Verizon bets the house on wireless

If Verizon stumbles while integrating Alltel, issues like heavy costs, line losses and bulging debt could again rise to the surface.

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(Fortune) -- Verizon is betting its planned purchase of Alltel will keep growth at its Verizon Wireless unit humming along. The giant telco better be right, because it is borrowing a huge sum to make the deal happen.

The owner of the nation's No. 2 wireless shop, Verizon agreed Thursday to buy No. 5 wireless player Alltel. Verizon shares rose 5% on the announcement, as the company and analysts pointed to the favorable price Verizon was able to get for its smaller rival. The deal would make Verizon the nation's largest wireless carrier.

"A year ago it was at auction and at a higher price than we got today," Verizon CEO Ivan Seidenberg said on a conference call Thursday, referring to last summer's $25 billion sale of Alltel to a private equity group led by TPG. "We took a risk that rather than overpaying, there would be a better day. And this is a better day."

What has made for a better day at Verizon is the distress being felt in the credit markets. The banks that financed the TPG-led buyout last year - Goldman Sachs (GS, Fortune 500), Citigroup (C, Fortune 500), Barclays (BCS) and Royal Bank Scotland (RBS) - are still holding about $24 billion in notes that haven't exactly been an easy sell amid the credit crunch. The sale of Alltel to Verizon helps them get that debt off their books.

By taking on $6 billion in new debt to finance the deal, and assuming $22.2 billion of outstanding Alltel debt, Verizon (VZ, Fortune 500) brings its total debt load to $63 billion. That's a substantial sum, and not without its risks.

"While we recognize the benefits of increased scale at a time when wireless industry growth is slowing," wrote Citi bond analyst David Hamburger on Thursday, "we think this transaction will increase Verizon's financial risk significantly." He cut his opinion on Verizon debt to deteriorating from stable.

Still, the company says it's willing to shoulder that heavy burden to take advantage of a long sought-after wireless expansion opportunity. For Verizon, wireless has always been its showcase property in its otherwise declining empire.

The company's costly expansion into TV has landed it squarely in a dead heat with cable outfits like Comcast (CMCSA, Fortune 500) and Time Warner Cable (TWC). The new customer wins are not offsetting the steady exit of its phone customers. The rate of Verizon's primary customer line losses hit 10.6% last year, as phone users switch to cable or wireless calling. The pace of that decline, as analysts like Bernstein's Craig Moffett point out, is accelerating. Verizon has lost more than a quarter of its residential phone lines since 2002, says Moffett.

Verizon Wireless, jointly owned by Verizon and Vodafone (VOD), has been the solid growth story that has kept investors from focusing too closely on the eroding landline business. But wireless growth is slowing, a trend that has been partially masked by the redistribution of millions of unhappy Sprint (S, Fortune 500) customers over the past three years.

"Maintaining the growth through the integration of [Alltel's] assets into the Verizon fold will be one of the main challenges," UBS analyst John Hodulik wrote in a research note Thursday.

Verizon is not alone in the massive telco debt class: AT&T (T, Fortune 500) has $73.5 billion in total debt on its books. And Verizon could point out that on a pro forma basis, including Alltel revenue, AT&T and Verizon have similar debt loads of around 61% of annual revenue.

But if Verizon fails to integrate Alltel flawlessly and growth slows further, issues like heavy costs, line losses and bulging debt could again rise to the surface.