Verizon Communications chairman and CEO Lowell McAdam left little doubt about his view on the future of traditional TV. 

“I think the linear model is dead,” McAdam said last week in an interview with Yahoo Finance. “It’s just going to take a long time to die.”

Rather than plowing more investment into that linear TV arena, Verizon will instead place bigger bets on digital, including its own Yahoo properties and a bit on “limited entertainment” content.

Tied to that thinking, Verizon has also dropped a plan to build an over-the-top TV service from scratch, opting instead to forge a partnership with an existing player that is willing to integrate digital content from Oath, the Verizon unit that contains Yahoo and AOL.

Related: Oath Puts Ad Target on Verizon’s FiOS TV Footprint

“Our view is that we should partner with those that are in the linear game,” McAdam said. “Let them be very good at what they do. We’ll add digital content into that mix, and we’ll position ourselves for where we become more of an over-the-top video culture versus the linear model that we have today.”

That’s a major swing, as Verizon previously had its sights on creating an OTT TV service that was not a “me-too” and able to stand apart from a growing array of virtual multichannel video programming distributors.

Under the new plan, Verizon is eyeing a Q4 launch on an OTT service that will blend Oath’s content into the lineup of an existing vMVPD offering. McAdam didn’t identify that partner, but Verizon has ample choices.

Given the competitive mobile services landscape, two seemingly unlikely candidates are AT&T’s DirecTV Now service and the one that T-Mobile is developing following its acquisition of Layer3 TV. Verizon might find a better fit by teaming up with YouTube TV, fuboTV, Sony’s Play-Station Vue, Philo, Sling TV and possibly Hulu, which launched a live TV service about a year ago.

MoffettNathanson principal and senior analyst Craig Moffett continued to be among the voices of reason after Verizon CEO Lowell McAdam reignited speculation the telco could be on the hunt for a transformational deal – read: Charter or Comcast – adding in a blog post that the telco simply can’t afford a big transaction.

Speculation has been high for months that Verizon, egged on by AT&T’s pending mega-merger with Time Warner Inc., would counter with a monster deal of its own with either Charter or Comcast. While the stock has settled since January, when reports first surfaced that the telco was eyeing a possible deal with Charter, McAdam told Bloomberg last week that he was open to merger talks with Comcast, Disney, CBS or any other major entertainment company that presented a compelling argument. 

Verizon definitely needs to do something – it is losing Fios TV customers and competition is getting thicker in its wireless business. But shelling out the tens upon tens of billions of dollars needed to fund a merger with Charter, Comcast, or Disney, would not be an easy task.

Now, McAdam didn’t necessarily say what end of the table Verizon would be on in any of those deals – buyer or seller – but most of the speculation has been around it being the buyer. And it also should be noted that McAdam didn’t say he was in talks with any of these companies, just that he would be open to talking with them, which, to be honest, he would have to say no matter what. Saying otherwise would only make them more vulnerable to shareholder suits.

But if investors see Verizon as being a deep-pocketed and free-spending buyer to right its listing ship, Moffett threw an ocean of cold water on the prospect.

In his blog posting, Verizon – A Sobriety Test, Moffett first notes that the telco’s leverage ratio has risen to about 2.6 times cash flow (its highest ever) as its profitability has eroded. While that would appear to provide some room for a deal – its target multiple is 4 times – the telco’s true leverage (which includes capitalizing all its operating leases and adding them to debt) that ratio rises to 3.4 times. Moffett added that Verizon has flirted with higher total leverage (3.5 times) in 2013 when it purchased the remaining interest in Verizon Wireless from Vodafone for $130 billion in cash and stock. But he noted that times were vastly different then – when it closed that deal in February 2014, Verizon’s organic revenue growth rate was 6.2%. In the just-passed first quarter, Verizon’s consolidated growth rate has plummeted to -4.5%.
“To state the obvious, the credit profile of a company growing at 6% is a bit different than that of a company shrinking by an almost like amount,” Moffett wrote.

So that would put a damper on how much cash Verizon could put into a big deal. But what’s that you say? Most companies want equity anyway, for the tax benefits? Verizon stumbles on that front too.

According to Moffett, the biggest wet blanket in an equity deal was, is and always will be Verizon’s stock dividend commitment.

