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Verizon Vibes Turn Negative

Scott Moritz

Updated from 7:15 a.m.

Verizon's (VZ) costly fiber-expansion plan is once again weighing on investors' minds.

Several recent developments have fans and skeptics alike wondering if all is well with the so-called FiOS effort. Verizon shares have been in retreat since hitting a one-year high in October.

On Tuesday, FiOS supplier ADC (ADCT) slashed its sales outlook, citing order delays from its telco customers. Verizon's excess inventory was fingered by one analyst as part of the problem. This echoes recent observations from Corning (GLW), another Verizon fiber vendor.

The news comes as Verizon has started notifying customers that it is hiking its monthly TV rates by about 8% -- a sign, perhaps, that the company is trying harder to boost revenue as bills from a costly growth plan come due.

Probably the week's most intriguing development was Monday's unexpected departure of Verizon's FiOS cheerleader-in-chief. Larry Babbio called it quits, saying he'll retire by March.

One industry observer says the Babbio departure is a clear sign of trouble ahead.

"This is the beginning of the end for FiOS," says the Washington, D.C.-based telecom investment veteran, who has no position in Verizon.

Some observers aren't convinced that Babbio's retirement has a lot to do with the FiOS performance.

"This wasn't really shocking," said one analyst. "Babbio has been stepping back for months."

A Verizon representative adds that the company is on track with FiOS. As for Babbio's departure, Verizon calls it a personal decision, given its deep leadership bench "and the success we are having in the deployment of FiOS broadband."

"With our strategies gaining traction in the marketplace, Larry felt the timing of March 2007 was right," Verizon said. "There's nothing more to it than that."

Still, Verizon has been heavily criticized ever since it launched its fiber-to-the-home strategy as a way of battling cable companies with the triple play of TV, fast Internet and phone service. Taking on the staggering costs of rewiring houses amounted to a gamble that a big data pipe would open up new sources of revenue.

The company hoped that investors would ignore the project's roaring cash furnace because Verizon's wireless joint venture with Vodafone (VOD) -- Verizon Wireless -- was the fastest-growing player in the hot mobile-telco sector.

But rival AT&T (T) has succeeded in taking a far less dramatic route toward video.

The San Antonio phone giant limited its fiber expansion to equipment offices and neighborhood nodes to help boost speeds over existing copper-wire connections. AT&T has started its U-Verse service in a few Texas markets and plans to have the TV offering available to 19 million homes by the end of 2008.

Investors have been a lot more comfortable with AT&T's cheaper plan.

"Verizon has underperformed AT&T ... because of their foolish decision to throw money at a small and shrinking part of their overall business," says the Washington telecom expert. He says that since the end of 2004, AT&T stock is up nearly 40%, while Verizon stock is down -- though a Verizon spokesman says that comparison fails to account for the recent spinoff of Idearc (IAR). He says Verizon shares are up 24% giving effect to that deal.

Verizon defended its FiOS strategy in September with an exhaustive presentation to analysts. The company says it budgeted $22.9 billion toward fiber investments and promised to cut its per-home installation cost to $1,350 by 2010 from $1,816 now.

Verizon also revealed its subscriber numbers. As of the end of September, the company had 100,000 TV customers and 500,000 FiOS Internet users. The company vowed to have 175,000 TV subscribers by year-end and to make FiOS available to 18 million homes by 2010.

Regardless of whether Verizon ends up hitting those targets, one disappointment for investors has been the failure of FiOS to vanquish cable rivals like Comcast (CMCSA), whose shares have soared this year, driven by hefty user gains.

"People were OK with FiOS until they saw that the cable companies were actually doing better, not worse," says one money manager with no Verizon positions. "Winning phone customers is always a lot easier for cable companies than winning TV customers is for phone companies."