And now as wireless becomes increasingly saturated, Verizon Communications Inc. (NYSE:VZ) is looking to digital media and advertising to stay competitive. Specifically, Verizon paid $4.4 billion in 2015 for AOL, and has proposed $4.8 billion for the acquisition of Yahoo! Inc. (NASDAQ:YHOO), both of which will expand Verizon’s efforts in digital media and advertising, a space which is expected to continue growing rapidly, as shown in the following chart.
However, Verizon’s pursuit of growth in this area is not because it is a bold innovator (Facebook and Google already dominate mobile advertising), Verizon is pursuing growth in this area out of dire necessity, particularly with regards to feeding it’s big dividend (4.4%) that shareholders absolutely demand.
Verizon’s Big Dividend:
Without question, many dividend investors love Verizon’s big steady dividend which has now been increased for ten consecutive years. But to put things in some perspective, the following chart shows Verizon’s recent dividend payout ratio as a percent of free cash flows
And as the above chart shows, the payout ratio has continued to climb dramatically in recent years. In our view, the climbing payout ratio makes CEO Lowell McAdam’s statement about being “the company we need to be for the future” particularly dire. Specifically, the industry is changing rapidly, and if Verizon cannot adapt (e.g. it’s trying to harness the growing online advertising market) then it will become very challenging to keep supporting the big dividend.
By way of comparison, the following chart shows the free cash flow dividend payout ratio for AT&T Inc. (NYSE:T), Verizon’s peer and also a big dividend payer at 4.8%.
And as this chart shows, back in 2014, AT&T Inc. (NYSE:T) faced the same challenge Verizon currently faces in terms of a precipitous dividend payout ratio. However, AT&T was able to address the issue by acquiring DirectTV (mainly for its cash flow qualities, but also for longer-term strategic reasons), and that subsequently helped improve AT&T Inc. (NYSE:T)’s dividend payout ratio (i.e. the deal was structured in a way that used a combination of debt and equity, instead of cash, so as to improve the aggregate dividend payout ratio to a more manageable level).
In Verizon Communications Inc. (NYSE:VZ)’s case, the strategic Yahoo acquisition (and the earlier AOL acquisition) are designed to do largely the same thing (i.e. improve cash flow in the short-term, and provide longer-term strategic growth opportunities). For example, Yahoo! Inc. (NASDAQ:YHOO) doesn’t pay a dividend, and neither did AOL, but both businesses generate plenty of free cash flow that helps Verizon meet it cash flow needs in the short-run, but also help with Verizon with its longer-term evolution strategy.
Worth noting, Verizon also helped support its big dividend payments in 2016 by selling some of its telecom properties to Frontier Communications for $3.3 billion in cash and $5.2 billion in Frontier stock (the cash helps support Verizon’s dividend, and the Frontier stock isn’t horrible either considering the large amount of government subsidies it receives via the “Connecting America Fund”). Additionally, Verizon raised over $5 billion in cash in 2016 by selling tower assets to American Tower Corp (NYSE:AMT).
