Both sides could lose in Verizon strikeAugust 8, 2011: 10:55 AM ET
Verizon's unions face problems that picket lines simply can't fix.
FORTUNE -- The union representing the 45,000 Verizon Communications' (VZ) employees who went on strike yesterday says that the company is using "Wisconsin-style tactics" in an effort "to strip away 50 years of collective bargaining gains for middle class workers and their families." The striking workers also made a point of highlighting the hefty $6 billion in profit they estimate Verizon will make this year as well as the $10 billion check the company just agreed to write to Vodafone (VOD). If it weren't so greedy, a well-off company like Verizon could obviously afford to maintain current worker benefits, the union argues.
Unfortunately for the union -- and for Verizon shareholders -- things aren't that simple.
Only one side of Verizon's business is booming, the wireless arm of the company that is staffed by non-union employees. Of the $9.6 billion in operating income Verizon recorded in the first half of 2011, 94% of it came from its wireless business, according to the company's SEC filings.
In the other part of Verizon's business, selling local phone lines and other types of "wireline" service, things look far more grim. Five years ago, the company had 47 million local phone lines in service. As customers have cut off landline service in droves -- 30% of American homes are now wireless-only -- that business imploded. Verizon now has 25 million local phone lines in service and is losing another 8% every year.
To keep pace with the shrinking landline market, Verizon has had little choice but to steadily slash its payroll. Five years ago, it employed 252,000. Now its payroll is down to 196,000.
Much like the large car companies in Detroit, the big local telephone companies first negotiated pension deals and health care benefits with their union members decades ago. For Verizon, those costs have proven far larger than originally estimated, haunting it.
Over the past 10 years Verizon has booked at least one type of "special" charge to cover retiree costs every single year. (Last year Verizon paid $1 billion in severance to coax another 11,900 union members to retire.) Verizon's total bill for the decade's worth of severance costs comes to a whopping $18 billion, according to an analysis by Craig Moffett of Sanford Bernstein & Co.
"These charges...are classified as 'special' items that are ignored by most investors," Moffett points out. Include them and suddenly the thin profit margin in Verizon's wireline business disappears altogether. (The wireline business also got a big boost from Verizon's "FIOS" network that replaced copper phones lines with fiber optic cables. Without that huge investment, the wireline segment would be shrinking fast.)
Retirement costs seem certain to continue to drain money from Verizon, perhaps even faster than before. One looming problem: underfunded pensions. The same low interest rates that make Verizon's 5.5% dividend yield so tempting to its shareholders lower returns on Verizon's pension investments. Union members are going to look to shareholders to make up the difference.
The gradual obsolecence of the phone network is going to be brutal for both Verizon and unions representing communications workers. Neither side can do anything to halt the march of technology, which is inexorably replacing old landlines with cell phones and calling services like Skype (which is in the process of being bought by MSFT). All they can do is try and stick the other guy with a bigger share of the inevitable pain.