Verizon Wireless can’t deny dividends much longer

February 18, 2010

VerizonĀ  has used its mobile subsidiary’s prodigious cash flow to acquire rivals such as Alltel and pay down debt, rather than share dividends with minority partner Vodafone. This policy can’t last too much longer. While the initial public offering of T-Mobile’s U.S. arm may kick off more consolidation in the sector, Verizon Wireless is probably out of the game due to size. More importantly, its parent could use the cash.

The wireless unit could pay out a substantial dividend to 55 percent owner Verizon and 45 percent holder Vodafone: The unit should generate around $12 billion of free cash flow this year. But nearly all of Verizon’s value is tied up in VW, so it probably wants to increase its stake. Boss Ivan Seidenberg said in January he is open to a deal if the price is right. Continuing to limit payouts raises the pressure on Vodafone to make a deal.

Verizon can’t delay much longer. It had about $2 billion of cash at the end of 2009. The company will receive another $5 billion in the next few months as final repayment of a loan extended to the wireless arm comes due. But this pile is already largely spent. Verizon’s landline operations are bleeding cash as customers drop service and may burn almost $700 million in 2011, according to Barclays. Meanwhile Verizon needs $5 billion to maintain its dividend.

While this year isn’t a problem, next year things could get tougher. Even with a planned $2 billion cut in capital expenditure, it’s not clear the group will generate enough free cash flow to continue shareholder payouts in 2011.

Of course, Verizon could take on more debt. Yet borrowing at the parent level while the subsidiary piles up cash isn’t a long-term solution. The wireless subsidiary will pay down its $22 billion of debt in around two years on its current path. That could put Verizon in the uncomfortable position of paying something like 6 percent on its debt while its subsidiary earns perhaps 1 percent on its growing hoard.

Verizon could sell traditional telephone assets and raise funds. Yet prices continue to fall. Selling chunks of its network may not bolster cash flow much, either. For example, Frontier Communications <FTR.N> has promised Verizon $3.3 billion in consideration for its purchase of landlines in 14 states — yet this may be in the form of debt. And repeated charges for firing workers to cut costs may eat up much of any windfalls.

Put it all together and something has to give at Verizon — and the most likely concession will be Verizon Wireless’ no dividend policy.

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