Shares of Vodafone (VOD) have witnessed quite some volatility over the past trading week. A week ago, reports hit the news wires that two of its US counterparts were preparing to make a combined bid for the company.
The Financial Times' Alphaville reported that AT&T (T) and Verizon (VZ) were preparing to make a combined $245 billion offer for the company. In a response to the rumors, shares of Vodafone rose up to 6% in Tuesday's trading session. From that point of time, shares have given up all the gains after executives involved denied the rumors about an imminent deal.
Yet something might happen later this year, as the strategic rationale for a deal is strong. Let's explore the positions of the three large companies being possibly involved in a deal.
Strategic Rationale For The Deal
If a potential deal were to go through, it would become the largest corporate deal ever. Ironically enough, it was Vodafone which holds the current record when it bought Mannesmann AG back in 1999 for $203 billion.
Vodafone's share price has been struggling in recent years, being down 30% from the highs in 2007, but the company owns a 45% stake in the promising Verizon Wireless business, with the remainder of the shares being held by Verizon.
The majority of Vodafone's valuation is being attributed to the wildly successful and profitable joint venture. Yet, Verizon has many times expressed its interest to buy the remainder 45% stake, as its traditional operations are struggling to remain profitable.
At the same time, AT&T failed to expand its operations in the US when the US anti-trust authorities blocked the proposed $39 billion acquisition of T-Mobile USA from Deutsche Telekom (OTCQX:DTEGY) two years ago.
For growth, the AT&T now has to look across borders. A potential acquisition of Vodafone's European operations would be risky, but would most likely occur at discounted valuation multiples. The company would furthermore acquire promising assets in the growing African and Asian markets.
Vodafone ended its fiscal year of 2012 with 7.1 billion Pounds in cash and equivalents, or little over $10 billion assuming one British Pound buys 1.5 US dollar. The company operates with 34.6 billion British Pounds in short and long term debt (little over $50 billion), for a net debt position of 27.5 billion British Pounds, or little over $40 billion.
Vodafone's European and African/Asian activities generated total revenues of 46.7 billion British Pounds in 2012, the equivalent of roughly $70 billion. The activities generated 14.5 billion British Pounds in EBITDA (almost $22 billion) and 6.2 billion British Pounds in operating income (little over $9 billion).
Shares of the ADR of Vodafone are currently exchanging hands at $28 per share, valuing the firm at around $138 billion. Adding to that the $40 billion in debt and the market "only" values the activities at $178 billion. A potential $245 billion deal would value the equity of the firm at little over $40 per share, a roughly 40% premium from current levels.
A Great Deal In The Making
Verizon's Strategic Rationale
Reports are indicating that Verizon would be willing to pay $135 billion to Vodafone for the 45% stake in Verizon Wireless, which would value the entire wireless company at $300 billion. Verizon currently has a market capitalization of $140 billion and operates with $50 billion in net debt, for a total enterprise value of $190 billion. This is roughly the equivalent of Vodafone's current enterprise value.
If Verizon were to finance $135 billion in both debt and equity, its enterprise value would increase towards $325 billion. Note that Verizon itself already indicated on multiple occasions that it would like to purchase the remainder of the stake in the wireless activities, but so far Vodafone's management has been hesitant to divest its most valuable asset.
The wireless activities hold a retail connection base of 115.6 million customers. The activities generated annual revenues of $75.9 billion in 2012. The profitability of the business is enormous given the low churn rates and a retail ARPU of $144 per account. The EBITDA of the business came in at $29.7 billion while operating income totaled $21.7 billion.
The $300 billion valuation, values Verizon Wireless at roughly 4 times annual revenues, 10 times annual EBITDA and 14 times operating income. The valuation is a little steep, but the activities are market leading, immensely profitable and growing in terms of market share. If a deal were to go through, the company could continue to pay outs its generous 4.2% dividend yield.
The $300 billion valuation for Verizon Wireless implies that the company's landline operations are valued at merely $25 billion. The wireline activities generated $40 billion in annual revenues for 2012, and reported EBITDA of $8.5 billion. Yet on a GAAP basis they are barely breaking even.
AT&T's Strategic Rationale
For AT&T, a potential deal could give the company a decent footprint in international markets. For the year of 2012, AT&T generated annual revenues of $127.4 billion, half of those revenues are derived from wireless activities. The company reported EBITDA of $17.5 billion and an operating income of $13.0 billion.
Given that Verizon would be willing to pay $135 billion for the wireless activities of the joint venture, AT&T would have to finance the remaining $110 billion. AT&T already has an enterprise value of some $275 billion, comprised out of $210 billion in equity and some $65 billion in net debt.
The $110 billion price tag would value the acquired activities at around 1.6 times annual revenues, 5 times EBITDA and 12 times operating income, after backing out the profit contribution from the 45% stake in Verizon Wireless. AT&T itself trades at 2.2 times annual revenues, 16 times annual EBITDA and 21 times operating income. As such a potential deal would occur at valuation multiples which represent a 30-50% discount compared to the company's own valuation.
The discount is understandable given the lower growth potential, especially in Europe. Yet the discount seems high enough to justify the proposed price tag. Another added benefit is that AT&T could charge its US consumers roaming charges when they travel abroad, generating lucrative additional revenue streams.
Yet analysts point out that involvement of AT&T will be less likely than a potential offer from Verizon. AT&T has engaged in sizable share repurchase programs in recent times to reduce its annual dividend payment. A potential deal would not only dilute the shareholder base, but also most likely reduce the annual dividend payout as well. Shares of AT&T are currently yielding 4.7% per annum. That might be too much to bare for investors in the stock, who rely on their quarterly dividend checks for their income.
Some Possible Objections
A possible mega-deal like this often results in a lot of resistance. The UK would lose one of its biggest companies and many retail investors would lose the nice dividend streams which Vodafone has provided them with over the past years. Politicians would most likely not be too happy either given the importance of employment in current economic times.
Yet, a potential joint-bid would make regulatory clearance easier. AT&T should get an approval fairly easy and Verizon should be able to own the joint venture (Verizon Wireless) solely without too many concessions.
A combined bid would make financing of the deal easier as well, although $245 billion is not a small amount. The US companies would require significant access to debt and equity capital markets, given the small cash balances at both firms.
Implications For Shareholders Of Vodafone
Despite the scale and a possible 40% premium compared to Vodafone's current stock price, the strategic rationale behind a possible deal remains for both Verizon and AT&T. Vodafone appears to be officially in play and most likely something will occur in the coming months, despite the fact that Verizon also denied rumors about a possible deal.
Given the lack of a recent uptick in the share price, the solid state of the business, and a relative cheap valuation, an investments in Vodafone looks quite attractive at the moment. Shareholders stand to benefit from two potential deals, Verizon's potential acquisition of the wireless activities and a possible AT&T bid for the European and African/Asian activities of Vodafone.
If no deal will eventually materialize, investors stand to receive a healthy 5.5% dividend yield in the meantime. While there are obvious risks, notably fierce competition and a further European slowdown of the economy, the trade-off favors a long position.