Verizon’s interest in buying a cable operator is back in the news, and late last week the company made an announcement. It wasn’t an announcement about buying Charter, and indeed the news was scheduled long before the Charter story broke. But Verizon’s news is very closely linked to its future acquisition plans.
On June 1, Verizon’s board said the company’s dividend will remain unchanged in the current quarter. No surprise there, but the announcement underlines a commitment Verizon and AT&T share, which limits both companies’ ability to grow through non-accretive acquisitions. Both companies pay out more than three quarters of their income as shareholder dividends. Verizon’s $2.31 per share annual dividend is smaller than AT&T’s, and its 67% dividend payout ratio is expected to come down this year as earnings increase. Still, a 12-digit acquisition like Charter Communications could force Verizon to borrow heavily in order to maintain its dividend.
Analyst Craig Moffett flagged dividend coverage as an issue for Verizon early this year, the first time the Charter speculation made the rounds. Moffett pointed out that Verizon might want to finance a deal primarily with equity in order to avoid taking on more debt. The company will finance its $3.1 billion purchase of Straight Path Communications with equity, but there’s a limit to the number of equity deals Verizon can do, because issuing more stock means paying more dividends. The carrier is caught between a rock and a hard place.
“While leverage limitations argue for a more equity-rich transaction, dividend payout ratios argue for a more debt-heavy one,” Moffett wrote. When it comes to Charter, “there may be no feasible solution that satisfies both of these considerations,” he said.
Last month, Moffett wrote that “things have only gotten worse” for Verizon when it comes to the company’s chances of buying a cable operator. Verizon’s first quarter earnings were disappointing and its ratio of debt to earnings before interest, depreciation and taxes is the highest in the company’s history, Moffett said.
Growth has slowed for Verizon as the rate of new smartphone subscriptions falls in the U.S. and as T-Mobile’s aggressive promotions take customers away from other carriers. Verizon has responded by expanding into other lines of business that complement wireless and may be growing faster than wireless. Media, fiber and the internet of things have all been target areas for Verizon’s mergers and acquisitions team.
The internet of things
Smartphone growth may be tapering off, but Verizon knows the opportunity to connect billions of other devices to its network is exploding. The company has recently upgraded its network to support LTE Category M1 for IoT connections, and it’s also exploring IoT businesses that don’t even involve its network. The company says its ThingSpace Iot platform is a resource for developers who want to connect devices through wired broadband, Wi-Fi, and even through competitors’ cellular networks.
The internet of things is also a cornerstone of Verizon’s acquisition strategy. In November the company closed on its $2.4 billion purchase of Fleetmatics, a provider of tracking and telematics solutions. Shortly before that it completed its purchase of fleet management software provider Telogis for an undisclosed sum said to be just shy of $1 billion.
Verizon is also well positioned to connect smart cities and autonomous vehicles because it has taken an early lead in the race to deploy outdoor small cells. These nodes could form a backbone for future IoT applications as 5G technologies make their way into carrier networks. Small cells typically need backhaul and fronthaul, and that’s one reason Verizon has been voraciously acquiring fiber assets. It’s also a reason that Verizon’s executive team probably won’t stop thinking about cable anytime soon.
“The next generation of wireless will be about small cells with small radii,” wrote Moffett. “And every one of those cells needs to be connected to a wire. That means lots and lots of wires. And Cable has the most wires.”
T-Mobile CFO Braxton Carter seems to be thinking along the same lines. Earlier this year, Carter said the combination of wireless and cable companies is “a question of when, not if.”
Verizon’s next steps
Unlike T-Mobile US, Verizon is probably too large to be bought by a cable company. Yet it’s not large enough to buy one without threatening the value of its core business. For now, Verizon may decide to take a breather and digest its recent acquisitions, giving its earnings time to catch up with its ambitions.
The company has a lot to digest. It’s $4.48 billion acquisition of Yahoo is set to close this month, followed by the $3.1 billion Straigh Path purchase. In February Verizon closed on the $1.8 billion purchase of XO Communications’ fiber network business.
Together, the cost of those three acquisitions is just over $9.3 billion, which happens to be the same amount that Verizon spent last year on shareholder dividends. Net income for Verizon was $13.1 billion last year.
“Truth be told, you really don’t have to wait for Verizon to issue more equity to get nervous about their dividend coverage,” said Moffett. “They’re already struggling.”
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