Verizon Communications Inc.: Capital Structure Choices
Verizon raise funds through internal and external means. Internal means is through the allocation of net cash generation from its operations for allocation on investments and expansion. External means involves debt financing and equity financing. Debt financing refers to taking out loans from financial institutions using its assets and financial/business standing to support its credit rating. Equity financing refers to the sale of shares or stocks to investors and partners who become part owners of the company.
To a certain extent, Verizon also utilizes mergers and acquisitions to boost its capital. Verizon merged with GTE in 2000 and acquired MCI in 2005 to increase its capital assets. (Verizon, 2009a) 2. Where do they fall in the continuum between debt and equity? The long-term debt-equity ratio of Verizon is 3. 85 as of December 2008. This value represents total liabilities of Verizon at USD160. 646 million and total shareholder’s equity of USD41. 706 million (Hoovers, 2009; Verizon, 2009b). The debt-equity ratio determines the extent that the company utilizes debt or equity financing in raising funds.
A high value means greater debt financing relative to equity financing while a low value indicates greater equity financing when compared to debt financing. Since Verizon has more funds raised through debt financing, then the company falls nearer debt financing. 3. How large, in qualitative or quantitative terms, are the advantages to this company from using debt? Debt financing enabled Verizon to generate a greater amount of funds. Its debt-equity ratio indicates that funds raised through debt represent an amount nearly four times greater relative to equity financing.
Majority of the funds raised through debt go to capital expenditures, such as the acquisition of Alltel in 2008 through a USD17 billion worth of credit obtained by the company (Verizon, 2009a). Verizon was also able to pay the outstanding debt of Alltel. Although, Verizon acquired a huge debt, the acquisition made Verizon the largest telecommunications company in the country ousting AT&T. This represents an expansion in customers and service capability that would translate into revenue generation extending towards the long-term to allow Verizon to pay-off its debt and gain profit.
4. How large, in qualitative or quantitative terms, are the disadvantages to this company from using debt? Debt financing also involves risks. Verizon utilized cash generated from its operations to pay off its debt, particularly its short-term debt. The company’s ability to pay off its debt lies in the expectation of continuous increases in its cash from operating activities, which is USD26. 2 million in 2008 up from USD25. 74 million in 2007 (Verizon, 2009c). So far, Verizon has been able to meet its debt obligations (Verizon, 2009a).
However, any downturn in cash generation would pose risks to its ability to pay off its debt. Its acquisitions that eat up most of its acquired credit may not be able to actualize the expected potential since competitors, especially AT&T would respond to the competitive merger. There are also problems in managing a large organization and Verizon already faced a number of controversies with customers involving products and services leading to lawsuits and uncompleted contracts. 5.
From the qualitative trade off, does this firm look like it has too much or too little debt? By comparing the qualitative advantages and disadvantages, Verizon appears to have too little debt. Its debt financing enabled Verizon to become the largest telecommunications company in the United States. When considered on its own, this is a gargantuan achievement when considered relative to the risk involved in debt financing. To date, Verizon has a high credit rating and it continues to meet its debt obligations.
There appears to be no major negative changes in its cash flow given the current developments. The extent of debt relative to the expected returns from investing in mergers and acquisitions also overshadows the risks. The acquisition of Alltel represents a significant growth in Verizon’s customer base and expected to usher revenue growth in the long-term.
References
Hoovers. (2009). Verizon Communications Inc. Retrieved June 21, 2009, from http://www. hoovers. com/verizon/–ID__10197,period__A–/free-co-fin-balance. xhtml?ID=10197&period=A&which=balance¤cy=1 Verizon. (2009a). Management’s discussion and analysis of financial condition and results of operations. Retrieved June 21, 2009, from http://investor. verizon. com/financial/annual/2008/mda05_01. html Verizon. (2009b). Selected financial data. Retrieved June 21, 2009, from http://investor. verizon. com/financial/annual/2008/fin01. html Verizon. (2009c). Consolidated statements of cash flows. Retrieved June 21, 2009, from http://investor. verizon. com/financial/annual/2008/fin05. html
