Verizon: The Final Frontier

Summary:

• Verizon’s acquisition of Frontier Communications for $20 billion aims to expand its fiber footprint and drive future premium mobility and broadband services.
• The deal, expected to close by early 2026, promises $500 million in annual cost synergies but there are serious concerns about overpayment and debt impacts.
• Verizon’s Q2 performance showed strong wireless growth and improved cash flow, but the acquisition’s long-term effects on dividends and expenses remain uncertain.
• Are there really benefits?

These are the voyages of the income name Verizon (NYSE:VZ). A company now debt laden, that had seen its cash flows evaporate, only to finally start rebounding despite immense competition and costs of operation. Still, we reiterate our Buy rating on Verizon Communications Inc. (VZ) shares today following news that the company will be acquiring Frontier Communications (FYBR). This is a rather interesting development and comes as the company has been seeing improvements to its cash flow outlook in the recently reported Q2 earnings. While we have had a buy rating on the stock since the low $30s, the stock has somewhat stalled out, hitting the low $40s. In our opinion, Q2 earnings were solid, and the acquisition brings new assets and customers into the Verizon enterprise. Let us discuss.

The acquisition and related thoughts

The rumor mill had been churning on this one for a while, what would happen with Frontier. It has been an obvious target for some time. The announcement was made officially this past Thursday that a definitive agreement had been reached for Verizon to acquire Frontier in an all-cash transaction valued at approximately $20 billion. That is a sizable hit to the balance sheet, make no mistake. Frontier is one of the largest pure-play fiber internet providers in the United States. The thought process here is that picking up a weathered Frontier will help to expand Verizon’s fiber footprint. Moreover, it should help drive future premium mobility and broadband services to new customers, as well as current ones too.

So, this deal comes at a hefty premium to Frontier’s prior trading prices. Under the agreement, Verizon will acquire Frontier for $38.50 per share in cash, representing a premium of approximately 44% to Frontier’s 90-day volume-weighted average share price as of the start of trading in September.

So what are the positives for Verizon on this $20 billion? Well, Verizon expects to realize at least $500 million in annual cost synergies by the third year following closing, primarily through increased scale, distribution, and network integration. Further, the deal will integrate Frontier’s advanced fiber network, which encompasses 2.2 million subscribers across 25 states, into Verizon’s portfolio of fiber and wireless assets, including its Fios offering.

Of course, this is subject to approval by Frontier shareholders, but we do not see a reason this will not pan out on that front. The transaction is expected to close by early 2026. However, it will face regulatory scrutiny. The CEO appeared on CNBC Thursday to discuss the deal, and believes this will not face too much regulatory pushback. Verizon CEO Hans Vestberg expects that its planned purchase will be approved by regulators:

“We are very confident that this will go through, but we also expect that the process will be thorough, and we have dealt with these types of processes before… [the deal] is not overlapping at all [with FIOS] as this was sort of a piece of Verizon before…it’s going to take some time”

However, this will also depend on which administration is in office. Without getting too far into the realm of politics, one has to imagination a more lax environment under a Trump administration when it comes to M&A activity, compared to a Harris administration as the latter is likely to extend the policies of the current Biden administration which has stepped up its anti-competitive blocking of large deals. Now, we would not consider this to be an over the top anti-competitive deal, but the fact is that in telecoms and internet providers, it is not exactly a hotbed of competition.

Upon closing, the deal is anticipated to be accretive to Verizon’s revenue and Adjusted EBITDA growth rates and drive significant cost synergies; however, exact impacts are questionable. One does have to worry about what impact this will have on the dividend payout ratio and its safety. This news comes as the company, a serial dividend raiser, just raised the dividend again to $0.6775 quarterly. The company also took the opportunity to reaffirm its guidance with this announcement, seeing adjusted EPS of $4.50 to $4.70 and wireless service revenue growth of 2% to 3.5%.

Now, while $500 million in cost synergies by 2029 sounds great, for $20 billion one has to wonder what impact this has on costs. If we look to the last year of operations, we see about $32.2 billion in selling, general, and administrative expenses, and nearly $17.8 billion in others related in the latest quarter. So, $500 million in savings is not all that great. With the massive premium, it can be argued that Verizon is likely overpaying. It is also unclear what costs will be associated with the merger on top of the deal (think legal, think integration related expenses), nor how long it will take to fully integrate. That can offset or delay added benefits. That is not uncommon with sizable acquisitions. Now, the $20 billion is also equivalent roughly to annual free cash flow, so dividend investors should be on the lookout for possible impacts to the payout ratio, which is vital to sustaining the dividend. In addition, impacts on debt reduction efforts are also in play.

