Are High Dividends Stunting The Babies' Growth?

If the seven Baby Bells played baseball with their dividend payments, their team batting average would be a stratospheric .964. Since their launch on Jan. 1, 1984, they have had 56 opportunities to raise dividends, and they have done so 54 times. The only exceptions: Nynex Corp. in 1991 and Bell South Corp. this year. The steady increases have made the group a Wall Street favorite (chart), especially this year, when low interest rates make the Bells' yields more attractive than ever.

But, while they may be proud of what they've done for investors, the CEOs of the Bells are anything but happy about this situation. Pressure from Wall Street to increase dividends, coupled with lagging profits, has pushed their dividend-payout ratios up to anywhere from 67% to 84%. In contrast, former parent American Telephone & Telegraph Co. pays out only about 50% of profits to shareholders in dividends, and MCI Communications Corp. pays out around 10%.

TENSION. Pressed by competition in local phones, the Bells need cash to make growth-company-type investments. But shareholders want the steady dividends that monopoly utilities pay. The upshot: tension between the Bells and their shareholders. "We've felt for some time that the dividend-payout ratio was on the high side," says BellSouth Chairman John L. Clendenin. "It's a case of not being able to have your cake and eat it, too."

Investors are likely to remain wary until they see evidence of rapid growth in revenue and earnings to make up for slower dividend increases. Ellen Davies, an analyst who helps invest funds for the University of California, says she believes the growth may come, but "right now, we'll look at dividend growth and current yield."

Indeed, Davies and other investors have reason to be cautious. Analyst Joel Gross of Donaldson, Lufkin & Jenrette Securities Corp. has examined the rapid rise of Bell stocks during the 1980s, and he concludes that most of the factors behind it have run their course. The decline in interest rates since 1984 accounted for 45% of the group's gains, Gross calculates, and at today's low levels, there's not much more room for further rate cuts.

Gross also notes that the Bells benefited from huge price hikes after divestiture, improved productivity from new phone gear, lower tax rates, economic growth, and a runup in the value of the Bells' cellular properties. While the economy is due for a rebound, prospects for most of the other factors are less certain. And now, the Bells face losing their monopolies. Gross says the wave of competition that washed over the phone-equipment business in the 1970s and long distance in the 1980s will inundate local phone service in the 1990s. "If you're the incumbent (carrier," says Gross, "it's not real pretty to look at."

No wonder shareholders prefer a dividend in hand to future profits from a cellular franchise in Outer Mongolia. To date, all of the Bells have bowed to their wishes - for good reason. By breaking tradition, they would risk losing longtime investors and not attracting new ones at the old price. Says Thomas M. Barry, senior vice-president for strategic planning at Southwestern Bell Corp.: "We understand the dilemma, but we don't think we're in a position to force the issue."

CUTTING LOOSE. In contrast, Pacific Telesis Group is thinking of forcing the issue - and in a dramatic way - by splitting itself in two. Regulated Pacific Bell would continue to pay big dividends, while the code-named New Telesis would pay little or nothing to shareholders in order to invest in high-risk ventures in unregulated markets.

Of course, the reason the Bells find themselves in a growth-vs.-dividends dilemma is that to date, they've produced plenty of dividends but not much growth. And that suggests a solution: Manage the existing business better so shareholders don't have to make a choice.

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