Updated from April 25 with additional information.
Verizon (VZ) has abandoned its long-stated goal of returning to its debt ratings prior to the $130 billion buyout in 2014 of the minority stake in its wireless unit, the telecom noted in a Friday filing with the Securities and Exchange Commission. Verizon will be hosting an investor call with analysts on Monday afternoon to discuss the change and other issues.
The shift raises questions about whether Verizon would be more open to an acquisition or other moves that would push its debt levels higher, or if it were merely acknowledging the reality of its balance sheet.
"We believe that Verizon remains committed to lower leverage and its current business plan does not include any change to capital allocation, such as shareholder returns," Moody's analyst Mark Stodden wrote in a report on Friday. Verizon's leverage is near the "upper threshold" of the telecom's Baa1 credit rating, Stodden wrote, and the analyst suggested that the telecom would not want to jeopardize its score.
"However, we also acknowledge that Verizon's recent public comments suggest a growing tolerance for transformative M&A, which could result in higher leverage and a potential ratings change," Stodden wrote.
MoffettNathanson analyst Craig Moffett suggested in a note on Monday that the FCC filing recognized that Verizon does not have "any serious hope of meeting their deleveraging targets" by the prior timeline. "Far from being an opening salvo for M&A, as many read the announcement, it should instead have been read as an admission that large scale M&A is increasingly out of reach," Moffett wrote, reiterating his view that Verizon's balance sheet cannot accommodate a mega deal such as a purchase of cable operator Charter (CHTR) .
Moreover, a wireless pact that Charter recently struck with Comcast (CMCSA) would essentially prevent a sale of the cable operator to Verizon.
The communications world is readying for consolidation. In late April, the FCC ended a quiet period blocking participants in a recent auction of wireless spectrum, ranging from the most of the big telecoms to Comcast and Dish (DISH) , from strategic talks. Meanwhile, the Trump administration's perceived regulatory permissiveness could open the door to larger deals.
Verizon CEO Lowell McAdam previously opened a can of worms recently with comments to Bloomberg that the telecom would entertain talks with Comcast, Walt Disney (DIS) or CBS (CBS) . Reports previously had linked Verizon to Dish, which has built up a portfolio of wireless spectrum licenses, and to cable operator Charter.
While Verizon would seem primed to take part in the deal frenzy, in earlier research MoffettNathanson analyst Moffett directed attention to the telecom's balance sheet. "It provides a welcome bit of sobriety to what has become a frustratingly speculative parlor game of who might buy whom in what is widely expected to be an M&A boom for the telecom industry," Moffett wrote.
Verizon's subscriber woes grabbed headlines after the telecom reported first quarter earnings on April 20. The telecom's posted net debt of 2.6 times Ebitda, up from a multiple of 2.4 times at the end of the fourth quarter and, as Nathanson noted, was the telecom's highest ever reported debt ratio. By comparison, AT&T, which reports tomorrow, had net debt of 2.29 times Ebitda at the end of 2016, according to FactSet, while Sprint reported 3.15 times Ebitda. T-Mobile USA reported net debt of 2.2 to 2.3 times Ebitda for the first quarter, but excluded obligations related to towers. FactSet put T-Mobile's year-end debt at 2.67 times Ebitda at the end of 2016.
"If you think Verizon might buy Charter, or that Comcast might buy Verizon, or that Verizon might buy Dish Network or its spectrum, or CBS, or ... well, even that fading collection of print magazines (and, yes, ad tech) at Time Inc. (TIME) , you might want to read this," Moffett commented.
Verizon's $130 billion purchase of U.K. communications group Vodafone's minority stake in Verizon Wireless in early 2014 knocked up its leverage. Net debt rose from one times Ebitda at the end of 2013 to 2.5 times in the first quarter of 2014, according to Verizon's regulatory filings. The ratio hit 2.5 times Ebitda in the first two quarters of 2015 but did not reach 2.6 times Ebitda until the first quarter of this year.
The carrier's "true leverage," as Moffett writes, would include operating leases, which the Financial Accounting Standards Board will require companies to include in debt in the next few years. Including the leases, Moffett noted, the current debt ratio would rise to 3.4 times adjusted Ebitda. By this adjusted measure, however, Verizon's debt ratios were actually higher in the first two quarters of 2015, when the metric hit 3.5 times, than they are now.
Verizon has struggled recently to hold onto mobile subscribers. Revenues have also slipped, Moffett noted, making the in leverage a more significant concern. "The quarter after Verizon closed the Vodafone deal in February 2014, their consolidated organic revenue was growing at a rate of 6.2% per year," Moffett noted. "In the just reported first quarter, their consolidated growth rate was -4.5%."
During Verizon's April 20 first-quarter earnings call, CFO Matt Ellis told investors that that the carrier is targeting pre-Vodafone debt levels, However, he suggested that Verizon is willing to wait a bit before de-levering if the right deal comes along. "If it means we push out when we get to those targets because we have a great opportunity, we're going to do that," he said.
Since buying the minority stake in Verizon Wireless, the telecom giant has targeted modestly sized digital properties such as AOL, which it bought for $4.4 billion in 2015, and Yahoo! (YHOO) , which Verizon is acquiring for $4.48 billion in a deal expected to close this year.
With the end of the wireless spectrum auction, the bigger opportunities alluded to by Ellis could materialize soon. Verizon will have to decide whether to sit out big deals, as it has done since consolidating its wireless business, or adding even more debt to the balance sheet.
Editor's note: This article was originally published by The Deal, a sister publication of TheStreet that offers sophisticated insight and analysis on all types of deals, from inception to integration. Click here for a free trial.
Read More Trending Articles: