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You've got debt: Verizon, AOL merger a risky buy

Tuesday, May 19th, 2015

I'm sure by now you have heard that Verizon, the nation’s largest wireless carrier, wants to buy AOL for $4.4 billion.

Your first thought may be, “Why would Verizon, or anyone for that matter, want to buy a company that does dial-up Internet service?”

That is the old America Online. The company has changed somewhat. With the acquisition of AOL, Verizon (NYSE: VZ) is looking to gain access to advanced advertising technologies, including the "One by AOL" platform that lets customers buy ads across platforms including video, online and TV.

Verizon will also gain access to the Huffington Post and TechCrunch, a website focused on information technology companies ranging from startups to established Nasdaq firms.

AOL also owns a half-hour reality show called "Connected."

This would mark the second AOL merger. The first, when it merged with Time Warner(NYSE: TWX) in January 2000, was a financial disaster. As you can see now, the company is worth only $4.4 billion.

So you may be wondering why Verizon would want to buy this company. Understand that Verizon is a utility company in an industry that is very competitive, and profit margins are rapidly shrinking.

So Verizon, apparently, believes it can become a player in the digital arena and hopes to see growth such as that of Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG) andFacebook (Nasdaq: FB). These three companies have a far lead on many competitors.

When I looked at the numbers on Verizon Wireless, I was shocked. (I have used Verizon Wireless for close to 20 years and keep hearing these great ads from T-Mobile(NYSE: PCS), which I am considering switching to.)

I tell investors to ask questions in order to understand a company. In this case, we want to understand whether Verizon is financially capable of buying AOL. When I looked at the financial statements for Verizon, I realized that this is a company that could be in bankruptcy within two years.

Why would I say that?

I'm sure investors like this company because of the 4.4 percent yield they receive on the dividend. Verizon uses 91 percent of its earnings to pay that juicy dividend, and, therefore, I believe is borrowing to find expansion of the company.

But Verizon has cash and short-term investments of $4.9 billion, so if it uses its cash for this acquisition, it would be left with only $500 million on the balance sheet.

The reason I believe we can see this company in bankruptcy within two years is the amount of debt it carries — $113 billion. Without going into detail and looking at how this debt is broken down, just imagine what the interest payments must be on $113 billion in debt.

To put that into perspective, you know the company has almost $5 billion of cash, which pales in comparison to the debt.

What you may not know is the equity. All the assets minus liabilities give you owners’ equity.

Now for what the equity is. If you own this company, I hope you're sitting down. It is only $9 billion. Yes, you read that right: Only $9 billion compared with a debt of $113 billion.

To put that in perspective, it would be like having a house worth $100,000 and you owe about $1.1 million — not much comfort there. And it only gets worse when you understand what the assets are, because $81 billion of assets are what is known as intangible assets, which can be written down in value if they do not meet a value test.

In other words, if the company needs to write down $10 billion of intangible assets because its value has decreased, Verizon would be worth a negative $1 billion.

I don't know how much clearer I could be other than Verizon is a very risky investment and it appears that this could be a desperate move to try to grow earnings in the future.

However, in the meantime, those interest payments will continue to come due and the debt will continue to rise, especially if Verizon makes this purchase and borrows the money because I don't think it wants to use up its cash.

I know the bankruptcy would be a surprise to some people because this is the largest wireless carrier in the country. I remember being on CNBC years ago and discussing how I felt that General Motors (NYSE: GM) could go bankrupt because of its excessive debt. Many people questioned how the largest car company in the country could go bankrupt.

Well, now we have seen General Motors go into bankruptcy, and the shareholders prior to the bankruptcy have lost their investment. So don't let the same thing happen to you.

If you don't own Verizon, don't buy it. And I'm not saying it will not go up on the short term or this is going to happen tomorrow. What I'm trying to explain is that the risk of this company is very high.

Do you have a question or a company you would like us to take a look at?
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