Verizon is bringing in some cash to help pay for its pending Frontier Communications acquisition.
Verizon (VZ 0.04%) pays a towering dividend. The telecom giant’s payout yields more than 6%, making it the highest-yielding member of the Dow Jones Industrial Average (and a top-10 payer in the S&P 500). One factor driving its elevated yield is concerns that the company’s hefty debt level might impact its ability to sustain that payout over the long term.
The company’s debt is on track to balloon further after it agreed to buy Frontier Communications (FYBR -0.50%) in a $20 billion all-cash deal. However, it recently made a counter move to cash in the value of its tower assets, which will bring in $3.3 billion to help enhance its financial flexibility.
Starting from a position of strength
Verizon ended the second half of this year with $149.3 billion of total debt (and $122.8 billion of net debt). While that’s a lot of debt on an absolute basis, the telecom behemoth can handle that level. Its net-debt ratio was 2.5 times, which is lower than telecom rival AT&T (T 0.46%). Even though AT&T had a similar debt load ($126.9 billion of net debt), it had a higher-leverage ratio of nearly 2.9 times. AT&T aims to get its leverage ratio down to the 2.5 times range in the first half of next year. Meanwhile, Verizon set an even lower long-term leverage target of 1.75 times to 2.0 times, which it also initially aimed to achieve by next year.
Verizon’s stronger balance sheet recently empowered it to make a move aimed at improving its competitive positioning versus AT&T in fiber. The company’s proposed $20 billion deal for Frontier will increase its scale by adding 2.2 million fiber customers. It will also enhance its ability to grow its fiber business, which will be able to reach 25 million premises. The deal should also boost Verizon’s earnings, given the expected $500 million in cost synergies it expects to capture.
However, the deal will delay Verizon’s ability to achieve its leverage target. Credit rating agency Fitch expects Verizon’s leverage ratio to be around 2.3 times by the time it closes the Frontier acquisition next year. It will then jump back up into the mid-2.0 times range before steadily falling back toward its long-term target.
A debt-reduction accelerant
Verizon could have de-leveraged its balance sheet solely with post-dividend free cash flow and earnings growth. However, it is taking a step to accelerate its ability to eventually achieve its leverage target by cashing in on some of its tower assets.
The company agreed to give Vertical Bridge the exclusive rights to lease, operate, and manage 6,339 wireless communications towers across the U.S. for $3.3 billion. The deal’s structure is a prepaid lease with upfront proceeds of about $2.8 billion in cash. Verizon will lease back the capacity on the towers for at least 10 years. Meanwhile, Vertical Bridge will have the ability to sign leases with additional tenants on those towers.
That upfront cash payment will help reduce Verizon’s debt level ahead of the Frontier acquisition. It will put the company in an even stronger position to handle that transaction, accelerating its ability to eventually achieve its long-term leverage target.
Verizon could sell other non-core assets in the future, including additional cell towers and some non-core fiber assets. That would further hasten its ability to reach its targeted leverage level.
A smart move
Verizon has been a great dividend stock over the years. It recently delivered its 18th straight annual-dividend increase, extending the currently longest dividend-growth streak in the U.S. telecom sector. While the Frontier deal has caused concerns that a reelevation in its debt level could jeopardize its dividend-growth streak, its tower transaction should help ease those worries. It enhances the thesis that Verizon can continue to pay a towering dividend that should keep growing.
Matt DiLallo has positions in Verizon Communications. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.