Verizon's Big TV Bet Pays Off

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Spending Its Way to Success

The TV strategy has been a very personal one for Seidenberg. He championed the pricey approach of stringing fiber lines into millions of homes and stuck to his guns even as investors battered his company's stock. Meanwhile, under former chief Ed Whitacre, AT&T, took a more conservative route, using a lower-cost combination of fiber and copper wire to deliver television service. Now Verizon has more than 500,000 paying TV customers, while AT&T has 100,000. "AT&T has been slower off the bat," says Comcast's Burke. "They have a tougher row to hoe, because they have not spent as much money on fiber, but they are a big company, serious about what they are doing, and spending a lot of money."

Verizon has one of the biggest capital spending programs in the world. The company plans to spend $23 billion between 2004 and 2010 to run high-speed fiber-optic lines directly into customers' homes to deliver television and speedy Internet service. Verizon says it will recoup about $5 billion of the costs in operating savings, because its fiber system is less expensive to maintain than traditional copper lines. "I feel very good about what we have done, relative to what people said we could do," says Marilyn O'Connell, senior vice-president of video solutions at Verizon. "I think we have proved that we can execute our business plan, that it is a good plan, although it will take another couple of years to achieve a return on investment," she says.

Verizon is following the same aggressive capital spending plan that it used in the wireless market, where it has seen strong financial returns. Its capital spending budget for 2007 is $14.62 billion, or 19.6% of its forecasted revenues of $93.8 billion, according to Goldman Sachs (adjusting for the 45% stake in Verizon Wireless held by Britain's Vodafone (VOD)). About $10 billion of that spending is focused on the wireline business, including the television effort. In comparison, AT&T's capital spending budget for 2007 is $18.5 billion, or 14% of its $119 billion in forecasted revenues for the year.

Reversal of Fortune

Over the years, Seidenberg has pushed the approach of big capital investments, even at the expense of short-term support among investors. AT&T, especially under Whitacre, relied a bit less on capital spending and a bit more on the big acquisitions that appealed to investors for their quick returns. AT&T's stock surged ahead for years, rising nearly 40% during 2005-06, even as Verizon's shares lost ground. But in recent months, their fortunes in the stock market have reversed, with Verizon outdistancing its telecom rival.

Now, Verizon has the potential to force Comcast and other cable operators into another round of capital spending. Goldman has a buy rating on Comcast, with a price target of $34. But it says risks to its investment thesis include the threat of the phone companies' ongoing video rollouts and the need to boost capital expenditures to address bandwidth constraints. Verizon's fiber network currently allows it to offer customers connections of 15Mbps to 50Mbps downstream and 5Mbps upstream. It can boost those speeds any time it chooses. The cable companies offer speeds closer to 5Mbps to 10Mbps downstream and 1Mbps upstream. That may be sufficient for now, but as consumers watch more video on Web sites such Google's (GOOG) YouTube and even upload their own clips, that may become insufficient.

There's some risk that AT&T could feel similar bandwidth constraints, although it says it's fine for now. "Right now, we believe we have the right architecture and that it meets our longer-term strategic needs," says Brian Buffington, marketing director for AT&T's TV service, known as U-Verse. He says the company is adding 7,000 to 8,000 video customers a week and that it can use compression technology and other techniques to free up more room on its network. AT&T also is ahead in the move to IPTV, which uses Internet Protocol technology to carry TV signals to TV sets. Verizon's fiber system uses a more traditional standard. IPTV allows AT&T to deliver television service using less bandwidth, according to Buffington, although there have been technological challenges to AT&T's approach (BusinessWeek, 2/12/07).

Video Customers Generate More Revenues

The phone companies have plenty of challenges ahead. Comcast and other rivals are biting into their traditional phone business. Verizon alone lost 579,000 residential phone lines during the second quarter. It's much easier for cable companies to enter the phone business than it is for phone companies to enter the TV business. They also are attacking the phone companies in other key markets, such as wireless phone service and communications for small and midsize businesses. Video customers, however, generate about three times as much revenue as phone customers do, which means that phone companies don't need to steal as many customers to stay even in terms of revenue.

At the very least, TV is helping phone companies hold onto customers. At Verizon, O'Connell says that the loss of customers to cable is falling in markets where Verizon has offered FiOS TV for at least six months. She wouldn't provide details on retention rates, but her comments are consistent with research that shows the overall rate of decline has slowed. The results are certainly good enough that rivals like Comcast are taking notice.

Rosenbush is a senior writer for BusinessWeek.com in New York.