Verizon’s Record Bid for Spectrum Expansion is Unlikely to Impact Dividend

Verizon closed out 2020 with solid financial results.  While sales contracted a modest 3% with minor pandemic related headwinds, earnings grew slightly thanks to margin improvements.

 

Cash flows remained strong and investors were rewarded with Verizon’s 14th consecutive annual dividend increase.

 

Overall, Verizon had a routine year despite the chaos found elsewhere as the world slogged through an economic downturn.

 

But as the global economy continues to stabilize, telecom companies are entering this year with increased instability.

 

Rising demand for so-called fifth-generation technology (5G) is pushing network providers to accelerate the development of their infrastructure.

 

The 5G network has the potential to be 100x faster and offer 1,000x more capacity than today’s technology, according to industry experts.  This means consumers will have more reliable service with less latency.

 

This is important to consumers who continue to expect more from their smartphones and expanding list of connected devices.

 

As a result, telecom companies must continue investing in their infrastructure to keep pace with consumer demands.

 

Demand for 5G technology seems to be reaching a tipping point and mobile providers are aggressively positioning themselves for the future.   

 

The next significant step for wireless providers to accommodate 5G is the expansion of coverage through the purchase of scarce spectrum licenses.

 

Spectrum refers to the FCC-regulated invisible radio frequencies that wireless signals travel over.  Spectrum frequency ranges fall into one of three bands: high, mid, and low. 

 

The high-band offers very fast speeds but does not travel far from the tower, whereas the low-band travels far distances but provides lower speeds. 

 

Mid-band is found in between and offers an attractive trade-off between connection speed and range.  This targets those living outside of dense city centers but not in rural areas.

 

Last December the FCC opened an auction for new licensing on the C-Band spectrum (mid-band) which has generated record-setting bids estimated to exceed $80 billion, far surpassing the prior record of $45 billion in 2015.

 

For legal reasons Verizon is not able to comment on the details of its bids yet, but they are believed to be the largest buyer with bid estimates reaching $40 billion.  For context, that's nearly one-third of last year's revenue.

 

The importance of this mid-band spectrum is clearly evidenced by these record-breaking bids.  This is especially so for Verizon and AT&T.

 

Following T-Mobile’s acquisition of Sprint last spring, it now boasts the nation's most complete spectrum portfolio with an abundance of mid-band spectrum.

 

For effective 5G coverage, providers need a well-balanced spectrum portfolio.  Verizon has what may be the industry’s largest portfolio of high-band spectrum, but it lags competitors in mid-band.

 

Verizon has found itself in a situation where it needed to be aggressive in this auction to support 5G expansion and to remain competitive with its peers.

 

Assuming expectations are correct, and Verizon is about to shell out $40 billion for its spectrum expansion, could the company’s dividend policy be affected?

 

Verizon will likely finance some, if not all, of this transaction with debt.  This comes at a time when management’s preferred leverage ratio (net unsecured debt-to-adjusted EBITDA) is already at the peak of its target range of 1.75x to 2.0x.

 

Should Verizon choose to finance the full estimated $40 billion auction bid with debt, we estimate its preferred leverage ratio would expand to nearly 2.9x.

 

However, it’s more likely that Verizon will fund the transaction with a mixture of debt and cash since the firm ended 2020 with an abnormally strong $22 billion in cash on its balance sheet.  

 

With this mixture, we estimate Verizon’s leverage ratio will expand to somewhere between 2.5x and 2.9x.

 

Although this is outside of management's preferred range, Verizon has consistently strong cash flows which should allow them to deleverage over the next few years.

 

But with an annual dividend commitment of $10 billion, is it possible Verizon would consider reallocating this cash to accelerate its deleveraging?

 

We don't think so. 

 

Verizon has a conservative payout ratio and generates predictable earnings thanks to the essential nature of its wireless services.  This provides the company the flexibility to continue supporting the dividend while also paying down debt.

Management has historically shown a strong commitment to the dividend and prioritizes it over deleveraging.

 

Coupled with the healthy amount of free cash flow Verizon retains after paying dividends, the firm will likely be comfortable managing slightly higher debt loads until 5G is scaled and becomes more profitable.

 

Already Verizon customers are showing a willingness to pay more for 5G, according to management.  This has accelerated with the new iPhone’s 5G compatibility and should help the firm retain more profitable subscribers. 

 

Verizon also currently offers 5G home internet in 12 cities and is hopeful to expand that to more than 20 additional markets this year.  

 

Like mobile, 5G home often provides greater speeds and capacity relative to home internet providers.  This is encouraging with the ever-growing list of connected devices in the home (TV, fridge, thermostat, doorbell, etc.).

 

Self-driving vehicles, drone delivery, and smart cities will all require 5G speeds and capacity to be fully adopted, too.  These markets can provide additional opportunities for Verizon to grow revenues.

 

Overall, Verizon will navigate these next few years with a little less financial flexibility as it builds out its 5G capabilities.  However, we feel confident the dividend policy will remain intact and are reaffirming our Very Safe Dividend Safety Score.

 

The biggest risk for investors going forward is what follows this “arms race” for spectrum in the C-Band auction.  

 

If these record-breaking spectrum bids turn into an accelerating spending trend rather than a one-time event, we would reevaluate our Dividend Safety Score.

 

Until then, Verizon should be able to balance capital expenditures and the corresponding revenue growth while supporting the dividend.