“Ordinarily, limitations to one’s balance sheet require that acquisitions be financed with equity instead,” Moffett wrote. “But for Verizon, issuing equity doesn’t just dilute earnings. It also carried with it a 5% coupon.”

Declining free cash flow has already put pressure on Verizon to cover its dividend. Moffett noted that in the first quarter, Verizon reported a free cash flow loss, which meant it couldn’t cover the dividend. Even using adjusted free cash flow, Moffett wrote that first quarter results suggest that Verizon’s dividends are 70% higher than their normalized free cash flow.

Moffett added that Verizon isn’t precluded from doing any deals, just ones where it has the highest free cash flow yield. It could do a deal similar to AT&T’s 2015 purchase of DirecTV. But Moffett added that the reason AT&T was able to buy DirecTV at a discount to its own valuation was that DirecTV was already priced for what Moffett called “secular decline.”

“Now, two years later it is indeed secularly declining (after adjusting for the forced migration of U-verse subscribers) and AT&T will soon be worse off for having bought it,” he wrote. “With the writing already on the wall, AT&T was forced to go back to the well to buy yet another massive asset, Time Warner, Inc., less than a year after their DirecTV deal closed.”

Buying an asset that is trading at a premium to Verizon – like Charter, Comcast, Dish or Disney – would make the dividend coverage and leverage ratios worse, he wrote. And one much talked about solution – buying a better asset but selling off its existing Fios assets to help finance the deal – only works if they can sell those assets at a higher multiple than the ones they are buying. That wouldn’t be easy.

The difficulty in finding a path to a deal goes both ways. Moffett noted that Charter’s big shareholder John Malone wouldn’t likely be eager to swap Charter (growing at a 7% clip) for equity in a company that is declining 4.5% with a dividend commitment currently more than 100%.

Moffett closed with his reasoning for upgrading Verizon to “buy” in February – the stock was cheap and sentiment was overly bearish.  

“Included in that overly bearish view was (is) the expectation that Verizon will do a badly dilutive acquisition,” Moffett wrote. “Perhaps they still will. But our analysis here suggests they may have less flexibility to do so than most seem to think.”

Verizon Communications finally got its long-simmering deal for Yahoo done, capping what has quietly amounted to a buying binge over the past seven months in which the telco has snapped up seven companies for nearly $10 billion in cash and stock amid its pivot toward mobile video and connectivity.

Verizon agreed to buy Yahoo for $4.8 billion, besting some big names among reported early bidders, such as AT&T as well as Quicken Loans founder and Cleveland Cavaliers owner Dan Gilbert. The price reflects how far the once-mighty search company had fallen: In 2008, Yahoo turned down an offer from Microsoft to buy the entire company for $45 billion. Eight years earlier, in 2000, Yahoo had a market capitalization of around $130 billion.

CEO Lowell McAdam’s new focus on mobile video and connectivity has led to the eclectic list of recent acquisitions. They range from digital video content providers like Complex — purchased as part of a joint venture with Hearst Media called Verizon Hearst Media Partners — to fleet management company Fleetmatics.

‘GROWTH CHALLENGED’

In a more traditional vein, Verizon also is buying XO Communications’s fiber business for $1.8 billion in a deal that should close in the second half of 2017.

MoffettNathanson principal and senior analyst Craig Moffett said in a research note that the Yahoo deal, especially, signals a change in overall strategy as the wireline business continues to soften.

Verizon lost a net 41,000 Fios TV customers in the second quarter amid a seven-week labor strike, and Fios customer gains overall have been dwindling steadily over the past few quarters. AT&T has also seen its U-verse TV customer losses mount: It subtracted 391,000 video customers in the quarter, more than the 384,000 net subscriber losses in the prior period.

Per Moffett: “The telecom industry is growth-challenged. Both AT&T and Verizon have now reported meaningfully negative organic growth. The Yahoo acquisition must be seen in this light. Verizon is seemingly acknowledging the end of an era; wireless penetration growth is over, and so too, seemingly, is ARPU growth from consumers for whom real disposable income has been stagnant for decades. The monetization of incremental data use through higher consumer ARPUs hasn’t worked out and IoT just doesn’t portend enough carrier revenue to be the next big thing. With this as a backdrop, Verizon is turning to an entirely new source of revenue for the wireless business: advertisers. It will take years to find out if the strategy pans out.”

