HEARD ON THE STREET   |   MAY 21, 2009

The High Wireless Act at Verizon

By MARTIN PEERS

Phone-company dividends have long been like death and taxes: a sure thing. Is that still the case?

That is a particularly acute question for Verizon Communications. It hasn't only suffered profit erosion in its traditional landline business, it is also spending heavily to build its new FiOS network. The result was no free cash flow from Verizon's wireline operations to pay the dividend last year.

Of course, Verizon Wireless is generating cash at the rate of about a billion dollars a month, Moody's estimates. But Verizon owns only 55% of the wireless company. Vodafone Group owns the rest. That means Verizon can't automatically tap the wireless cash. The wireless company isn't paying dividends, only tax-related distributions, which last year totaled about $1.5 billion.

So how did Verizon afford its $5 billion dividend in 2008? The tax distributions helped, as did $670 million in dividends from Verizon's interest in Vodafone Italy. But Verizon also had to borrow.

Verizon shouldn't have to do that again anytime soon. It is due to receive $11 billion from the wireless company in repayments of internal loans this year and next, covering dividend outlays for both years.

Once those loans are repaid, however, Verizon will likely again face a funding shortfall. The company is banking on FiOS-related capital spending declining after next year, when the build-out is completed. Right now, the company is spending $2 billion a year on the build-out, excluding the cost of connecting homes. That means free cash flow from wireline should rebound somewhat in 2011.

Given that access lines will likely continue to decline, though, wireline's cash-generating ability in 2011 is hard to assess. In addition, capex spending will be affected by the number of new customers connecting to the FiOS service. Another variable affecting wireline's cash: Verizon is forecasting a $500 million increase in pension contributions next year to cover a deficit resulting from the market crash.

All that means wireless will remain crucial for paying the dividend. By 2011, the easiest route to tapping cash will be for Verizon Wireless to pay a dividend to its two owners. If the wireless company paid out $12 billion in dividends, for instance, Verizon Communications' would get $6.6 billion.

While that should give comfort to income-oriented shareholders, it points to Verizon's inherent weakness. The company has full exposure to the declining landline business and only limited ownership of the lucrative wireless operation.

Buying Vodafone's stake in wireless would be enormously expensive. Sanford C. Bernstein estimates it could cost more than Verizon's current $85 billion market capitalization. But unless Verizon can figure out a way to strike a deal, the limitations of its partial ownership will only become more evident for investors.

Write to Martin Peers at martin.peers@wsj.com

Printed in The Wall Street Journal, page C10