Verizon OK But Growth Slowing Slightly

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Verizon (VZ) reported a pretty solid quarter and made constructive — if not detailed — comments about 2008. The market is focusing on some slight misses in key metrics, but I think that has more to do with the suddenly negative sentiment toward the telcos than with the quarter.
EPS, adjusted for one-time items, of 62 cents exactly matched estimates. Revenue of $23.8 billion were just short of estimates. Wireless results were good, with something for bulls and bears. Revenue growth of 13.6% was a little shy of estimates, but net adds, churn and data revenue look good. The small revenue shortfall appears to emanate from lower-than-expected average revenue per unit, with the best explanation being a competitive environment in the important holiday season.
The conference call had several questions about the sustainability of wireless growth, especially if the economy weakens. Verizon appears to be gaining share at the expense of Sprint Nextel (S) . AT&T (T) can make the same claim. Management said that the company is monitoring the economy and its impact on all of Verizon’s businesses very closely, and so far, there is nothing evident that would make it change its sales expectations for any business, including wireless.
On the wireline side, revenue was as expected, with slightly better margins. Looking out several years, management said that margins in wireline can move meaningfully higher. Access line losses were 8.1%, a bad number, but not an acceleration from last quarter.
FiOS numbers look pretty solid, with TV adds of 225,000 very close to estimates and broadband adds of 246,000 at the low end of estimates. I think some of the weakness in the shares this morning is due to a few estimates that had broadband adds closer to 300,000.
For 2008, management said it expected a “solid year,” with EPS growth and rising margins. The company also stated that it has contingency plans to cut expenses quickly should the economy begin to negatively impact revenue. Capital spending is projected to be lower than 2007.
Overall, I think investors are finally realizing that the fears about competition and economic weakness that have surrounded cable shares are also relevant for telco shares, including wireless. The 80%-plus penetration in wireless in the U.S. is definitely a concern given economic fears.
Will wireless growth slow? Will new subscribers be lower quality?
Less optimism about wireless and slightly more cautious estimates of FiOS broadband adds will probably linger, but I think the sharp pullback in Verizon shares (and AT&T) is incorporating a scenario that is worse than what currently exists. Thus, barring a sudden slowdown in operating metrics, the shares should stabilize relative to the market. And relative to the market, I think they represent decent value, although not as good value as AT&T.

Missing iPhones Found at Sundance

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I’ve been reading up on the phenomenon of the missing iPhones and the only thing I can conclude is they might all have been at Sundance. Honestly, it seemed every line we were standing in had multiple iPhones in use. I know that speaks more to where Apple has mindshare than anything else, but I can confidently state that iPhone market share among movie fans and Hollywood types is at least meeting expectations.
On a serious note, I think there are two issues. First is whether demand for the iPhone at current prices and as currently configured is less than expected. Second is whether meeting unit volume expectations through sale of unlocked phones is positive or negative for Apple.
The answer to the first question may be yes, particularly in Europe. However, enough phones have been sold and current customers are satisfied enough that demand issues can be solved with a 3G phone, a lower-priced unit, lower prices, or increased functionality. Say what you want but the activation of over 2 million phones in seven months suggests that the iPhone is here to say.
As for unlocked phones, Bernstein did some interesting work, suggesting that there is earnings downside if a higher-than-expected portion of the unit volume is unlocked due to the loss of carrier payments. Carrier payments might be as high as $20 a month at close to a 100% margin. Bernstein believes that if 3 million of the 10 million phones that might be sold in 2008 are unlocked, Apple would earn 37 cents less in EPS this year and next year. That works out to 8% and 6% of current 08 and 09 EPS estimates, respectively….

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Sundance Wrap Before Reality Returns

