The upcoming earnings reports of telecom giants AT&T ( T) and Verizon ( VZ) are expected to underscore the growing strength of their wireless divisions at the expense of their struggling landline operations. With AT&T set to report third-quarter earnings Wednesday and Verizon to report its own the following Monday, the woes of their landline business segments should once again be on full display, as cash-pinched customers have continued to disconnect home phone access lines in favor of wireless connections. "We think the incremental pressure on residential access lines is more of a function of wireless substitution (with consumers cutting the cord to save money) than incremental competition from cable," writes Chris Larsen, research analyst with Credit Suisse, in an earnings preview. The shares of Verizon and AT&T have been under pressure since last they reported earnings in late July. AT&T has slid 20% and shares of Verizon are down 21% over the last three months. Fear over landline losses has prompted analysts to reduce estimates for third-quarter profit, especially given current macroeconomic conditions. According to Thomson Reuters, analysts have reduced estimates for earnings per share and revenue for both companies over the last month. Analysts on average are expecting AT&T to post a profit of 71 cents a share on revenue of $31.1 billion. Verizon is expected to post a profit of 66 cents a share on revenue of $24.5 billion. The trend of landline losses is nothing new. In its last quarterly report, AT&T said total connections fell 8.1% from the year ago period, worse than many anticipated.
In its landline segment, operating revenues have declined over the previous four quarters. Adjusted operating margin for the landline segment slid to 20.1% in the second quarter from 21.7% in the same quarter a year earlier. An increase of 170,000 U-verse video connections was a positive for AT&T in the second quarter, but that gain was offset by a sharp decline in retail consumer primary and additional landlines. Retail business landline connections have also continued to drop, falling 3% over the previous year. Many expect the same to show up in the company's third-quarter earnings release. "The bad news is that consumer wireline appears to be under increased pressure," writes Larsen. "Wireless substitution continues to be a driving force for line losses, and we do not believe the DSL price cuts had enough time to make a full impact on
the third quarter." Verizon's core business also suffered in the second quarter as its landline revenue fell 1.8% from a year ago. Total landlines fell 8.5% in the second quarter from a year ago, with a large amount of that decline coming from the residential segment. Verizon's operating income margin was 8.8% in the second quarter, unchanged from the same period a year earlier. Credit Suisse's Larsen is among those analysts ratcheting back estimates, citing the weakening macroeconomic environment and more aggressive wireless competition. He recently reduced his third-quarter target for AT&T to 71 cents a share from 73 cents a share, citing the pressure on the consumer wireline business.
RBC Capital Markets analyst Jonathan Atkins was also cautious about AT&T's earnings, due to "greater EPS dilution than we had previously anticipated from wireless subsidies and a challenging wireline environment in the areas of access lines, broadband, and IP pricing." Stifel Nicolaus analyst Christopher King says that his target for AT&T is in line with Wall Street's expectations, while his estimate for Verizon is a penny lower than the average forecast. "We do expect to see the beginnings of some consumer-driven pressures in
third-quarter results, as subscriber additions for basic cable, Verizon's FiOS, and wireless data average revenue per subscriber could all be under mild pressure," he says. On the positive side, wireless results from both Verizon and AT&T should be strong in the third quarter, although analysts are turning more cautious with their outlooks for the balance of the year and into 2009. While both companies have feasted on Sprint Nextel's ( S) subscriber base with the help of exclusive contracts for devices from Apple ( AAPL) and Research In Motion ( RIMM), the potential for earnings dilution because of subsidies is increasing. AT&T is the exclusive carrier for Apple's iPhone 3G in the U.S., offering the device at a subsidized price for its subscribers. The move to a subsidy-based model eliminated the revenue-sharing model it had with Apple, and AT&T said it expects potential dilution to earnings in the range of 10 cents to 12 cents a share in 2008 and next year. "The good news is that our checks have indicated better wireless subscriber additions, which unfortunately come with increased near-term dilution," writes Larsen. "In addition to better-than-expected iPhone sales, our checks indicate that interest in the iPhone had a halo effect on the sales of other smartphone devices, which also have higher than average subsidies."
Additionally, with wireless penetration above 80% in the U.S., there is a limited pool of new subscribers for AT&T and Verizon to compete for. With AT&T unveiling the lower-priced popular Apple iPhone 3G during the quarter, Verizon could be faced with slower wireless growth. Verizon hopes to combat the iPhone 3G with its own exclusive BlackBerry Storm, the first touch-screen device from RIM, which is due for release later this year. Analysts also hope for more clarity on what both AT&T and Verizon are expecting for 2009, as the current credit crisis and slowing economic growth show no signs of relenting. "The negative macro events and increasing competition that has had a negative impact on our 2008 outlook are likely to continue into 2009," Larsen writes.