The Long and Short
Fair Value Thoughts on New Jumbo Verizon Deal
Meredith Contente | March 12, 2021
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) recently tapped the market once again to fund the remaining $36 billion in spectrum licenses that it had not already financed. Despite overwhelming demand for the 9-part deal, it priced with a modest concession to secondary bonds, leaving some room for upside. Moody’s expects that the additional debt will extend the company’s deleveraging time horizon, and the rating agency lowered their outlook from positive to stable while reaffirming its Baa1 rating.
The deal was announced after the market close on Wednesday night, and by early morning the book size was already at $40 billion. Fast forward a couple of hours and the books grew to over $115 billion. The initial deal size was expected to be in the $20-to-$25 billion range, with $25 billion launching just after noon, making it the largest investment grade bond deal year-to-date. The potential spread upside available is anywhere between 8- to-14 bp across the curve (Exhibit 1).
Exhibit 1. VZ New Issue Launch/Fair Value Spreads
5G the Path Forward
Management spent the large portion of its investor day discussing the importance of 5G and why it was imperative to spend $53 billion for additional C-Band spectrum. VZ launched its nationwide 5G dynamic spectrum sharing (DSS) network in October 2020 with coverage in over 1,800 cities, covering more than 200 million of the US population. VZ ended 2020 with 60+ 5G ultra wideband (UW) mobility cities and 10+ 5G UW home cities. 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 still largely remote in certain areas, 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 both growth opportunities and improve cash flow generation in 2021.
As the top bidder in the C-Band Spectrum auctions, VZ noted that they more than doubled their existing mid-band spectrum holdings. VZ was successful in securing 140-200 MHz of C-Band spectrum in every available market. As such, management noted that over the next 12 months, they expect to have incremental 5G bandwidth to 100 million people in the initial 46 markets, with coverage expecting to increase to more than 250 million people by 2024. Not only is the C-Band spectrum important to VZ’s 5G expansion, but management noted that it also provides for more roaming opportunities and improved economies of scale as C-Band is a widely used spectrum across the world.
Moody’s Revises Outlook to Stable
Moody’s revised its positive outlook to stable while affirming its Baa1 rating, noting that the debt funded spectrum investments will extend the company’s deleveraging time horizon beyond what Moody’s felt was consistent with its positive outlook. While VZ remains publicly committed to debt reduction and has a net leverage target range of 1.75x-2.0x, with the new debt deal, net leverage is expected to increase to 2.8x in 2021, up from 2.0x at year-end 2020. Moody’s believes it will now take VZ roughly four years to return to the high end of its net leverage target. Moody’s noted that its stable outlook reflects its expectation that VZ will continue to deliver on strong revenue, EBITDA and cash flow growth which should help the company to bring its adjusted leverage to 3.0x by year-end 2023. According to Moody’s, VZ’s adjusted leverage will likely peak at 3.5x at year-end 2021.
S&P and Fitch Maintain Existing Ratings and Outlooks
S&P reaffirmed VZ’s BBB+ rating and stable outlook noting that while leverage is likely to rise close the agency’s downgrade trigger of 3.25x in 2021, they remain confident that VZ can reduce leverage over time. S&P noted that VZ benefits from a steady subscription-based revenue stream which underpins its stable outlook. Despite higher levels of capital expenditures over the next 3-4 years, EBITDA should remain strong as it derives nearly 90% of total EBITDA from the wireless business. That said, leverage will begin to decline over the same time frame. Additionally, Fitch also affirmed its A- rating with a stable outlook given management’s commitment to use excess cash flow after dividends over the next 3-4 years to bring leverage closer to the company’s net leverage target. That said, Fitch does not anticipate any share repurchase activity during this time frame as management has been vocal about not resuming share repurchases until it reaches its leverage target. Despite a competitive wireless market, Fitch believes VZ remains in a strong competitive position, given its high EBITDA margins, low churn and vast national coverage.