The news that Verizon Communications (NYSE: VZ) will acquire Frontier Communications Parent (NASDAQ: FYBR) appears to make strategic sense. For all of its consider 5G, fiber stays a critical an element of the broadband communications infrastructure, serving each consumers and businesses.
Unfortunately for Verizon’s shareholders, it has decided to buy Frontier at a time when the company faces significant financial struggles. Hence, even when the acquisition goes through, it’s liable to occur to the detriment of a selected group of shareholders. Here’s why.
Who suffers throughout the Frontier acquisition?
Probably the most probably victims of the acquisition are Verizon’s income investors — in other words, people who own the stock purely for the dividend.
As conditions stand now, Verizon is taken into account among the best dividend payers throughout the S&P 500. At a payout of $2.71 per share annually, recent investors earn a dividend yield of 6.5%. That’s five times as high since the S&P 500’s 1.3% average return. Also, it exceeds the returns one can earn from a certificate of deposit, which, even in today’s market, rarely exceed 5%.
Furthermore, the payout has risen for 18 consecutive years, with the company announcing the latest increase right after the Labor Day holiday. Moreover it’s notable because dividends might be adjusted at any time. Since ending such a streak could mean reputational damage to a stock, firms are likely to sustain such streaks if possible.
The dividend comes with an annual cost of greater than $11 billion. That’s significantly below the $19 billion in free money flow Verizon generated throughout the last 12 months. Such conditions make the payout appear sustainable — until you look deeper.
Why the dividend is likely to be not sustainable
Unfortunately for Verizon’s shareholders, the company must generate greater than $8 billion in annual free money flow not tied to the dividend.
This can not be since the acquisition price for Frontier is an all-cash deal of $20 billion. Verizon can refinance Frontier’s $11 billion in debt, which is included within the acquisition price. After adding Verizon’s current liquidity of $3.9 billion, Verizon can probably accumulate enough money to complete the acquisition.
As an alternative, the issue that must worry dividend investors is its total debt, which was greater than $149 billion before Verizon announced the approaching Frontier purchase. The company had only reduced that by $1.4 billion in the first six months of the yr, indicating slow progress with this challenge. Moreover, as previously mentioned, Verizon will assume Frontier’s $11 billion in long-term debt, taking your complete debt to $160 billion.
Furthermore, pressure to reduce or suspend its dividend may come from its competition. T-Mobile didn’t pay dividends before introducing a payout late last yr. Still, at a 1.3% dividend yield, it’s a comparatively modest expense for the company.
What is also more problematic for Verizon shareholders is AT&T‘s example. After 35 straight years of increases, AT&T slashed its dividend by 45% in 2022 amid its own crushing debt burden. Its stock suffered for about 18 months after the dividend cut but has increased by about 45% throughout the last yr. That move may give Verizon’s management the duvet needed for a dividend cut that appears increasingly inevitable.
Addressing Verizon’s dividend situation
Amid news of the Frontier acquisition, Verizon dividend investors should consider selling the stock. Indeed, income investors may not want to let go of such a high yield, and with free money flows exceeding dividend costs, some shareholders may not see a reason to sell.
Unfortunately, the Frontier purchase will significantly add to an already crushing debt burden. Which will likely make Verizon’s wisest plan of motion to drastically reduce or suspend dividend payments.
Even when reducing the dividend boosts Verizon’s stock future, it must be of little use to investors who stuck with Verizon for its payout. Hence, dividend investors should probably unload this stock before a dividend cut brings further selling.
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Will Healy has no position in any of the stocks mentioned. The Motley Idiot recommends T-Mobile US and Verizon Communications. The Motley Idiot has a disclosure policy.
Prediction: Verizon’s Purchase of Frontier Could Prove Costly for 1 Group of Shareholders was originally published by The Motley Idiot