Last Updated: April 4, 2008: 2:34 PM EDT
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Verizon's tough call

The No. 2 wireless carrier desperately needs new revenue streams to offset declines in its core home phone business.

By Scott Moritz, writer

NEW YORK (Fortune) -- Verizon Wireless scored a major coup recently when it agreed to pay nearly $9.4 billion for wireless spectrum to build what could be the country's largest and fastest cellphone network. In a victory lap of sorts, Verizon executives on Friday hosted a conference call during which they predicted the network would blanket the nation in two years and boasted of the huge revenue opportunity for years to come.

CEO Ivan Seidenburg went so far as to call the company's ambitious plans for the newly-acquired 700 megahertz radio waves "transformative."

Let's hope so. Verizon's (VZ, Fortune 500) warm and fuzzy forecast of a gleaming future in wireless masks the cold reality facing the country's No. 2 wireless carrier: It's core business, landline phones, is slowly disappearing and the amount of debt it's taking on to finance a 4G network, as the next-generation of cellphone services are called, is rising fast.

Craig Moffett, an analyst with Bernstein Research, noted as much in a message to investors on Friday. Timed to Verizon's presentation to analysts on Friday, Moffett released a report in which he reminded investors that the company's present outlook is "nothing short of dismal."

"Someday, Verizon will be all about wireless data [and] rule the roost in wireless broadband," wrote Moffett. "Someday... but not today."

Specifically, Moffett noted, Verizon primary customer lines were cancelled at a rate of 10.6% last year as more customers switched to cable or wireless phone services. The pace of that decline is accelerating, according to Moffett, who points out that Verizon's primary residential phone lines have dropped by 27% since 2002.

Home phone service is still Verizon's biggest business, but it now accounts for only 29% of sales, according to Moffett. Verizon reported revenues of $93.5 billion in 2007.

Many customers are fleeing to cable companies like Comcast (CMCSA) and Time Warner Cable (TWC), which have successfully bundled lower-cost video, calling and Internet access services into single monthly packages. In response, Verizon and AT&T (T, Fortune 500) are building expensive video systems, but they're still losing customers by the thousands.

Wireless growth has long been Verizon's salvation in this downward trend. The carrier has not only gained mobile phone users from the steady decline in landline customers, it has also profited from the higher revenue generated by wireless calls. That's because, unlike a conventional call where customers pay only for the calls made, wireless carriers bill for calls made and received.

Even so, wireless services alone won't completely offset the revenue shortfall from fewer landline customers, which is why Verizon is investing heavily in mobile data services like Web access, GPS navigation and e-mail. What's more, Verizon is hoping that a joint venture with Vodafone (VOD) will give it the global scale necessary to negotiate lower prices on infrastructure and phones once it switches to a new wireless technology known as long term evolution, or LTE.

The cost of building its 4G wireless broadband network will be staggering, according to some analysts. Verizon isn't saying how much it plans to spend building the network, but has estimated that its total capital investments will be less than the $17.5 billion spent in 2007. That does not include the $9.36 billion it now owes on the wireless spectrum licenses.

To be sure, Verizon doesn't have much trouble attracting fresh capital these days. This week the company raised $4 billion from debt sales to help pay for the wireless spectrum. This pushes Verizon's total debt to about $35.1 billion. As investors have grown leery during the broader credit crisis on Wall Street, Verizon may find it harder, and more expensive, to secure additional funding in the future.

The big telco is in a tight spot. Wireless expansion is necessary to offset its core declines, but the problem is that investors won't like the costs or the deeper debts required to make it happen. To top of page