McAdam, though, told analysts on the July 26 call that Verizon believes these seemingly disparate purchases mesh to form a cohesive strategy focused on bringing video content to younger consumers by any means possible.

The XO Communications buy helps build the foundation: deep fiber assets, such as 40 metro fiber rings in several major cities, will provide a fat pipe for services. The XO deal also includes an agreement to license wireless spectrum that will provide Verizon with a clear path to 5G deployment, which McAdam said he considers “wireless fiber.”

“With wireless fiber, the so-called last mile can be a virtual connection, dramatically changing our cost structure,” McAdam said.

At the core of the so-called video evolution are the changing consumption habits of younger consumers toward mobile and digital content.

“Over the past several years, we have dramatically expanded the ways in which we can deliver content wherever and however the digital customer wants it,” McAdam said. He cited offering large and small bundles of linear content through wireline Fios TV; over-the-top content delivery; online content and publishing and advertising technology via AOL; mobile video content through its go90 offering; and its joint venture with Hearst.

MOBILE MEDIA MOVES

With the Yahoo, deal, according to McAdam, Verizon is “scaling up to be a major competitor in mobile media.” Yahoo’s portfolio of online properties and mobile applications attract more than 1 billion monthly active consumer views. Yahoo also brings additional online content, through Yahoo Sports, Yahoo Finance, Yahoo News, email through Yahoo Mail and expands the overall company’s analytics and ad-tech capabilities. Verizon’s $4.4 billion purchase of AOL last year brought in such content producers as The Huffington Post, TechCrunch and Engadget.

Verizon Communications, a little more than a decade after it launched its Fios TV and Internet service, is moving quickly toward what it believes is the future of the video industry.

It’s a future that hearkens back to TV’s over-the-air origins, where consumers can get all the bandwidth and content they want with no strings attached.

Verizon appears to be banking that mobility — long a buzzword in the video business, but one that hasn’t yet made a big dent in overall viewership — will take a dominant position in the next several years.

For the past year, the New York-based telco has been on a tear to remake itself into a 5G powerhouse:

• In February of 2015, Verizon agreed to sell Fios assets in Florida, California and Texas with more than 1 million video customers to Frontier Communications for $10.4 billion, a deal that is expected to close March 31;

• Verizon bought XO Communications’s fiber network in February for $1.8 billion;

• It launched FreeBee data, a sponsored data service that allows customers to download and watch certain video content without using up their wireless data plans, in January;

• It launched Custom TV — one of the first successful “skinny” video bundles — in April of 2015, revamping the package this February;

• It launched mobile-only, ad-supported over-the-top video service go90 in October of 2015;

• It purchased online icon AOL in June of 2015 for $4.4 billion.

BIG SHIFT AHEAD

Verizon’s recent moves point to its belief that a major shift in the video business is coming, Craig Moffett, principal and senior analyst at MoffettNathanson, said.

“It seems like they’ve made a complete reconceptualization of the video business inside of Verizon and have decided if there is an opportunity in video, it’s in wireless, location-based advertising,” he said. “If they’re going to win in that business, they’re going to have to disrupt the video ecosystem. It seems to me that they have decided that any ties they have to the status quo are a liability.”

Nowhere in the product set is that more evident than with go90. Launched in October, go90 has been downloaded by about 2 million users, has according to some reports. It was ranked No. 300 among all apps on the iTunes Store and No. 20 against all entertainment apps, according to UBS Securities telecom analyst John Hodulik.

Go90 is different than the other millennial-targeted mobile services in that — for now — it is fully ad-supported, meaning Verizon isn’t charging a monthly fee for the service. Customers can watch about 8,000 on-demand titles and stream content from MTV, Comedy Central, ESPN, Food Network, Discovery Channel, AwesomenessTV and others.

Increasing the number of go90 users is a priority, but it’s not the main point of the service, Verizon chief financial officer Fran Shammo said on a January earnings call.

“The key to us is not the downloads; the key is viewership,” Shammo said. “It’s around content and we will continue to add content that is favorable to all generations of population.”

