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With Verizon Communications Inc. (NYSE:VZ), the second-largest U.S. phone company, last week reporting an increase in profitability at its wireless unit I am now much more confident that Vodafone (NASDAQ:VOD) shareholders are likely to be seeing another 'special dividend' from Verizon Wireless early next year.

Before we delve a bit deeper into Vodafone's dividend prospects, it is perhaps good to ascertain what has been happening with some of its European competitor's dividend policies.

While many investors regard telecommunication companies as semi 'utilities', churning out cash and increasing dividends, not all is rosy in Europe. The European telecommunication sector has seen several changes to dividend policies during 2011 - 2012. During the last twelve months, six European telecoms companies have changed their dividend payout policy, in all cases resulting in reduced payouts to shareholders and in some cases even eliminating dividend payouts altogether.

The most significant was the announcement from Telefonica (NYSE:TEF), at the end of 2011, that, following an initial reduced dividend payout, it was subsequently forced to cut the current-year dividend to zero in order to contribute the rebuilding of cash reserves due to a high burden of debt repayments for 2013-15.

Since, Telefonica has gone even further selling its shareholding in China Unicom, earlier this year, and is now looking to raise additional funds by floating 23 per cent of its German operation and aiming to list (or, sell) part of its Latin American operations.

Other companies that have reduced their dividend payouts include The Netherlands' KPN (OTC:KKPNF)(which cut the share buyback programme), France Telecom (FTE) (which moved to a Free Cash Flow cover metric, effectively implying lower dividends if Free Cash Flows falls), Telecom Italia (NYSE:TI) and Portugal Telecom (NYSE:PT) (which both halved their dividends), and Telekom Austria (OTCPK:TKAGY) (which halved its dividend for 2011 and 2012).

In comparison how Sustainable is Vodafone's Dividend?

Vodafone should be able to maintain a healthy dividend payout despite the prospect of a slowdown in the growth of its core dividend (from 7 per cent per annum) beyond fiscal 2013, and the uncertain timing of the dividend it receives from Verizon Wireless.

With its 45 per cent shareholding Verizon Wireless Vodafone is partially a play on developments in the U.S. mobile telecoms sector.

According to a recent report from Bank Berenberg, since it received the "special dividend" from Verizon Wireless, in January 2012, Vodafone's shareholder returns have basically been made up of three key components:

1) the 'core' dividend;

2) the "special" dividend relating to the dividend income received from the 45% stake in US operator Verizon Wireless; and

3) share buybacks using disposal proceeds.

For 2012-13, Vodafone has stated that it is targeting core dividend growth of 7 per cent per annum (culminating in a core dividend of 10.2 pence for the year to March 2013). In 2012, this was supplemented by the 4 pence special dividend relating to the dividend income from Verizon Wireless. In addition, Vodafone has 'returned' a massive £6.5bn of cash through share buybacks following the sale of shareholdings in China Mobile, SFR and Softbank.

Taking into account that total dividend cover at Vodafone is starting to look a bit strained, according to Bank Berenberg, but still recognizing the company's strong balance sheet position - and its track record of rewarding shareholders, they expect that the total dividend payout from Vodafone going forward is likely to reflect:

1) a somewhat slower pace of core dividend growth - say a 2-3 per cent per annum growth in the 10.2 pence core dividend estimated for 2013;

2) continued dividend income from its 45 per cent shareholding in Verizon Wireless, at a level of maybe £2.8bn (approx $4.5bn) per annum;

3) the use of some £1bn ($1.61bn) of the Verizon income to supplement the Vodafone core dividend, equating to 2 pence per share of "special" dividend;

4) the use of £1bn ($1.61bn) to continue buying back Vodafone shares, cutting the share count and gradually reducing the core dividend burden and thereby improving Free Cash Flow coverage of the core dividend; and

5) the use of the remaining £800m ($1.28bn) or so of the Verizon Wireless dividend income to pay down debt.

On this basis we remain firm holders of Vodafone shares.

Source: Vodafone's Dividend Is Safe, With More To Come