When Verizon reported its Q2, revenues were below expectations. We covered this previously, but a few points are noteworthy to remind you of. The earnings power was once again strong considering a revenue figure that missed expectations by $240 million. Revenue hit $32.8 billion and increased 0.8% from last year. Wireless growth was strong, while business revenues were down once again. In the wireless segment, there was 3.5% revenue growth from last year to $19.8 billion. As for net additions, retail postpaid phone adds hit 148,000, and retail postpaid net adds were 340,000. Churn is a metric to watch and retail postpaid phone churn was a small 0.85% while postpaid customer churn was in line with norms at 1.11%. Broadband saw net additions of 391,000 while there were also 378,000 fixed wireless net additions. It is important to note that 2 was the second quarter in a row of sub-400,000 broadband net additions. So why pick up an internet fiber provider? Perhaps because while Fios is enjoying net growth, it is slow. There were 28,000 Fios Internet net additions in Q2.

Now, we touched on operating expenses above and in Q2 2024 operating expenses were $24.98 billion, but this was a decline from last year’s operating expenses of $25.37 billion. Verizon reported $7.8 billion in operating income, and this was up 8.3% from last year’s $7.22 billion. Now if the acquisition adds $500 million in synergies to cost savings by 2029, that works out to $125 million a quarter, give or take. When you look at expenses of over $25 billion, it is not all that impressive, quite frankly. The company reported $1.15 in EPS with adjusted EBITDA of $12.3 billion. Before this announcement, Verizon was on the comeback, and free cash flow was impressive, following a few years of pressure.

Cash flow from operations in Q2 was $9.5 billion, and capex was $4.1 billion. Dividends paid were about $2.8 billion in Q2. Free cash flow was $5.8 billion, and the payout ratio was about 48%. For the year, we are anticipating a payout ratio of less than 70%. The impacts to debt long-term are also a consideration. The debt remains massive. The net debt in Q2 dipped slightly to $122.0 billion, down $4 billion from the start of the year, and the net debt-to-adjusted EBITDA ratio ticked down from 2.6X in the sequential quarter to 2.5x this quarter.

Looking ahead

We have some reservations about the price tag here in this rate environment. The biggest positive here is that the deal will significantly expand Verizon’s internet business. The FIOS internet service was largely confined to the northeastern U.S. Following the deal, Verizon will now have an internet presence in nearly two dozen more states. Since the deal won’t close until 2026, this gives Verizon time to plan for its cost allocations and set itself up (one would hope) for paying for the acquisition, the related-costs, and preserving the dividend. With such a deal, we also do not know what customers will do. Will they stay on with Frontier (or whatever Verizon decides to call them and the plans)? Or will they churn out? What will the impact on pricing be to customers? These are unknown risks. With the internet services now expanding, this sets up cross-promotion potential. For example, in the northeast, where available, customers can bundle internet, cable, and phone services for significant savings. That may be a tangential benefit. But a lot has to go right for the deal to even start being accretive to EPS and EBITDA. In fact, it may take a year plus before the deal starts to be accretive post close. The major risks here are the impact on the balance sheet, mostly through debt impacts and capex, and subsequent hits to cash flow.

After turning around the company to a large degree versus two years ago, investors can continue to sit and collect the bountiful dividend, which continues to be raised. However, the deal introduces new risks to the investment. These risks are many quarters down the road, but come this time next year, a lot more scrutiny into the deal and the anticipated impacts will start to factor in to the pricing of shares. However, we stand by a buy call based on where we are today. The expansion efforts will take time, but the cross-promotion potential is strong with the deal. We do think Verizon is overpaying based on the cost synergy projections, however. On top of that, getting through regulators may depend somewhat on not just the impacts on competition, but also on the November elections.

Have something to share?

Can they overcome their debt burden with this major purchase? Will the deal get blocked? Do you agree that the November election may play a role in the outcome of this deal? Do you think Verizon is overpaying? Are you a long-term investor, holding on to the stock for dividends? Know of any other dividend-paying stocks that are strong contenders? Anything else to add to the discussion? Let your voice be heard.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of VZ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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