Image source: Verizon.
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The demise of smartphone subsidies has led to a lot of changes in the financials of U.S. wireless carriers. While the cash coming in is roughly the same as before, the accounting is totally different.
Subscriber's on Verizon's Edge, or AT&T's Next, plans put $0 down and pay off the phone over 18 to 30 months, but they're still technically paying for the device in full when they receive it. The wireless carrier is simply financing a loan for the phone. So, while carriers used to book a $450 loss on the sale of a new iPhone, they now book a much smaller loss from their financing activities.
To make the accounting work, carriers have taken to securitizing their equipment installment plan receivables and selling them to banks. The carriers have been accounting for the securitization from their balance sheets, but the cash shows up in their cash flow statements, providing a nice boost to cash flow in the near term. Where iPhone sales used to be a drag on cash flow, they now become a boon.
The only problem is the credit rating agencies see those equipment installment plan securities and view them as extra unsecured debt. That gets lumped in with other debt and reduces the credit ratings for Verizon or AT&T. That's why Fran Shammo is exploring an alternative method to getting cash out of those receivables.
An $8 billion "drop" in cash flow
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Don't be surprised when Verizon reports operating cash flow for the second quarter about $2 billion lower than expected. Shammo isn't planning to securitize any of Verizon's receivables this quarter.
Instead, he plans to start the process of selling asset-backed securities on the receivables -- the devices supposedly being the assets. These securities will be sold on the public market instead of negotiated privately with the banks Verizon currently works with. Additionally, since they're backed by assets, the debt will be rated AAA, probably lowering the cost to Verizon.
Best of all, the ratings agencies won't see it as unsecured debt, saving Verizon's credit rating for when it needs to tap the debt market.
But while Verizon will see cash coming in -- possibly even more than before because of lower debt costs -- it won't be able to count that on its cash flow statement. It will show up under short-term debt on the balance sheet.
More equipment installment plans coming
Last quarter, 68% of devices activated on Verizon's network were on equipment installment plans. It expects that number to climb to 70% this quarter. Overall, 48% of customers are on unsubsidized service plans. AT&T, comparatively, sold 90% of its smartphones without a subsidy, and about half of its total subscribers are on Next installment plans.
Overall, Jefferies analysts expect total equipment installment receivables to climb to about $40 billion next year. As more customers switch to installment plans, the new securitization method will become increasingly important. There's potential for Verizon's $8 billion in annual receivables to double as it moves consumers off its subsidized plans. With the typical upgrade cycle now slightly longer than two years, it's looking at carrying more than $32 billion in potential equipment installment receivables.
With over $110 billion in debt on its balance sheet already, Verizon will greatly benefit from recategorizing its equipment installment plan securities. Investors should expect the other wireless carriers, like AT&T, to follow suit.
The article Verizon Is About to Change This $8 Billion Piece of Its Business originally appeared on Fool.com.
Adam Levy owns shares of Verizon Communications. The Motley Fool owns shares of and recommends 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.
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