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If you love movies and have never been to Sundance I highly recommend it. This was my first visit and I found an incredibly well organized and orchestrated festival. Pulling it off is no easy task. There are seven venues with nine screens in Park City alone plus additional showings in Salt Lake City and Ogden. In Park City, eight films are simultaneously running from 9 AM through the midnight showings. We attended 9 films total including 4 each on Friday and Saturday. Every showing was easily sold out including last minute “wait list” tickets which are available in limited quantities in the two hours prior to the start of a show. The venues are scattered over several miles of Park City so a free transportation system of buses is available. We never had to wait more than 10 minutes for a shuttle and only got caught in a really packed bus a couple of times.
The only downside is the expense but the incredibly well staffed and friendly volunteers (many standing outside directing pedestrian traffic for hours at a time) make you accept the stiff price for meals. Film tickets were $15 and available at the main box office early morning for each day’s showings.
Of the nine films I saw with my 17 year old indie movie addicted daughter, we liked Anywhere USA the best. It probably doesn’t have much of a commercial future but it is really well done and makes its editorial viewpoint known without being preachy. We also enjoyed Hamlet 2, the big story out of Sundance because it sold for $10 million, the second largest sale ever after Little Miss Sunshine. It is a straight out comedy and was the far and away the crowd favorite. On Friday night we had dinner with several critics, including David Poland of Movie City News, who explained that Focus Features bought the film figuring if they could get the theatrical run to $20 million the film would be nicely profitable including DVD sales. Hamlet 2 is no academy award nominee but it should be a box office success.
Sorry to have used up space to chat about movies but I hope you enjoyed the diversion from the always intense and recently often sour market commentary. It’s time to get back to reality, the market, and stocks.

Slow Sales At Sundance

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I got to Sundance yesterday and caught my first movie. I am visiting a good friend in Salt Lake City so I won’t be spending full time at the festival until today. I hope to catch 3-4 films on Saturday and Sunday before heading back to Chicago. Even though I’ve missed some good stock market rallying, it is very good to be away. My investments have done poorly so far this year. Space and distance helps to clear my head and will allow me to confront the difficult decisions better next week.
This is my first visit to the Sundance Film Festival. From Wall Street’s perspective the festival only matters as it relates to the purchase of films by the major studios. Sundance historically ahs been a festival more about independent film that the sales of those same films. Over the past few years, it has become more of marketplace, and this year it the marketplace that is generating the most news. Or maybe I should lack of news.
Because of the writer’s strike, which has postponed production on many films due in theaters in late 2008 and 2009, I believe expectations were raised that sales of films at Sundance would be robust in terms of both volume and price. Most of the stories about film sales at the festival have noted they have been slow and at prices below expectations. I suspect this is a case of the bar being set too high, much like with earnings on Wall Street. The agreement between the Director’s Guild and the Studios may also be impacting sales because it has raised hopes for a quick end to the writer’s strike.
I realize none of this has much to offer for market forecasts or stock ideas but it’s been a crazy two weeks so I hope you appreciate the diversion. I’ll be seeing the top selling movie on Saturday, Hamlet 2, which went for $10 million. I’ll tell you what I think about it and the other films I see next week.

More Thoughts on Apple

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In my Apple (AAPL) earnings summary on Tuesday, I said there were enough issues to prevent the stock from staging a quick rebound. Those issues don’t justify the type of decline we saw yesterday (down big intraday), but the stock is overowned, and as Jim Cramer pointed out, the big money is rotating away from tech, industrials and energy to financials, retail and other early-cycle stocks.
Morning-after analyst commentary was predictable. Many analysts defended the stock, with several increasing estimates given the big beat in the fiscal first quarter. Most noted that guidance seems unusually conservative and that the company should still at least meet the consensus for the March quarter.
Also predictably, there were a few downgrades. The downgrades were based on loss of momentum for the stock and iPods and general worries about consumer spending (that, of course, brings up the question of whether Apple is a retailer or a tech stock).
Few would argue that Mac momentum remains robust and will have an outsized positive impact on financial results as Mac sales becomes a larger percentage of revenue due to the higher margins.
iPods, on the other hand, are creating real concern given the “non-linearity” of U.S. demand in December. In fact, U.S. iPod units were flat in the fiscal first quarter. International sales must have been better than expected given the overall numbers and management’s comment that despite the slow December in the U.S., overall linearity for iPods was as expected in the December quarter….

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Mortgage Refinancings a Bullish Development

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I spent yesterday afternoon and evening traveling from Chicago to Salt Lake City on my way to the Sundance Film Festival in Park City.
In the morning, I chatted with my mortgage broker. He told me he was getting flooded with calls but not a lot of action yet. He said he many clients that are in position to refinance with 30 year fixed rate mortgages now at 5.4% and falling. One undeniable fact about the 175 basis points the Fed has cut is that it has brought mortgage rates way down. Tony has chronicled this well including the impact it can have on the subprime resets. If mortgage rates drop much further (Bill Gross thinks the Fed is targeting 4% to 4.5% for mortgage rates), it will be a huge boost to the beleaguered and unconfident consumer. Oil has backed off and heating season is going to be over soon. And more rates cuts are on the way.
With this in mind, I was pleased to read a Ned Davis Research report where their economist, Joe Kalish, noted that refi applications rose 17% last week to their highest level since March 2004. Furthermore, refi apps are up 150% in three weeks, the biggest increase in seven years.
Somewhere else I read that the average mortgage in the US carries a rate of 6.1% and nearly 70% of current mortgages could now be considered refinancable. That may have been on RealMoney but I was so busy preparing to leave for Utah that I didn’t copy down a quote or link.
The bottom line is that interest rate reductions are starting to bite….

