodafone owns 45%, minority interest expense rose to $3.0 billion in 2005, which substantially reduces the share of earnings attributable to Verizon. Vodafone also holds a put right of up to $20 billion for its interest, exercisable in 2006 and 2007 at up to $10 billion per year, which is a potential future cash obligation.

What are the main risks flagged in the filing?

The filing highlights intense competition from cable, wireless, VoIP and other carriers; technology substitution eroding access lines; and regulatory uncertainty, including FCC unbundling rules, intercarrier compensation reform and universal service changes. Other risks include rising pension and retiree health costs, which increased net benefit expense to $1.4 billion in 2005, and integration risk from MCI. Credit rating downgrades and the Hicksville environmental remediation (with ongoing personal injury claims) are also noted. Verizon management states that legal and regulatory matters are not expected to have a material effect on financial condition, though they could affect results of operations.

VZ 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 14, 2006. Cited figures are marked; the original filing is the authoritative source.

Verizon's 2005 10-K (filed March 14, 2006) describes a company in transition: wireline access lines are declining while wireless, broadband (FiOS, DSL) and long distance grow.

Consolidated 2005 revenues rose 5.4% to $75.1 billion^a and operating income rose 13% to $14.8 billion, led by Domestic Wireless revenue growth of 16.8% to $32.3 billion. Net income was $7.4 billion ($2.65 diluted EPS), down from $7.8 billion in 2004, which included a $516 million discontinued-operations gain. The drop reflects a $787 million TELUS gain in 2004 that did not recur, lower equity earnings, and higher minority interest of $3.0 billion, largely Vodafone's 45% share of Verizon Wireless.

The filing is dominated by the pending MCI acquisition, which closed January 6, 2006. The combined company gains a major global IP network (over 270,000 domestic and 360,000 international route miles) and the Verizon Business brand, with management targeting roughly $1.1 billion^b in annual synergies by 2008. Integration will add costs and capital expenditure, and 2006 capex is guided to $17.0–17.4 billion including MCI, versus $15.3 billion in 2005.

Verizon also issued $4 billion^c of notes in February 2006 and redeemed MCI debt, while its share buyback authorization was raised to 100 million shares. Investors should weigh the strong wireless franchise and cash generation (operating cash flow of $22.0 billion) against structural pressure in wireline voice, a 2006 credit rating downgrade by S&P to A, and the execution risk of integrating MCI. Information Services is being explored for divestiture, and large uncertainties remain in regulatory proceedings, the Hicksville environmental matter and the Vodafone put option on Verizon Wireless.

02—Key points

Key Highlights

Consolidated 2005 operating revenues of $75.1 billion, up 5.4%; Domestic Wireless grew 16.8% to $32.3 billion, with 51.3 million customers (up 17.2%).
Domestic Telecom revenues fell 1.1% to $37.6 billion as switched access lines declined 6.7%, while broadband connections rose 47.6% to 5.1 million.
Net income of $7.4 billion ($2.65 diluted EPS) fell from $7.8 billion in 2004, which included a $516 million discontinued-operations gain and a $787 million TELUS gain.
MCI acquisition closed January 6, 2006, adding a global IP network; management expects $550M, $825M and $1.1B of synergies in 2006–2008 and integration costs of $400M, $325M and $275M.
2006 capital expenditures guided to $17.0–17.4 billion including MCI (about $15.4–15.7 billion excluding MCI), versus $15.3 billion in 2005.
Operating cash flow of $22.0 billion funded $4.4 billion in dividends ($1.62/share, up 5.2%) and $4.7 billion of acquisitions and investments, including $3.0 billion for NextWave PCS licenses.
Total debt of $39.0 billion; S&P lowered Verizon's long-term rating to A in January 2006, and Moody's downgraded it to A3 in December 2005.

03—Questions

Frequently Asked Questions

How did the MCI merger change Verizon's business and financial outlook?
MCI closed on January 6, 2006, giving Verizon one of the largest end-to-end global IP networks and creating Verizon Business to serve medium and large enterprises and government customers. Management expects merger synergies with a net present value of about $8 billion, with annual benefits of $550 million in 2006, $825 million in 2007 and $1.1 billion in 2008. Integration costs are estimated at $400 million, $325 million and $275 million over the same three years, and integration capital spending is $1.6–1.9 billion. The cash consideration included about $779 million in supplemental payments, plus MCI debt redemptions and the Carlos Slim share purchase.
Is Verizon's wireline business shrinking, and can growth offset it?
Yes, the wireline voice business is in structural decline. Domestic Telecom revenues fell 1.1% in 2005 because switched access lines dropped 6.7%, driven by competition, technology substitution and wireless substitution. Growth areas are offsetting part of this: data revenue rose 10.5%, DSL and broadband connections reached 5.1 million, and long distance lines reached 18.4 million. Management says growth-area revenues (wireless, broadband, long distance, business data) were 58% of total revenues in 2005, up from 53% in 2004, and that FiOS fiber deployment is central to the strategy.
What is the key value driver in Verizon's results?
Verizon Wireless, a 55%-owned joint venture with Vodafone holding 45%, is the main driver. Its segment income rose 34.9% to $2.2 billion, and it is the most profitable U.S. wireless carrier by operating income. Because Vodafone owns 45%, minority interest expense rose to $3.0 billion in 2005, which substantially reduces the share of earnings attributable to Verizon. Vodafone also holds a put right of up to $20 billion for its interest, exercisable in 2006 and 2007 at up to $10 billion per year, which is a potential future cash obligation.
What are the main risks flagged in the filing?
The filing highlights intense competition from cable, wireless, VoIP and other carriers; technology substitution eroding access lines; and regulatory uncertainty, including FCC unbundling rules, intercarrier compensation reform and universal service changes. Other risks include rising pension and retiree health costs, which increased net benefit expense to $1.4 billion in 2005, and integration risk from MCI. Credit rating downgrades and the Hicksville environmental remediation (with ongoing personal injury claims) are also noted. Verizon management states that legal and regulatory matters are not expected to have a material effect on financial condition, though they could affect results of operations.

04—Continue

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