AT&T Inc. (T) and Verizon Communications Inc. (VZ): The Results Are In

AT&T Inc. (T)AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ) just reported 2Q earnings, and these two telecommunication giants are telling similar stories to us all.

Costs are half of the equation

AT&T reported that the expenses associated with higher smartphone selections by its customers drove net income down 2.1% this quarter. However, the higher revenue for each smartphone should offset the increased costs over time.

Rising revenue is good, but cash is king

AT&T Inc. (NYSE:T)’s revenue increased by 1.6%, or $600 million, to $32.1 billion this past quarter from the year-ago period. The wireless business was up 5.7% on smartphone sales, and the wire-line business was up 2.4% on additional U-Verse subscribers.

Verizon Communications Inc. (NYSE:VZ) increased its consolidated revenue by 4.3% and increased EPS by 14.1% year-over-year. The main drivers of this growth were FiOS add-ons and an increased number of wireless devices.

These increases lead to a strong free cash flow position at both telecoms. AT&T generated $9.5 billion in free cash flow from operating activities, and returned more than $5.7 billion to shareholders via repurchases and buybacks. Verizon also generated $9.5 billion in free cash flow, and reduced debt outstanding by $2.6 billion.

Smartphone saturation

This past quarter, AT&T Inc. (NYSE:T) had 88% of postpaid-phone sales registered as smartphones. This is concerning for future revenue growth in the wireless business for both AT&T and Verizon Communications Inc. (NYSE:VZ). These two companies have been relying on the mobile-phone growth engine to fuel their earnings and free cash flow, and market saturation could lead to shrinking margins. As carriers run out of new customers, they will start to compete on price.

This saturation is bad news for companies like Apple Inc. (NASDAQ:AAPL), which are now competing against other manufacturers for the same number of customers. But, it is good for one company – Google Inc (NASDAQ:GOOG) . Google makes its bread and butter by having smartphones connect to the Internet and use its search engine. Google doesn’t care about the manufacturer of the phone, so long as users use its search features.

Verizon and AT&T Inc. (NYSE:T) currently have 10.5% and 9.5% net profit margins, respectively, and both pay out nearly 60% of free cash flow in dividends. Verizon Communications Inc. (NYSE:VZ) has a yield of 4.1% and AT&T has a dividend yield of 5.1%

The key differences between AT&T Inc. (NYSE:T) and Verizon are in their dividend and company structures. AT&T is a wholly owned wire-line and wireless company, whereas Verizon Communications Inc. (NYSE:VZ) owns its wire-line assets, but only half of Verizon wireless. Verizon shares the wireless assets with Vodafone Group Plc (ADR) (NASDAQ:VOD) on a 55%/45% basis.

U-Vers & FiOS

AT&T Inc. (NYSE:T)’s U-Verse and Verizon Communications Inc. (NYSE:VZ)’s FiOS are making up larger and larger parts of their businesses. The U-verse segment at AT&T now makes up one-half of revenue from one-third last year, with over 9.4 million subscribers.

AT&T Inc. (NYSE:T) and Verizon plans on increasing its broadband speeds at an aggressive rate going from an average of 24 Mbps to 45 Mbps from 2012 through 2013. AT&T Inc. (NYSE:T) is expecting to increase those speeds even further to the 75-megabit per second (Mbps) to 100-Mbps range, and recently announced a fiber optic
1 gigabit per second (Gbps) Internet roll out in Austin, Texas.

Coincidentally, Google Inc (NASDAQ:GOOG) recently announced that Austin, Texas will be the next site to roll out Google Fiber. Google rolled out free Internet to Kansas City, Mo. consumers and the option for a 1 gigabit connection for $70 per month.

Google Inc (NASDAQ:GOOG) is in the business of connecting people to the Internet and landing them on its homepage. Google’s advertising revenue made up over 90% of its revenue and will continue to be the dominant driver of Google Inc (NASDAQ:GOOG)’s profit. Google has net profit margins of 19.6% translating into $32.58 earnings per share but does not pay a dividend. Google continues to fill its coffers with cash, now sitting at $54.4 billion. This financial cannon could be used for share repurchases, new infrastructure or even acquiring an Internet service provider.

Foolish bottom line

AT&T repurchased over 300 million shares this quarter.  When a company repurchases shares, it no longer has to pay a dividend on that particular share, so Ma Bell will now save $150 million in dividend “expenses” each and every quarter by retiring those shares. AT&T Inc. (NYSE:T) has the largest dividend of the US telecom companies, and continues to be one of the most shareholder friendly companies around. Verizon Communications Inc. (NYSE:VZ) is a close second, but the fact that it doesn’t outright own its most valuable asset is troublesome, as the company would have to take on massive amounts of debt to purchase it.

Both telecoms make great income investments, but companies like Google Inc (NASDAQ:GOOG) that have massive amounts of cash on hand may be looking to disrupt the lucrative Internet-service-provider business model.

The article AT&T and Verizon: The Results Are In originally appeared on and is written by Wes Patoka.

Wes Patoka owns shares of AT&T Inc. (NYSE:T), Verizon Communications Inc. (NYSE:VZ), and Google. The Motley Fool recommends Google. The Motley Fool owns shares of Google Inc (NASDAQ:GOOG). Wes is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.