UPDATE: S&P Lifts Outlook on Verizon (VZ) to Positive; Sees Leverage Continuing to Decline

(Updated - August 4, 2014 3:16 PM EDT)

Standard & Poor's Ratings Services today revised its rating outlook on Verizon Communications Inc. to positive from stable. At the same time, we affirmed our 'BBB+' corporate credit rating and A-2 short-term rating on the company.

The rating outlook revision reflects our expectation that leverage should continue to gradually decline, potentially reaching our 2.75x upgrade threshold by 2015. While the level of Verizon's participation in the upcoming spectrum auctions remains uncertain, and will most likely delay reduction in leverage over the near term, we expect the company will continue to stockpile cash over the second half of 2014 to lessen needed debt funding.

Under our base-case scenario, we have assumed the following:

• A range of $6 billion to $8 billion of spending for the AWS-3 auction, based on the purchase of 10x2 MHz (20 MHz) license at a price of $0.96-$1.25 per MHz POP.
  
• Assuming spending at the high-end of this range for AWS, under our forecasts, we estimate Verizon has capacity to spend up to an incremental $5 billion on spectrum while still achieving adjusted leverage of 2.75x in 2015. Above that amount would likely delay leverage falling below our threshold until 2016.
  
• While the company has stated publicly that it is focused on AWS-3, we believe Verizon will also likely participate in the broadcast incentive auctions in 2015. For this auction, we have assumed a price of $1.50 per MHz POP, in line with AT&T's public price estimates. At this price, a 5x2 MHz license would cost about $4.5 billion and 10x2 MHz would cost about $9 billion.
  
• These assumptions lead to a range of total spectrum purchases of $10.5 billion to $17 billion, with incremental debt financing in the $5.5 billion to $12 billion range.

Apart from the required expenditures, we believe this level of spectrum purchases would improve Verizon's capability to support advanced LTE applications and higher mobile data speeds, supporting its strong position in wireless, which is a key underpinning of our business risk assessment. Our business risk profile further reflects profitability and operating metrics that are among the best in the wireless industry, with service margins and retail postpaid churn of 50.3% and 0.94%, respectively, for the second quarter of 2014. Margins for its peers range widely from about 42.6% for AT&T Inc. to 13%-14% for Sprint Corp. The company also has a significantly sized wireline telecom business which, while subject to degradation from continued wireless substitution, also includes a growing base of FiOS video ustomers, totaling 5.4 million as of June 30, 2014, as well as FiOS broadband customers, totaling 6.3 million. Total wireline revenues have stabilized over the last two quarters with healthy growth in consumer revenue, and a lower rate of decline with core enterprise customers. All of these factors support our "strong" business risk assessment.

Our base-case assumes the following:

• U.S. GDP growth of 2% in 2014, improving to 3.1% in 2015, which we expect to have a relatively neutral impact on wireless and contribute to modestly improving trends with core enterprise customers in wireline.
  
• Roughly 4%-5% growth in total wireless retail connections in 2014, with the majority of growth coming from lower-revenue but still profitable connected tablets.
  
• A continued deceleration in average revenue per account (ARPA) growth in 2014 due to increased uptake in Edge installment plans and lower priced tablets. We have assumed a continued modest increase in uptake rates from 18% in the second quarter, but with the overall impact of installment plans well below peers.
  
• Total wireless revenue growth of 6%-7% in 2014, with decelerating growth in 2015.
  
• Wireless EBITDA margin of in the low-43% area in 2014 and 2015, with modest benefit from installment plans.
  
• Relatively flat wireline revenue in 2014, based on first-half results, with the potential for very low-single-digit percent growth starting in 2015.
  
• Total capital expenditures of $16.5 billion to $17 billion for 2014.

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