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Dividends divide telco playing field

A Moody's analyst is raising concerns about the hefty dividends paid by older telcos.

In a recent report, Mark Stodden, vice president and senior credit officer at Moody's, noted that while AT&T Inc., Verizon Communications Inc., Frontier Communications Corp. and CenturyLink Inc. have a long history of rewarding shareholders with "generous dividends that compensate for their low growth profiles," some tough choices may lie ahead. Rising competition in the wireless and wireline segments has forced operators to cut prices, even as they spend billions on network upgrades and spectrum purchases.

"The incumbent must choose: protect market share with capex or cut investment to cushion the dividend. Unfortunately, we see the latter as the more common outcome and expect the incumbents to continue to lose market share in all segments except wireless, where investment levels remain high," Stodden said.

AT&T regularly spends the most on dividends among its peers. In both the first and second quarters of 2016, the company used $2.95 billion of its free cash on dividend payments, respectively representing 41% and 69% of the company's levered free cash flow from each quarter. Notably, AT&T's dividend payments have grown in recent years: The company paid $524 million more in dividends in the second quarter of 2016 than it did in the same quarter of 2013.

"The old companies are sort of locked into their dividends," said Steve Birenberg, portfolio manager and owner of Entermedia Funds and president of Northlake Capital Management LLC, in an interview. He added that it would be difficult for these companies to cut their dividends given how important they are to investors.

"There's a lot of shareholders that are in there because of the dividend," Birenberg said.

Turning to Verizon, the company put $2.30 billion of its cash toward paying dividends in the second quarter, on par with the amount it spent in the first quarter. By comparison, the company paid $1.47 billion in dividends in the second quarter of 2013.

Much like AT&T, Verizon's dividend is on a clear growth trajectory. On Sept. 1, Verizon's board declared a quarterly dividend of 57.75 cents per outstanding share, an increase of 1.25 cents per share, or 2.2%, from the previous quarter. At the time, the company noted that its board had approved a quarterly dividend increase each year for the last decade.

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CenturyLink paid $296 million in the second quarter, up from $290 million in the first quarter, and Frontier paid $176 million, down slightly from $177 million in the prior period.

Though it paid the smallest aggregate amount, Frontier's dividend yield leads the pack at greater than 10%, according to SNL Kagan data as of Oct. 10. CenturyLink's dividend yield is close to 8%, and both AT&T and Verizon have dividend yields of just under 5%.

While higher dividends may be attractive to shareholders, Stodden worries these hefty payments "weigh heavily on these players as they try to digest prior M&A and de-lever balance sheets."

Further complicating matters is that competitors like T-Mobile US Inc., Sprint Corp. and Level 3 Communications Inc. are largely unconstrained by dividends.

"Challengers … aim to take market share through aggressive pricing and leveraging technology to disrupt the business models of the incumbents," Stodden said. T-Mobile in particular, with its "Uncarrier" strategy, has had a significant impact on the industry. After having sparked a price war a few years ago, it is now pushing forward with unlimited data and zero-rating plans.

T-Mobile does not currently pay a dividend on its common stock, and according to its investor site, "does not have any plans to." The company does, however, pay a preferred stock dividend.

This has left T-Mobile free to devote more of its financial resources to attracting subscribers or improving its network, without having to worry about protecting its free cash flow to fund a dividend payment.

But Birenberg noted that T-Mobile's dividend policy may very well change in the next couple of years.

"T-Mobile is a growth company so therefore they don't need to pay much of a dividend. But they've been pretty firm on their target of switching over to much heavier free cash flow starting this year," Birenberg said.

As T-Mobile matures, he expects the company will begin offering a dividend on its common shares.

"But I don't think they'll ever go to as high of a dividend as Verizon and AT&T have at least because they would want to retain that flexibility," Birenberg said.

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