Later, at the Deutsche Bank Media, Internet & Telecom conference on March 8, Shammo said that the addition of AOL’s 350 million users could help add needed scale to the service.

“Eyeballs will be the winner at the end of the day because the more eyeballs I can get to that platform, the more advertisers that are going to come and want to advertise, and therefore I can monetize the usage,” he said.

That strategy has emerged from Verizon’s past eff orts to pay more and more for additional wireless usage — efforts that haven’t worked in part because disposable income in the U.S. hasn’t really grown since 1991, Moffett said.

“Go90 is not about trying to create a substitute for Netflix,” Moffett said. “They’re not out competing with other video services in the traditional sense; they’re trying to create advertising inventory.

“They need to get customers to spend some time looking at their phones. If they can get customers to spend time engaged with the device, they are highly confident that there is a long list of advertisers who will pay for reaching those customers.”

In a research note, Hodulik recounted a meeting with AOL CEO Tim Armstrong, saying the company estimates there is an $80 billion near-term incremental opportunity in the ad space — $40 billion from video and $40 billion from mobile. AOL held 40 meetings for go90 with advertisers during the fourth quarter, Hodulik said. It will spend 2016 building an audience for the service and expects “real traction this year.”

All this seems like a huge departure from when Verizon launched Fios as a means to tap into the lucrative TV market and preserve what at the time was a rapidly declining wireline business.

When Verizon introduced Fios in Keller, Texas, in May of 2005, it — along with AT&T’s U-verse — was supposed to be the last nail in cable’s coffin. It spent $20 billion on a massive fiber upgrade and unleashed unheard-of data speeds (up to 50 Mbps!) on a bandwidth-hungry public.

Now cable is enjoying a resurgence — Charter Communications and Time Warner Cable both had their first positive video-customer growth in nearly a decade in 2015 — and Verizon’s Fios TV has seen its growth slip.

But Verizon’s reversal of fortune doesn’t mean the Fios experiment was a failure. For many people who follow the company, Fios will remain a key component in Verizon’s new direction and will play an additional role. Verizon’s new mantra is mobility.

Lowell McAdam, Verizon’s CEO, said as much in 2014, telling an industry conference its then-recent purchase of Intel’s OnCue video service would enable it to take Fios content over-the-top and make it mobile on a nationwide basis.

The telco’s strategy is to use its existing network to deliver wired broadband and television service throughout its territory while also serving as a backhaul network for its wireless assets. Chief network officer Kyle Malady said Verizon fiber currently passes about 20 million homes, and the telco has already started trials for the next generation of wireless technology — 5G — with its promised 1 Gigabit-per-second speeds.

In the meantime, the company still sees opportunity in wireline service.

“From what you’ve seen from us, obviously there is no one answer,” Verizon spokesman Ray McConville said. “There is no ‘one-size-fits-all.’ We’ve adapted ourselves to have something for everyone.”

In some ways, Verizon is a walking contradiction. It has said it wants to grow the Fios TV business, yet it sold a huge chunk of video and broadband subscribers last year to a CLEC. In an era when rival cable companies are scrambling to accumulate greater and greater scale, Verizon appears to be taking the opposite stance.

BEEFING UP REGIONALLY

The main thrust behind the recent asset sales has been to cluster its operations in the more densely populated Northeast and Mid-Atlantic regions, Malady said. In addition to being able to target a bigger pool of homes for service, the concentration also makes its network more efficient to operate.

Both video and broadband growth have slowed. Fios TV added just 20,000 video customers in the fourth quarter, its lowest quarterly growth ever, and Fios Internet added 99,000 subscribers, down from 145,000 additions in the prior year.

Shammo said Verizon still sees growth opportunity even in its more-mature Northeastern markets. At about 5.8 million video customers at the end of 2015, Fios TV has about 35% penetration throughout its footprint. That’s about the same as Charter Communications, the cable operator that many in the industry believe has the greatest video-subscriber growth potential of any U.S. incumbent.

Shammo isn’t the only one who believes Verizon can squeeze more growth out of the wireline network.

According to Barclays telecom analyst Amir Rozwadowski, Fios TV is expected to grow to about 5.9 million customers by 2017, up 5% from 2014. At the same time, Fios broadband customers are expected to rise 18% to 7.8 million customers by 2017.

