HEARD ON THE STREET   |   APRIL 28, 2009

For Verizon, Land Lines Are a Hang-Up

By MARTIN PEERS

There comes a point in every secular decline when the business falls off a cliff. Has the phone industry's long-shrinking land-line business hit that point?

Verizon Communications reported Monday that first-quarter operating income from wire-line fell 34% to $691 million, a slightly bigger drop than AT&T's last week.

The plunge at Verizon is more significant because, unlike AT&T, Verizon doesn't fully own its wireless business. That means it can't as easily tap wireless cash flow to fund its roughly $5 billion annual dividend payout.

Verizon on Monday outlined measures to improve wire-line margins, including cost cutting. But there is a limit to how far and fast a business with high fixed costs -- like a telephone operator -- can cut to keep pace with rapidly declining revenue.

The profit plunge of the past two quarters was likely worsened by cyclical pressures, including higher pension costs related to the stock-market swoon. But, on top of customers canceling access lines, what may be hurting Verizon's margins is growth of its new FiOS network for TV, Internet and phone.

Given the high programming and marketing costs related to FiOS, its customers are almost certainly less profitable than old-fashioned phone customers. As Sanford C. Bernstein analyst Craig Moffett notes, "FiOS is doing a better job of replacing revenue than operating income."

And the capital costs of installing the service are helping wipe out wire-line's free cash flow. Still, that could change when the rollout is completed next year. Investors lately have focused on wireless growth. They shouldn't ignore the struggling wire-line operations.

Write to Martin Peers at martin.peers@wsj.com

Printed in The Wall Street Journal, page C10