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Verizon Takes a Hit in Its Most Valuable Segment


Image source: Verizon Communications.

36,000 postpaid phone customers left Verizon Communications (NYSE: VZ) last quarter. That's in stark contrast to the third quarter last year, when the leading retail wireless carrier added 430,000 new postpaid phone connections.

During the company's conference call following the earnings report, CFO Fran Shammo told analysts, "We have been successful in retaining our high-value postpaid smartphone base." The language indicates the company is more focused on retaining its most profitable customers instead of competing with T-Mobile (NASDAQ: TMUS) and Sprint (NYSE: S) for customers seeking more value. That strategy echoes AT&T (NYSE: T), which has been bleeding postpaid phone subscribers for a couple years now.

Simply retaining postpaid phone subscribers will lead to slower revenue growth and make it more difficult to increase profits if this becomes a long-term trend for Verizon.

Management says it's not as bad as it looks

Verizon's postpaid churn rate climbed 11 basis points year over year to 1.04%. That's it's highest level since 2014. In its earnings release, management pointed to higher-than-average churn in tablets as the main culprit for the increased overall churn rate. 

This quarter, Verizon gave investors additional insight into where churn is coming from. In its earnings release, management noted, "Retail postpaid phone churn was up 2 basis points year over year and remained below 0.90 percent for the sixth consecutive quarter."

That statistic is thrown out to indicate that the problem stems from lower-than-average gross additions, not a massive subscriber exodus. Postpaid device activations declined 7.7% year over year. The vast majority of that decline is the result of fewer customers upgrading their devices than last year. That's a problem facing every wireless carrier.

A couple factors affecting gross additions

Shammo provided a couple of factors that impacted Verizon's net phone additions in the third quarter.

The first is the rollout of unlimited data plans from T-Mobile and Sprint, which Verizon didn't respond to. I noted previously that gross additions are going to be the biggest area where Verizon and AT&T see the impact of these unlimited plans.

But Shammo believes the effect is just temporary. "There's going to be a two- to three-week period of time where there is an impact to our growth," he told analysts on the earnings call. "After that three weeks, everything kind of normalizes back out." Those comments would indicate that Verizon has already seen its gross additions move back to normal.

The second big impact came from the Galaxy Note 7 recall. Shammo said, "Historically, Verizon has always been the No. 1 leader in high-end Samsung phones." This reasoning is somewhat faulty, however, considering every carrier was impacted by the recall.

Shammo also mentioned the iPhone 7 launch, which has resulted in a backlog. (Carriers don't count device sales until they're delivered.) That happens every year, though, so it shouldn't have a major impact on Verizon's net additions compared to previous releases.

Retention isn't enough to grow

While Verizon recently implemented a price increase for its customers, simply retaining high-value customers isn't enough to grow its revenue. In fact, the company's average revenue per connection (including device installment billings) declined slightly over the past year.

That decline is most indicative of the trend of customers holding onto their phones longer. Even with the recent increase in service revenue pricing, Verizon can't afford to continue losing postpaid phone customers and still meet the Street's relatively modest earnings growth expectations.

Shammo's comments provide hope that Verizon will return to positive postpaid phone net adds in the fourth quarter, but the pressure from the competition has never been stronger. Investors punished the stock after the poor earnings results, but if the trend continues for several quarters, it may be time for investors (myself included) to reassess Verizon.

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Adam Levy owns shares of Verizon Communications. The Motley Fool recommends T-Mobile US and Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.