What does the Verizon-Vodafone deal mean?

For dividend investors, the move means years of stable dividend growth. But the US telco will also have far less financial flexibility to make quick moves in the fast-changing industry.

By TheStreet Staff Sep 3, 2013 11:49AM

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Customers enter a Verizon Wireless store in New York City on July 23, 2010 (© Jin Lee/Bloomberg via Getty Images)By Antoine Gara

Investors trying to understand the implications of Verizon's (VZ) $130 billion acquisition of a 45% stake in Verizon Wireless (TheStreet) should focus on the telco giant's 2.9% increase to its quarterly dividend.

Verizon had many strategic options heading into the second half of 2013 given its low debt, record profitability and high cash-generating abilities. That Verizon chose to use its position of strength in the U.S. wireless industry to buy Vodafone's (VOD) stake in Verizon Wireless indicates the company is now moving into a phase where it will focus on its dividend growth above other strategic planning.

At $130 billion, Verizon's acquisition of the remaining 45% in Verizon Wireless is the third-largest deal in corporate history. Still, the acquisition by Verizon is entirely a matter of corporate financial management and it has few strategic implications.

Full control of Verizon Wireless likely will add years of stable dividend growth for Verizon investors. It also means the company will have far less financial flexibility to make quick moves in the fast-changing telecom industry.

The deal appears to be financially attractive for Verizon and will allow the carrier to consistently increase its earnings and dividend over the next few years. The telecom company is financing its stake purchase with $60.2 billion in stock at near-record share price highs and it will raise about $61 billion in debt for the deal at what are near historic interest rate lows for highly rated corporations. Verizon is also selling back some European assets to Vodafone and will use cash to fund parts of the deal.

For such financial commitments, Verizon said owning 100% of Verizon Wireless will immediately add about 10% to its earnings per share and up to 16% in EPS by the end of 2014. The free cash flow of Verizon Wireless will also help the telecom increase its dividend, which now sits at 53 cents a quarter, or a yield of nearly 4.5%, one of the highest in the Dow Jones Industrial Average ($INDU).

After the transaction closes, expected in the first quarter of 2014, Verizon will carry a total of $108.7 billion in debt, or about a net debt of 1.9 times pro-forma EBITDA (earnings before interest, taxes, depreciation and amortization), according to calculations from Evercore Partners analyst Jonathan Schildkraut. Such debt represents about a doubling of Verizon's financial commitments. However, Schildkraut calculated the company will generate up to $70 billion in annual free cash flow between 2014-2016, allowing it to quickly repay creditors.

While the next few years may be a predictable story of growth in Verizon's earnings and cash returns to investors, the company is now far more exposed to fundamental shifts in the wireless industry or to new strategies from competitors such as AT&T (T), Sprint (S), T-Mobile (TMUS) and possibly Google (GOOG) and DISH Network (DISH).

In that sense, Verizon's deal can be seen as a bit defensive (TheStreet). The company is harvesting its remaining low-hanging fruit, after being a first mover in the U.S. wireless industry a decade ago.

Harvesting profits and cash flow are a staple of Dow dividend payers such as Merck (MRK), Procter & Gamble (PG) and Exxon Mobil (XOM). What Verizon isn't doing is preparing itself for a new strategic growth push were such as need to arise.

Verizon sits at a confluence of many fast-changing and high-growth markets. It is one of the biggest buyers of Apple (AAPL) and Google (GOOG) handsets. The company's cable business is a major distributor of broadcast, movie and cable TV content. Its fiber business also supports consumers' increasing reliance on streaming video content such as Netflix (NFLX).

Each of these industries could shift on a dime with a technological innovation or a strategic push from the likes of Apple or Google. Meanwhile, Verizon's cash-gushing Verizon Wireless industry also faces the threat of competition from price-cutting telecoms like Sprint and T-Mobile that could hit margins in coming years.

Verizon is betting $130 billion on status quo in the U.S. wireless and communications industry.

Investors who owned the company's shares for its 4%-plus dividend should be heartened. The future is much less clear, however, for those who invested in Verizon as a means to gain exposure to growth of the mobile communications industry in the U.S.

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