The Fios fiber network isn’t just tethered to residential TV and broadband service; it also carries data traffic between wireless cell sites. That means that Verizon will be ready when video traffic increasingly shifts to wireless, a move many pundits see coming.

According to Cisco Systems’s Visual Networking Index, mobile video traffic accounted for 55% of all mobile data traffic in 2015; by 2020, 75% of the world’s mobile data traffic will be video. That means robust backbone networks will be more important than ever.

“The next five years are projected to provide unabated mobile video adoption,” the report said. “Backhaul capacity must increase so mobile broadband, data access, and video services can effectively support consumer usage trends and keep mobile infrastructure costs in check.”

That’s where the Fios backbone network and the telco’s eff orts to make 5G wireless technology a reality come in.

“At the bandwidths they’re talking about [for 5G], the nodes are going to need to be close together, and they are going to require fiber,” Malady said.

Fiber also becomes an extremely important factor once wireless video traffic increases, as anyone who has tried to stream the season premiere of a popular show like Game of Thrones knows. Wireless streaming is only as good as the pipes behind the towers transferring the data.

“The network behind it is the key, because that’s where a lot of these things get choked at peering points,” Malady said. “It all comes down to having good fiber connections between these places to move the bits.”

But in the bandwidth business, demand eventually outpaces supply. Verizon’s purchase of the XO Communications fiber network will mainly help its enterprise business, but it will also help with wireless backhaul, particularly between smaller cell sites. It’s capacity that Malady said is more than needed in today’s environment.

5G’S FIBER FOUNDATION

“I have been around for 27 years and I haven’t seen the growth curve stop,” Malady said. “It just keeps going up and up and up, and people’s demand for bandwidth continues to grow, and that’s why we think we’re pretty well-positioned with our fiber assets, and that’s why we’re requiring more.”

Touted as the next generation of wireless, 5G still has a way to go, as standards still haven’t been created for the service. But like its predecessors before it — 4G and LTE — 5G is the next evolution in wireless technology, offering speeds 30 to 50 times faster than 4G, reduced latency and improved power efficiency. Verizon has been at the forefront of the technology, beginning field tests of the technology earlier this year and predicting a limited commercial rollout as soon as next year.

“Just like we were out ahead of the market on LTE, we’re ahead of the market on 5G,” Malady said. “By definition, at the bandwidth we’re talking about, cell sites and nodes require a lot of fiber. Fiber is a big piece of the equation.”

Shammo is equally enthused.

“We believe that 5G is near-term, not far-term, and it is going to bring a whole different dynamic to the industry,” Shammo said at the Deutsche Bank conference. “It is going to give another growth profile for this industry.”

Verizon CEO Lowell McAdam stopped short of taking sides in Apple's legal battle with the Obama Administration over access to encrypted info on the iPhone of one of the San Bernardino shooters, but he blogged his strong support for encryption Monday and said that, bottom line, the government should not have direct access to technological privacy back doors.

Apple is fighting a court order, sought by the FCC, to create a way to hack into the password protected phone.

'[A]ny decisions made about access to those systems need to be considered carefully," McAdam wrote. "Should one government be given access to your personal information or the operations of connected infrastructure? If we say 'yes' to one government, how about others? If governments have access, how can we be confident that those with bad intentions can’t use those same systems to gain access through hacking?"

He said those questions need careful answers given what is at stake, but said that "without taking sides on the Apple case specifically," he said Verizon clearly stands for strong encryption with "no back doors."

"We support the availability of strong encryption with no 'back doors' that would enable government access to private information, which we believe would degrade security and privacy for millions of users," McAdam said.

The administration more broadly has been seeking workarounds to encryption in the case of targeted investigations involving potential threats to life or safety.

As for the specific circumstances of the Apple case -- a single phone of a possible terrorist and how Apple would have to create the back door -- McAdam said that case represents unique policy issues that should be addressed by Congress.

"In particular, there may be legitimate reasons for preventing the destruction of data, such as the investigation of terrorism and serious crimes," he said. But if so, "[t]hese conditions must be strictly defined by law, not arrived at haphazardly on an ad hoc or case-by-case basis, as in the Apple case."

That said, McAdam said Verizon opposed any solution that "would place direct technical access in the hands of law enforcement."