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It’s all about the spectrum at Verizon

| November 13, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Verizon Communications Inc. (VZ) tapped the market recently for a sizeable $12 billion in new debt with proceeds largely earmarked for acquisitions, including spectrum licenses. Nationwide C-band spectrum auctions kick off in early December and the additional proceeds increase the company’s cash position to approximately $21 billion, of which $15 billion could be spent in the upcoming auctions. While some of the proceeds may be used to fund the previously announced acquisition of TracFone Wireless, VZ will be an aggressive competitor in the spectrum auctions as this mid-band spectrum is imperative to its long term 5G strategy. Despite the incremental debt there is value in the new deal, which witnessed some volatility post launch and is currently being offered at or close to launch spreads. Based on where secondaries were trading prior to announcement, there is about 5 bp of upside in the 5-, 10-, 20- and 30-year tranches and 10 bp of upside in the 40-year tranche.

Exhibit 1. VZ New Issue Launch/Fair Value Spreads

Source: Bloomberg TRACE; Amherst Pierpont Securities

Agencies Believe in Spectrum Spending

All the rating agencies affirmed VZ’s ratings (Baa1/BBB+/A-) upon the deal announcement. Both Moody’s and S&P also maintained their positive outlooks despite the incremental debt as their ratings and respective outlooks incorporated the potential for spectrum spending. Moody’s maintains the view that spectrum is the “most important core asset in a wireless network operator’s portfolio.” The agency goes on to note that investing in spectrum is akin to a long-term M&A strategy. That said, they expect the spectrum purchases will be monetized over time, similar to how synergies are realized. With VZ’s commitment to further debt reduction and a net leverage target of 1.75x-2.0x, slight increases in leverage for spectrum purchases are viewed as strategic and believed to strengthen the company’s operating profile. If all $12 billion of the recent debt issuance were used to fund spectrum purchases, net leverage increases from 2.1x as of 9/30/20, to just over 2.3x.

S&P echoed a similar view while noting its base case forecast for spending in the upcoming auction was $10 billion which could push leverage to the 2.5x area (this number includes S&P’s adjustments). This 2.5x leverage ratio happens to be S&P’s threshold for an upgrade to single A. In order to be upgraded, leverage needs to not go much higher than 2.5x in 2021 and the company would need to prove its case for further deleveraging in 2022. While VZ remains committed to the dividend, share repurchases are the company’s fourth capital allocation priority. As such, VZ has not repurchased any shares since 2015. With the dividend consuming roughly $10.2 billion on a LTM basis, this leaves over $11 billion for debt reduction.

5G the Path Forward

VZ launched its nationwide 5G dynamic spectrum sharing (DSS) network in October with coverage in over 1,800 cities, covering more than 200 million of the US population. VZ also expanded its 5G Ultra-Wideband (UW) service to 55 cities, 43 stadiums and arenas and 7 airports. VZ plans to add 5 additional cities, bringing the total to 60 by year-end. The 5G UW service provides for download speeds that are 2x faster than 4G and can handle data volumes 100x larger than previous capabilities. Additionally, VZ noted that its 5G UW speeds are faster than wired broadband. In the age of COVID, with both work and education mostly remote, faster speeds can mean more productive employees and students, no matter the location. Furthermore, VZ will see a significant improvement in capital efficiency from a cost/MHz perspective as more people adopt 5G enabled phones such as the iPhone 12. That said, 5G will add to growth opportunities in 2021 and could further improve its cash flow generation.

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