Implications Of The Deal Between Vodafone And Verizon

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 |  About: Vodafone Group plc (VOD), VZ
by: Core Equity Research

Vodafone Group PLC (NASDAQ:VOD) share price has recently shown an increase, over speculation that the company is selling its 45% stake in Verizon Wireless to Verizon Communications Inc. (NYSE:VZ). VZ has been quite open about its desire to buyout VOD's stake and has made similar attempts in the past. The news came from VZ's CEO Lowell McAdam who stated at a Consumer Electronics Show in Las Vegas that the company is once again considering this option and that previous attempts have failed in part due to the large price tag assigned by VOD on its stake in the company. This time the deal looks highly likely as it is reported that VOD has narrowed the market value gap to VZ on the US Venture and that the European company could get as much as USD 135 billion for their stake in the company. In this article I have presented how important Verizon Wireless is for both companies and which company would gain if this transaction is materialized.

Verizon Wireless

Verizon Wireless is the largest mobile network operator in the US. It provides wireless services to 115.78 million subscribers and was able to add 2.442 million subscribers to its network in the 4th Quarter of 2012, more than twice to its nearest competitor. The company has been able to expand through acquisitions over the years and its most recent acquisition of AWS spectrum licenses from a consortium of cable companies indicate towards a similar trend into the future.

Verizon Wireless has outperformed its competitors, based on the 4th Quarter FY12 results as shown in the following table.

Carrier

Subscribers (millions)

Net Adds (millions)

Churn (Avg. Monthly)

ARPU

Verizon Wireless

115.78

2.442

1.21%

$54.21

AT&T

106.957

1.094

1.42%

$46.94

Sprint Nextel

55.306

-0.342

2.55%

$50.02

T-Mobile USA

33.388

0.061

3.70%

$41.31

Click to enlarge

Source: fiercewireless.com

Verizon Communications Inc. (VZ)

Verizon Communications (VZ) is a provider of communication, information, entertainment products and services to consumers, businesses and governmental agencies. The company currently operates in two segments, Wireless and Wireline. In the wireless segments the company primarily operates under the brand name of Verizon Wireless and this segment contributes to more than 66% of the company's revenues and a large portion of the company's Operating Income. As the company's wireline segment continue to contract, is becoming more dependent on Verizon Wireless.

 

Verizon communications

   

in USD Millions

2012

2011

   

Total Operating Revenues

115,846

110,875

   

Total Operating Expenses

102,686

97,997

   

Operating Income/(Loss)

13,160

12,880

   
 

Wireless Segment

Wireline Segment

in USD Millions

2012

2011

2012

2011

Total Operating Revenues

75,868

70,154

39,780

40,682

% of Total Revenues

65.49%

63.27%

34.51%

36.73%

Total Operating Expenses

54,100

51,627

39,720

39,723

Operating Income/(Loss)

21,768

18,527

60

959

Click to enlarge

Source: Verizon Communication 2012 4th Quarter Consolidated Financial Results

Although the wireless segment has a major contribution to the company's consolidated revenues, only 55% of those revenues can be ascribed to VZ, in proportion to its ownership in Verizon Wireless. Similarly as reported in the Company's consolidated financial results of 2012, out of the total consolidated net income of USD 10,557 million, only USD 875 million was attributable to VZ, merely 8.3% of the total net income. As shown in the table below, this figure has dropped significantly as compared to 2011 and is likely to remain low in the future as well due to a decline in the wireline segment.

 

Verizon communications

in USD Millions

2012

2011

2010

Total Net Income

10,557

10,198

10,217

Net Income Attributable to Non-controlling Interest

9,682

7,794

7,668

Net Income Attributable to Verizon

875

2,404

2,549

Net Income Attributable to Verizon

(% of Total Net Income)

8.29%

23.57%

24.95%

Click to enlarge

Source: Verizon Communication 2012 4th Quarter Consolidated Financial Results

Based on the consolidated financial results of 2012, the company's Free Cash Flows to the Firm are equal to USD 11,376 million. But as with revenues and net income, only a percentage of these cash flows could be ascribed to VZ. If we take the percentage of FCF attributable to VZ as the percentage of net income attributable to VZ, this rate comes out to be 19%. So it could be estimated that only USD 2,162 million (19%*USD 11,376 million) of the total free cash flows could be attributed to VZ. Thus VZ's annual dividends of around USD 5.5 billion are not sustainable and would have to rely on Verizon Wireless' cash flows in the future in order to continue to pay large dividends to its shareholders.

Thus according to the above facts and analysis, VZ is heavily dependent on Verizon Wireless for future growth in earnings and revenues.

Vodafone Group PLC (VOD)

Vodafone provides voice and data communication services to both consumers and businesses and is one of the largest telecom companies in the world. VOD has significant presence in Europe, Middle East, Africa, Asia Pacific region and the United States. The company has achieved a stable growth in revenues and service subscribers over the years.

VOD's financial results indicate that profits from Verizon Wireless make up significant part of the company's profits. Almost 44% of the company's operating profits are from Verizon Wireless in 2012 and 89% in 2011. This said the geographical diversity of VOD's operation makes it less risky and less dependent on any single region.

 

Vodafone Group

in USD Millions

2012

2011

Operating Profits

11,187

5,596

Share of results from Safaricom

38

39

Share of Results from Verizon Wireless

4,925

5,020

Share of Results in Associates (% of Operating Profit)

44.02%

89.70%

Click to enlarge

Source: Safaricom Financial Results and Vodafone Financial Results. Rate used to convert Safaricom results into GBP are GBP 1=KES 132 for 2012 and GBP 1=KES 133.77 for 2011.

Verizon Wireless' revenues growth has been greater than the growth in revenues of other segments in which VOD operates.

 

Vodafone Group

Verizon Wireless

 

Europe

Africa, Middle East and Asia Pacific

US

Growth in Revenues

0.52%

4.24%

9.53%

Click to enlarge

Source: Financial Results of Vodafone and Verizon Communication

Although a significant portion of the company's Operating Profits are derived from Verizon Wireless' earnings, VOD is less dependent on Verizon Wireless than VZ.

Conclusion

Although the buyout is still uncertain and many analysts are casting doubts on whether this deal would materialize, but if it does, large sum of money would exchange hands. Both companies are significantly dependent on Verizon Wireless, but Verizon Communication has a greater reliance on the Verizon wireless. In my opinion, if this deal materializes it would be beneficial for both companies. This is because VZ would benefit from control over all the assets and revenues of the company which is much needed due to its contracting market share in the wireline market and VOD on the other hand would receive a hefty amount for its stake and could use this amount to expand into other sectors or to consolidate its position in regions where it currently operates. Also VOD has seldom received any cash gains from Verizon Wireless and this would be a great opportunity for the company to cash in its investment. Thus in our view shareholders of both the companies would benefit from this deal if it materializes.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.