How Realistic Is This Telecom Buyout?

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The big news surrounding Verizon (NYSE: VZ) concerns the relationship the company has with Verizon Wireless and Vodafone (NASDAQ: VOD). Verizon CEO Lowell McAdam recently told the Wall Street Journal that his company had the strength to acquire Vodafone’s 45% interest in Verizon Wireless. Investors should consider the probable outcome of Verizon making such a move.

How Realistic Is This Purchase? 

First of all, despite persistent rumors, Verizon is not going to purchase Vodafone, nor is Vodafone going to purchase Verizon. There regulatory hurdles such a move would entail is not worth the trouble and both management teams know it.  Vodafone is in the number one or number two market position in many countries while Verizon is number one in the United States. Furthermore, the two companies use different wireless technology which would result in little economies of scale savings under a merger.  In addition, while Verizon would pick up international operations for a relatively cheap price, investing in European operations is something investors are leery of right now. One potential upside would be if Verizon found a buyer for some of the European operations it would receive in a purchase of Vodafone.

The more likely scenario is Verizon purchasing Verizon Wireless. While McAdam noted that the joint venture is still working well and consolidation is not necessary, it was still something Verizon was interested in doing.  The reason seems clear.  The joint venture began when wireless was in its infancy.  The partnership allowed the companies to share the costs and pool the risks.  But now Verizon Wireless is the lead growth operation for both companies.

As McAdam noted in the interview, there are a couple of ways Verizon could pull off such a deal.  There could be an outright buyout of Verizon could purchase the company in parts over time.  The problem for Verizon investors is whether either scenario will end up benefiting them in the long run.

Currently, Vodafone is reaping the benefits of substantial dividend payments from Verizon Wireless.  Keeping those dividend payments within Verizon is an obvious benefit to investors.  The total dividend payment for 2012 was roughly $8.5 billion.  Keeping that money all in Verizon will make investors tremendously happy.

But it will be expensive to keep those payments within Verizon.  Analysts peg the price to buyout Vodafone at over $100 million.  An outright purchase would mean substantial debt for the company and a lack of any dividend payments to shareholders for the foreseeable future.  The company has been working on reducing debt, which now stands at roughly $52 billion and dividend payments have recently resumed.  Buying out Verizon Wireless from Vodafone would require a substantial increase in debt and would undoubtedly end the dividend. 

Is The Purchase Viable From A Valuation Standpoint?

One fact that makes the Verizon Wireless purchase appear viable from Verizon’s perspective is Verizon’s stock valuation. Currently the stock is trading near a 9 year high of its multiple.

Currently it is trading at a multiple of close to 19.  This is substantially higher than its close competitors.  AT&T is trading at less than 15, Sprint (S), due to lack of earnings has no multiple.  It is only when you get to smaller cap communications stocks, like CenturyLink (trading around $29) that you see the higher valuations.  A smaller cap company like CenturyLink could not pull off a deal of this magnitude because of its size, while the larger cap competitors like AT&T and Sprint (S) would be unable to use their stock valuations in a helpful way.  Verizon is in a rather unique position of using their high valuation as currency.  Such a move would keep debt down to a manageable level and keep shareholders happy.  I see this as a likely move to make, where Vodafone acquires a 10% to 15% interest in Verizon.  Such a deal would make everyone happy, as Vodafone would not have to face the uncertainty of Verizon Wireless dividend payments with this move.

Conclusion

For years there have been talks concerning Verizon and Vodafone and their wireless joint-venture. The recent news could be another chapter in this saga. But now is a good time for Verizon to pounce. A weakened Europe makes Vodafone vulnerable, and Verizon’s almost historic high valuation sets it up nicely for a buyout of the wireless division. If Verizon can make the move by using that high valuation to its advantage and keep the resulting debt burden relatively low, it will be a win-win for Verizon investors.


StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends Vodafone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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