Verizon Communications Inc's leverage will jump significantly after its wireless arm acquires junk-rated Alltel Corp, but with strong cash flows and a commitment to paying down debt the impact on its ratings will be relatively limited.
Verizon Wireless said on Thursday it would buy rural mobile phone service provider Alltel for $28.1 billion, including debt, which would vault it to first place in the US market ahead of AT&T Inc.
Under the deal, Verizon Wireless would acquire the equity of Alltel for $5.9 billion and take on an estimated $22.2 billion in debt, mostly incurred when Alltel was taken private in November in a leveraged buyout by TPG Capital and Goldman Sachs Group Inc's GS Capital Partners.
Verizon's leverage, a measure of debt to earnings before interest, taxes, depreciation and amortisation (EBITDA), will increase to 1.7 times, compared with 1.0 times at the end of 2007, Gimme Credit analyst Dave Novosel said in a report.
"Verizon should be able to reduce debt fairly quickly, although we are perplexed by management's forecast of $23 billion in debt reduction in the first two years after the merger," he said.
Novosel estimates that Verizon will produce free cash flow of roughly $3 billion in the first year after the transaction closes, but noted debt reduction will be postponed as Verizon Wireless distributes cash to Vodafone and parent Verizon to cover tax liabilities. These include $550 million in 2009 and $670 million in 2010, while Verizon is also facing integration capital spending of $900 million, he said.
The cost to insure Verizon's debt with credit default swaps have risen to around 69.5 basis points, or $69,500 per year for five years to insure $10 million in debt, from 59.5 basis points on Wednesday, before the deal was announced, according to Phoenix Partners Group.
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