Verizon Communications Inc. (NYSE:), which is a leading player in the US communications industry, has been in the news for its purchase of the 45% stake that Vodafone held in Verizon Wireless. Though widely supported by the street, some investors were worried as to whether the company would be able to cope with the huge amount of debt that had to be issued for the deal, especially since the growth in the telecom sector has not been robust and competitors are engaged in aggressive pricing.sir_aragorn / 123RF Stock Photo
However, it should be noted that interest rates are highly favorable for this move, and it should give the company additional firepower to deal with future challenges in the sector. Not only has the company raised its dividend for the 7th year in a row, its growth prospects appear bright, as well. Together, they should dispel any lingering doubts about the wisdom of the Vodafone deal or the company's ability to succeed in the short term.
The Verizon-Vodafone deal
, which was created out of AT&T () in 1984, currently operates its communications business through Verizon Wireline and Verizon Wireless. Vodafone, which held a 45% stake in the latter, sold the stake in September for $130 billion. This reduced its stake in a maturing American market so it can focus on its European operations. Verizon,(which had to issue debt to the tune of $67 billion to finance the deal) made use of the relatively low interest rates that are currently prevailing to ensure that the deal does not prove too costly.
However, the deal raised Verizon's debt to about $116 billion. This led to Moody's Investors Service downgrading the company. Further, with the American telecom marked maturing and competitors engaged in fierce price wars many questioned the wisdom of such a large deal for Verizon.
However, the deal also meant that VZ would get the full profits accruing to Verizon Wireless, and were freed from the often acrimonious relationship that it shared with Vodafone. As analysts point out, this should provide the company greater flexibility to align with market trends and also to use the profits to invest in assets and/or reward shareholders.
Verizon's dividend history
Although Verizon does not possess AT&T's long history of raises, it has been on a 6 year dividend raising streak. It recently extended to the seventh year by announcing a 2.91% dividend growth to $0.530 per share. This represents a dividend yield of 4.4%. Compared to AT&T's five year DGR of 2.3%, VZ's DGR now stands at 4.23%. Further, it gives a Chowder Number (Current yield + DGR) of 8.63, which is higher than the number that the Chowder Rule demands telecom companies.
Other positive indicators
VZ has an quarterly free cash flow of $3.72 billion, whereas the money it needs to pay dividends (2.6 billion outstanding shares at $0.53 per share) is just $1.37 billion. With the exception of one instance VZ's quarterly free cash flow has never been below the company's dividend needs.
Looking ahead the company's growth is expected to be in the range of 10% per year for the next five years. Again, this is much better than the 6% forecast for AT&T and the 5% for the industry as a whole.
The company recently its plans to swap 700MHz of A-block airwaves with T-Mobile () for $3 billion, a profit of $0.6 billion compared to the $2.4 billion that the company paid in 2008 for the spectrum. This gives the company some valuable funds to reduce debt, invest in other operations and reward shareholders. On the other hand, the company is in talks with Intel () to acquire its WebTV service for $500 million. This naturally means an additional cost to VZ, but investors should remember that the company has experience in running this type of business. Ideally this will have a positive impact on VZ's balance sheet in the long run.
So what should the investor do?
As the above analysis shows, Verizon's balance sheet and its growth prospects should provide enough evidence that the Vodafone deal will not be a hindrance to the company's ability to pay dividends. It cannot be denied that the Vodafone deal is momentous, but Verizon possess' the ability to handle the debt while maintaining dividend raises, investing profitably and improving its balance sheet.
Further, its two smaller deals with T-Mobile and Intel should help the company in this regard, as well. All said, the company has excellent prospects for growth in the coming years and investors who already have VZ in their portfolio would, therefore, be advised to "hold". Those seeking a stable dividend paying company's stock would be advised to "buy" into VZ's stock.
Author: Justin Martin