Verizon Debt Ratings Downgraded Following $130 Billion Vodafone Deal
Moody's Investors Service has downgraded Verizon Communications long-term debt ratings by one notch as a result of its decision to purchase Vodafone Group's 45% stake in Verizon Wireless with a significant component of debt.
The downgrade reflects the increase in leverage (Debt to EBITDA) resulting from the addition of about $67 billion of new debt which will more than double Verizon's debt load to $116 billion (GAAP) upon closing of the transaction.
In addition, the approximately 1.3 billion shares of new common stock that the company will have to issue will have a large impact on its ability to generate free cash flow (and deleverage) since it increases Verizon's annual common stock dividend by about 50% to about $9 billion. Consequently, Moody's said that they expect leverage to remain elevated for quite some time.
"The downgrade to Baa1 from A3 is based on our expectation that, for an extended period of time, leverage will be materially higher than our prior forecast," stated Dennis Saputo, Moody's Senior Vice President.
"In addition, our expectation for significantly higher cash tax payments beginning in 2014 will limit Verizon's ability to reduce the incremental $67 billion of debt associated with the transaction," concluded Saputo.
Based on Moody's projections, Verizon's consolidated Moody's adjusted debt balances will be about $127 billion at the end of 2014 (assuming that all excess cash between now and then is applied toward reducing debt). FYE 2014 leverage (Moody's adjusted) is projected to be about 2.9x. EBITDA is expected to grow over 5% in 2014 (and 2015) mainly due to the continued strong performance of Verizon Wireless but also reflecting margin expansion at the wireline segment. Constraining free cash flow is the increase in cash taxes coming from Verizon gaining 100% ownership of Verizon Wireless, the additional interest cost from the $67 billion debt raise and the increase in dividends from the additional shares issued.
Consequently, even if Verizon uses all of its free cash flow to reduce debt (as expected), debt balances will still be over $120 billion at the end of 2015 and leverage will be around 2.7 times.
While unlikely in the near future due to the large amount of debt issued, Moody's could eventually raise the company's ratings if operating performance exceeds expectations. Specifically, positive rating pressure could develop if Verizon's adjusted Debt to EBITDA and Free Cash Flow to Debt ratios were likely to be sustained below 2.5x and above 5%, respectively.
The ratings could come under pressure if adjusted Debt/EBITDA was likely to exceed 3.0 times or FCF/Debt remains in the low single digits for an extended time period. The most likely reasons for this would be: i) Verizon Wireless' operating performance falters as a result of increasing competition and/or industry pricing pressure; ii) the financial performance of the wireline operations deteriorates; or iii) Verizon commences a series of debt funded acquisitions, including large amounts of debt funded spectrum purchases.