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Telephone and Data Systems (TDS) cut its dividend because of a need to grow its fiber business, too much leverage, and changing strategic priorities. It is one of three Dividend Kings to do so thus far in 2024.

The company’s challenges and lack of growth caused the share price to fall until recently. Moreover, the dividend yield rose to over 10%, a percentage typically associated with a distressed company. Although the new dividend rate is safer, the potential for another cut still exists.

Overview of Telephone and Data Systems 

Telephone and Data Systems is a regional telecommunications company founded in 1968. It operates through two business segments: US Cellular and TDS Telcom. US Cellular is a regional wireless business operating mainly in the Midwest and Great Plains States. It also operates in the Pacific Northwest, New England, and mid-Atlantic states. It offers pre-and post-paid mobile phone service. The company also owns 4,382 towers and sells space to third parties.

TDS Telecom is a residential and commercial broadband business with about 827,000 customers. Its infrastructure consists of copper, coaxial, and fiber lines. Total revenue was $5,160 million in 2023 and $5,119 million in the past twelve months.

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Source: TDS Investor Relations

Dividend Cut Announcement

On Tuesday, May 28, Telephone and Data Systems announced a dividend cut. The company’s quarterly dividend rate was $0.19 per share before the news. The dividend is now $0.04 per share, a 78.9% reduction. The news was included in a press release regarding the sale of US Cellular operations and spectrum to T-Mobile (TMUS). The statement said:

“TDS remains confident in its plans to drive growth and create value by investing in fiber expansion. To support those plans, TDS is resetting its approach to capital allocation. Specifically, the Board has declared dividends for the second quarter 2024 at approximately 20% of the previous level for its Common Shares and Series A shares. This shift in approach is expected to free up additional capital that can be used to support the company’s fiber program, among other purposes. No changes are anticipated in the dividends to be paid on the Series UU and Series VV preferred shares.”

“TDS is paying a quarterly dividend of $0.04 per Common Share and Series A Common Share payable on June 28, 2024, to holders of record on June 14, 2024.”

Effect of the Change

The company presented little other information. Management did not address the dividend cut in the quarterly results or the earnings call in a significant manner. However, by implementing a roughly 80% dividend cut, Telephone and Data Systems is clearly trying to reduce its cash requirement to invest in the fiber business.

It may also be trying to address rising debt and leverage levels. The leverage ratio has increased to about 3.7X, while interest coverage is less than 1.0X. Also, free cash flow has been negative for the past three years. That said, the primary motivation seems to be freeing up cash flow for fiber business growth.

As a result, Telephone and Data Systems lost its 50-year dividend increase streak and is no longer a Dividend King. A company rarely drops off this list because of reducing or omitting the dividend. However, 2024 has been a watershed year. So far, three companies have fallen off the list. Besides Telephone and Data Systems, Leggett & Platt (LEG) and 3M Company (MMM) lost their Dividend King status, albeit for different reasons.

Challenges

Telephone and Data Systems was experiencing declining revenue and earnings per share because its fiber business was not yet profitable and its cellular customer base was declining. Next, the leverage ratio was rising, and interest coverage was falling.

This implied that capital expenditures were not driving top—or bottom-line growth. Consequently, EPS did not cover the dividend payout for many years. These metrics are signals investors must pay attention to for avoiding dividend cuts.

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Source: Portfolio Insight

(Click on image to enlarge)

Source: Portfolio Insight

Higher Leverage

Telephone and Data Systems' long-term debt has been increasing since 2019. At the end of 2019, it was $2.309 million, but by the end of 2023, it had climbed to $4.073 million. Similarly, total debt rose from $3.373 million to $5.143 million in the same period.

Likewise, net debt increased from $2.908 million to $4.971 million in the same stretch. The leverage ratio rose from a reasonable ~2.22X to an elevated ~3.74X. Conversely, interest coverage fell from ~1.15X to ~0.77X.

The credit rating is BB/Ba1, a non-investment grade rating.

Telephone and Data Systems Telecom Has Been Struggling

TDS Telecom is in the wireline, cable, and fiber business. It’s a competitive space, and despite growing capital investment, the business is struggling and not profitable. TDS Telecom has been shedding total connections because it is generally losing wireline, cable, and commercial customers faster than it can grow the fiber business.

That said, the most recent quarter was more promising, as net additions were positive. Moreover, residential revenue per connection rose 7%, and operating revenue grew even more, at 10%. As the percentage of fiber grows and coaxial and copper declines, the firm may become consistently profitable.

US Cellular Lacks Scale

US Cellular is the fourth largest wireless business. However, it is significantly smaller than its three competitors: AT&T (T), Verizon (VZ), and T-Mobile. The pre- and post-paid net additions have been negative since at least the first quarter of 2023. However, tower revenue is positive and usually rising.

Telephone and Data Systems is selling this business. Some of it may be sold to T-Mobile and the rest to Verizon. However, both deals may face antitrust issues.

Dividend Safety

Telephone and Data Systems' dividend safety was inferior before the announcement. The telecommunications company received a dividend quality grade of ‘F’ from Portfolio Insight. Hence, it is the bottom percentile of dividend stocks tracked. Moreover, as seen on the chart below, the dividend yield had soared to 10%+ before the cut. Percentages at this level are typically indicative of a distressed company.

After lowering the dividend by nearly 80%, the estimated forward dividend yield is around 0.75%. The quarterly rate is $0.04 per share. The forward dividend yield is less than the S&P 500 Index’s average.

The annual dividend now requires about $18.08 million ($0.24 yearly dividend x 113 million shares), compared to $83 million in 2023. However, the dividend payout ratio will still be negative or over 100% in 2024 and potentially 2025. We expect the annual free cash flow difference to be used to expand the fiber business and eventually deleverage.

That said, the risk of another dividend cut still exists.

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Source: Portfolio Insight

Final Thoughts on the Telephone and Data Systems Dividend Cut

Telephone and Data Systems' dividend was at risk of being slashed for many years. Revenue and EPS were falling. At the same time, leverage rose, and interest coverage dropped. The firm was losing mobile phone connections in a competitive environment.

Furthermore, capital expenditures for fiber expansion were rising but had yet to pay off. Management’s priorities were growing the fiber business instead of paying a growing dividend. As a result, Telephone and Data Systems cut its dividend, losing its Dividend King status.

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