Verizon Wireless: Poised For Growth Or Another Dropped Call?

| About: Verizon Communications (VZ)

As of 2011, Verizon Wireless (NYSE:VZ) is the second largest mobile phone provider in the world today in terms of revenue. Vodafone (NASDAQ:VOD), the European telecom giant stands at the number three spot and currently owns a hefty 45% stake in Verizon Wireless. The big question on everyone's mind is simply what is the next move for both of them?

Will Verizon Buy Vodafone?

If Verizon Wireless buys out Vodafone, they will become the world's largest mobile phone provider overnight. According to the Ahonen Index Top 25 of Mobile Industry, as of 2011 the top three mobile providers in the world currently by revenue are China Mobile, Verizon Wireless, and Vodafone. With Vodafone and Verizon joining forces, these two companies combined would have a reach and scope that would be tremendous. Verizon stands to gain a great deal if they acquire Vodafone.

Part of Vodafone's strategy is to focus in new emerging markets such as Africa and India where the potential for market growth is astronomical. The problem with this deal is that it is unlikely to happen anytime soon. It just doesn't make fiscal sense for Verizon or Vodafone right now. The reason comes down to the capital required to buy out Vodafone and the unlikelihood that the board of directors for Vodafone would go for the deal, at least for right now. Doing so would increase their debt to a point that would put them at over 5 times Net Debt/EBITDA, which would raise a couple of red flags suggesting that Verizon would be taking on more debt than it could handle right now. On top of that, Vodafone has a stronger financial position with both higher ROE and net profit margin in 2012. The more realistic outlook is that Verizon will continue to pay healthy dividends to Vodafone and both companies will continue to slowly grow. Vodafone's share of profits from Verizon Wireless in 2012 came to £4.9 billion, or just over $7.4 billion, a 9.7% year-on-year growth rate. Vodafone can see no good reason to change this symbiotic relationship at this time.

The Next Move

Both Verizon and Vodafone are dynamic corporations that have large market shares in their respective regions. Currently 99% of Europe can make calls across the Vodafone network, and £304 million was invested in 2012 towards research and development of Vodafone's networks and services. The company has dominance in the European market, similar to the dominance Verizon maintains in the U.S. market. Vodafone not only dominates Europe, but also has their hands deep in Fiji, Kenya, Tanzania, South Africa, Afghanistan, and Qatar.

Verizon currently holds over 100 million connections and over 94 million customers. Major changes would unfold if either one were to buy out the other. The first major change would simply be that whatever company emerged out of the buyout would be the world's largest mobile provider by far. The reach of the new company would dominate the European and United States market. It would be a global giant that would be hard for other companies to compete against. Joining forces would mean that the strategy of the new company would have to incorporate elements of both strategies to execute it successfully. If Vodafone were to purchase the other 55% of Verizon, they would have to integrate their goals to fit the United States market versus the predominantly European market that they serve.

Will This Turn Verizon into a Bull or a Bear?

If Verizon were to make the move to purchase Vodafone, the company would suffer for some time. A large amount of debt would be incurred, and systems and procedures would have to be centralized, costing man hours and logistics planning. In the long term, the company would probably do well, but for the short term, Verizon would go through some rough financial times and the stock price would most likely suffer. However, the executives at Verizon know this and would most likely not take this large step forward at this time. Verizon's debt to equity ratio has slowly been rising to a current 1.44, the highest it has been in the past 10 years. Net income for Verizon took a major hit in 2009 dropping by 43.2% in 2009 and another 30.18% in 2010 and then only dropped by 5.69% in 2011. The ten year average for their net income growth just recently went into the positive in 2011 at 19.98%.

This shows that the telecom industry is highly sensitive to changes in the economy. When times got tough, people start dropping options on their phone plan, upgrade their phones less, and cut services and channels in the home. Verizon needs to keep this mind before they get themselves into a large amount of debt in an acquisition. A move like that, combined with another economic downturn, could put Verizon in a very ugly position that would be hard to come back from. As long as Verizon does not make any moves right now that would overload the company and continues to put money towards improving networks and infrastructure, they will continue to be the mobile leader in the United States. In the future, if Verizon is in the financial position to buy Vodafone, and Vodafone has not already bought up the remaining 55% of Verizon, such a move could make them a worldwide mobile leader. Until either company is ready to do that, it is a safe assumption that they will both continue to be profitable companies in their own right.

Mobile phones are clearly an integral part of life worldwide. Smartphones are the present and the future, and Verizon and Vodafone are both poised to ride the wave of future mobile growth. Over the next twenty years, smartphones will not be a luxury, but the standard. The question is which company will come out on top as the world's largest mobile phone carrier?

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Business relationship disclosure: This article was written by an analyst at Catalyst Investments.