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Apple: Not Good Enough For This Stock

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I am not going to recap all the numbers from Apple as you can read that elsewhere. The December quarter was very good but not without issues. Mac and iPod sales came in a little below aggressive estimates. This was easily made up by better than expected ASPs. A bigger issue will be that US iPod units were flat and were a little weaker in the holiday season than the first part of the quarter. Be ready for the iPod is dead headlines. Management said it was happy to trade units for ASP and this was part of the strategy behind the Touch. I see nothing else to quibble about in the December quarter.
Guidance for the March quarter is the real issue that took the shares down 10% after hours. 94 cents on revenues of $6.8 billion is below the $1.09 and $6.98 billion consensus. In its last quarterly report Apple actually guided above consensus so while they are very conservative, there is some precedent to interpret this guidance unusually negative.
The guidance assumes much worse sequential performance than has occurred the last two years….

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Best Case For Apple

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I’ll be covering Apple’s earnings call after the close. Here is my preview. I decided to look at aggressive assumptions to see where a best case scenario might be for the December quarter. Since the stock needs both a substantial beat and decent guidance I wanted to see what the beat might look like.
Here are the assumptions I used: (1) 2.5 million Macs sold with ASPS up about $75 sequentially, (2) 25 million iPods with ASPs up to $175 vs. $163 last year, 2.5 million iPhones shipped generating $315 million in revenue, a 30% increase in all else driven by Leopard sales, and a 100 basis point sequential uptick in gross margins.
These assumptions lead to revenue of $9.85 billion and EPS of $1.88 versus the current high estimates of $9.96 billion and $1.77….

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Apple 1Q08 Preview

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Another Apple earnings report comes after the close today, so time for lots more overanalysis and outsized volatility in the usually volatile shares. Estimates have been rising as the quarter went along since it became apparent that Mac sales were booming. News from MacWorld that Leopard and iPhone sales were ahead of expectations in the December quarter raised the bar further. The only product line with any concern is iPods where there is some worry about unit volumes relative to high expectations….

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Special Market Comment

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Overseas markets continued to fall sharply last night in Asia and today in Europe. Two day losses in many markets while the US was closed for the Martin Luther King holiday reached 10% or more. US futures have been trading down between 4% and 7% since Sunday night.
In response to what can only be described as a global panic, the Federal Reserve cut the Federal Funds rate by 75 basis points to 3.50% at about 7:20 CST this morning. US markets initially cut their losses by about half but now, a half hour later, the market is right back to pre-Fed levels. Initial commentary on CNBC and websites like RealMoney.com are quite skeptical of the Fed action. They are stating that it reeks of desperation and is too little too late.
To be perfectly honest I have no idea what is going to happen in the short-term. We could head much lower as buyers just don’t seem willing to step up. We could also rebound quickly and sharply as short-covering ignites a rally that gives potential buyers some relief and confidence. I am surprised by the size and speed of this decline. I thought the market would be tough to navigate in early 2008 with risk skewed to the downside. However, I wasn’t expecting this.
I do not plan to trade today except to possibly do a little buying in accounts that are very heavy in cash reserves. The reason I would invest some money in these accounts today is that the Fed action reminds us that their will be a monetary and fiscal policy response that eventually will calm investor nerves and give the economy some traction for renewed growth.
Lower rates are a positive for the long run. Stock prices should be higher than current levels within six to twelve months as investors eventually look ahead to the next economic expansion. We may go lower first but at some point we will rebound. We also do. We always have.
The Fed cut might not help right away but it signals to me that this is not going to turn into a disaster. That means its time to hunker down, ride it out, and wait for stability at which time better decisions can be made without the emotion that lousy markets inevitably invite.
Market declines are very painful. It hurts to see your portfolios sink in value. But if you do not need your investments for a year or more this is painful experience but not the end of the world.
I am in the office and available if you want to talk further about the markets and your investments. I can be reached any time between 7:30 AM and 10 PM Chicago time.