Telecom Giants Levering Up At the Wrong Time
Telecom yield hogs are likely shaking in their pig pens.
But with both companies levering up and accumulating assets as the U.S. merger and acquisition boom goes full tilt, should shareholders be worried?
I’ll let history be our guide . . .
In 1984, the American Telephone and Telegraph Company, often referred to as “Ma Bell,” was split up to create more competition in the telecommunications industry.
Seven “Baby Bells” were created, but consolidation since then has resulted in a highly concentrated industry once again.
A long and complicated series of mergers and acquisitions have brought many of the Baby Bells back together, helping to shape present-day AT&T and Verizon.
These companies and their predecessor firms have been serial acquirers. But as with most things in life, timing of M&A is everything.
The Danger of Leveraged Acquisitions
In the midst of the tech bubble and merger boom in 1999, AT&T purchased two giant cable companies – TCI and Media One. The deals, which were valued at over $100 million combined, were part of an attempt to diversify AT&T’s businesses, provide growth opportunities and create synergies.
Well, the resulting debt load proved too burdensome, and AT&T had to spin off AT&T Wireless and sell AT&T Broadband a few years later.
So this deal, although strategically sound, was ill-timed and ultimately destroyed shareholder value.
As it turns out, history tends to repeat itself . . .
Over the past weekend, AT&T announced plans to buy DirecTV (DTV) for $48.5 billion in cash and stock. The deal is an attempt to diversify AT&T’s revenue mix, provide additional growth opportunities and create synergies.
AT&T intends to finance the cash portion of the transaction through a combination of cash on hand, sale of non-core assets, committed financing facilities and “opportunistic” debt issuance.
The other U.S. telecom behemoth, Verizon Communications, has grown even larger through a mega-acquisition, as well.
This past February, Verizon completed its $130-billion acquisition of the 45% stake in Verizon Wireless it didn’t already own from Vodafone Group PLC.
Verizon had to more than double its debt load to finance the purchase, and the company’s credit rating was promptly downgraded by both Moody’s and S&P.
Now, AT&T and Verizon’s timing is certainly suspect. Why wait until 2014 to undertake such large transactions?
Are these deals really being done with shareholders’ best interests in mind?
Creating Shareholder Value
One of the primary jobs of corporate executives is to allocate capital.
Will they distribute excess cash to shareholders through dividends or repurchases? Are they going to grow internally (organically) or grow by acquisition?
The importance of these decisions cannot be overstated . . .
Unfortunately, most managements display poor timing and overpay for acquisition targets, resulting in mediocre shareholder returns.
Let’s take a look at how well the managements of AT&T and Verizon have created shareholder value.
The chart above shows the total returns for the equal-weighted AT&T and Verizon Composite, which could be thought of as an approximate Ma Bell proxy, versus the S&P 500.
As you can see, the long-term total returns for these firms are now virtually identical to that of the broader market. This may come as a surprise to some, since these two telecom stocks sport yields that are well above average.
Now, it’s important to keep in mind that both AT&T and Verizon are doing large acquisitions after an epic, multi-year bull market in U.S. equities. Average valuations are higher than they’ve been at any point since the credit crisis.
But the best time to buy assets is when they’re cheap, not in the midst of an M&A boom fueled by Federal Reserve stimulus and excess liquidity.
They’re also adding significant leverage, which will put a strain on both companies – and their abilities to raise their dividends – should the economy worsen.
Based on the ineptitude of their managements to time these mega-deals, the total returns for AT&T and Verizon will likely track that of the S&P 500 over the long term, just as they have for the past 30 years.
Safe (and high-yield) investing,
Alan Gula, CFA