When it comes to dividend stocks, megatelecoms AT&T (T -0.40%) and Verizon (VZ -0.36%) are at the top of income investors lists. And that makes sense, with a near-duopoly in the higher-growth wireless business and government enforced monopolies in wireline communications, the barriers to entry are pretty sound. For dividend stock investors looking less for growth and more for income, these two companies offer an attractive risk/reward scenario.
That said, dividend stock investors want to ensure some level of earnings and revenue growth for their income investments for a couple of reasons: First, this helps companies keep their valuations (read: stock price) from tumbling. Next, top-line growth above the level of expense inflation leads to higher cash from operations and -- in a ceteris paribus world -- higher free cash flow for future dividend increases.
So for dividend stock investors, the question is which one of these companies is taking the best business strategy in order to grow its dividend for years to come? The answer between the two is Verizon.
Verizon now owns its wireless division outright
For growth, both companies have chosen to acquire two separate businesses. Verizon recently completed a transaction in which it bought its minority owner out in order to fully own its wireless business. Before the transaction, Verizon only owned 55% of its wireless business with Vodafone owning 45%. Nearly 15 years prior, when wireless was in its infancy, Verizon cut a deal for this joint venture.
The deal quickly became a windfall to Vodafone at the expense of Verizon shareholders. Last fiscal year, Verizon paid out $12 billion in minority earnings with the vast majority going to Vodafone for its wireless holdings. For comparison, Verizon reported only $11.5 billion in net income. So if Verizon would have owned its wireless business outright, earnings would have been doubled. Verizon offered the largest debt issuance in history (nearly $50 billion), added to it nearly $60 billion in stock plus additional cash to buy the wireless division back for $130 billion.
AT&T is looking toward pay TV with its DirecTV purchase
AT&T is looking at addressing growth by acquiring DirecTV in mostly a share-related transaction that totals nearly $50 billion. AT&T is paying the equivalent of $66.50 in stock and $28.50 in cash. Right now, AT&T would need to increase its shares outstanding by more than 900 million shares. The deal has been approved by DirecTV shareholders, but in still awaiting regulatory approval.
What AT&T gets is a way to enter the pay-TV field in a meaningful way. Its current pay-TV offering, U-verse, is relegated to third-party status boasting a minuscule 5 million US subscribers. DirecTV's 20 million U.S. subscribers would make AT&T the largest pay-TV provider in the U.S., although it's perfectly prudent to mention the current No.1 pay-TV provider, Comcast, is looking to combine with Time Warner Cable that would overtake AT&T's newly formed entity.
It comes down to what you think is a growth industry: pay-TV or wireless?
The thesis is simple: wireless is still a growth industry and pay TV really isn't. Pay TV is fighting a powerful trend called cord-cutting in which many are abandoning the format for streaming-based services like Netflix and Hulu. The number of U.S. households without pay TV has jumped from 4.5% in 2010 to 6.5% this year. DirecTV has performed rather well over the last two years in regard to this U.S. trend by recording tremendous growth in Latin America, but even now that's only 20% of the company's revenues.
Wireless communications continues to be a growth industry led by subscribers' insatiable demand for data. Verizon's wireless revenue grew nearly 7.5% per year over the last two fiscal years. When the company announced the deal to buy its wireless division outright, management estimated the action would be immediately accretive to earnings by 10%; on its first year-over-year quarterly comparison owning its wireless business outright, its EPS was 31% higher.
For dividend stock investors, it is a matter of not only the current payout, you also need to consider how the company plans to continue and raise its dividend. Although both companies can continue their above average payouts, by Verizon owning its high-margin wireless business outright, it has the ability to add subscribers and increase revenue per user via higher-priced data plans. AT&T seeks to grow revenue via pay TV, an expense more U.S. households are abandoning by the day.