A merger and acquisition of the scale never seen before seems to be in the air. Behind the speculation are the three most visible names in the wireless communication sector; Verizon Communications (NYSE:VZ), Vodafone Group plc ADR (NASDAQ:VOD) and AT&T (NYSE:T). If the deal comes through , Verizon gets full control of its mobile network segment, Verizon Wireless, something that it had wanted for a long time. Vodafone, the joint owner of Verizon Wireless gets a hefty premium; but how does AT&T figure in?
Investors would also want to know what is in it for AT&T particularly in light of the company's announcement last week of its intentions to build A 1 gigabit fiber network in Austin.
The Verizon Wireless deal
Verizon Wireless is a segment of Verizon Communications through which it offers wireless voice and data services and equipment sales. The other segment is Wireline. Verizon owns 55% of Verizon Wireless and the other 45% is owned by the Britain-based Vodafone.
Verizon Wireless is a profitable venture and gave Verizon Communication $9.78 billion and Vodafone $8 billion as dividend last year. Vodafone is not particularly happy at the arrangement. The British mobile operator is already struggling in a weak European market, bogged down as it is by the debt crisis in the region. 45% ownership of Verizon Wireless is one of the very few profitable investments it has made in the last ten years. Being a majority partner, Verizon Communications can anytime choose to withhold dividend under the pretext, real or otherwise, of making acquisitions and/or expansion.
Initially, there were speculations that Vodafone might sell its stake in Verizon Wireless. However, it now appears that Barclays USA has been asked to work out a deal for THE whole of Vodafone. This is where AT&T comes in. According to a Financial Times report, it is likely to be a three-way deal where Verizon buys Vodafone's 45% share in Verizon Wireless and AT&T takes its non-U.S. assets.
According to the report, should the deal come through it will be at an offer price of 40% premium to Vodafone's CMP or near about 260p a share putting Vodafone's enterprise value at $245 billion. It will be history's biggest ever acquisition, much bigger than the previous record holder - the $182 billion takeover of Time Warner by AOL way back in 2000.
The deal holds something for all the parties involved. Vodafone gets a premium for its 45% stake and also saves around $20 billion in tax. Verizon gets full ownership of Verizon Wireless, something that it has been striving for a long time now.
AT&T, as Merrill Lynch's David Barden said, is "the missing piece of this puzzle" of stalled talks to resolve the Verizon/Vodafone partnership that spans back eight years.
What is in it for AT&T?
In 2011, the Federal Communications Commission (FCC) nixed the AT&T's bid for buying T-Mobile USA, a subsidiary of Germany-based Deutsche Telekom. The rejection was an effort by the regulator to block the company from acquiring any more U.S. assets in the telecom space. If AT&T has to expand, the only way it can do is by looking at overseas assets. The deal is tantamount to accomplishment of the company's stated ambition of expanding in Europe and becoming the largest wireless player and, as Merrill puts it, "secure for AT&T purchasing power and competitive know-how that could be deployed domestically in its ongoing battle with the substantially larger Verizon Wireless (in post-pay)."
The FCC estimates mobile traffic to expand 30 times in 2015 and unless additional airwaves are made available, consumers will experience call drops, delays and slower data downloads. In September 2012, the FCC approved a proposal to reclaim public airwaves currently being used by television broadcasters and auction them for use in broadband networks. The auction, slated to be held in 2014, is considered to be an attempt to provide for the creation of high-speed Internet networks necessary for fuelling development of next generation of mobile devices.
However, the Justice Department has told the FCC that the auction should be structured in a way that allows smaller wireless players to get a fair share of spectrum to ensure the market is competitive. While this is good news for smaller players like T-Mobile and Sprint (NYSE:S), AT&T (and also Verizon) has every reason to complain as it puts a cap on how much spectrum it can acquire.
The Justice Department's filing showcases the high value of the spectrum to be auctioned. Much of it is due to over reliance on the Internet, access which can in a way be considered as a necessity just as electricity.
Fiber optic networks have the ability to provide 100 times faster speeds. However, most of the wireline connections are through antiquated copper wires, which is why the average consumer has to depend on slower speeds. The situation is difficult to change as it requires huge capital expenditure on building infrastructure on wired connections. Verizon started to build its fiber optic communication network (FiOS) in 2006 but had to shelve the project midway as it found it difficult to complete. AT&T spent $19.7 billion on it in 2012 after having spent $20.3 billion in 2011.
It appears that Google (NASDAQ:GOOG) is now trying to bring about a change and free the average American from the shackles of what can at best be called the oligopolistic environment of the telecom industry. Google announced that it is planning to extend its fiber optic network beyond Kansas City, deep into the heart of Texas, in Austin. The announcement came on April 9, 2013 and the very same day, AT&T also announced its intention of building a 1 gigabit fiber optic network in the same city.
Just as AT&T is striving to get FCC to make additional spectrum available for mobile broadband and is planning for expansion of its wireline IP network for offering more speed to consumers, it is also working on growth areas. The company is working in collaboration with Verizon Wireless and T-Mobile to develop Isis mobile wallet, an IP-based automation and home security service that will allow customers to manage their home through a connected mobile device or PC.
The company is also preparing for the time when new wirelessly connected cars appear in the market. It already has deals with car manufacturers such as Ford, Nissan and BMW and expects to offer services such as voice driven emails, accept calls, check traffic ahead and send signals to the house to make appropriate changes in lighting and thermostat settings as the car approaches the driveway.
The industry is brutally divided into wireline and wireless. Comcast (NASDAQ:CMCSA) and Time Warner (TWC) dominate the wireline segment, whereas AT&T and Verizon are the country's largest wireless service providers.
The trend is towards a mobile world. At the same time, speed is of essence. It is only a matter of time before speed becomes a major issue with consumers. AT&T is apparently preparing itself for that eventuality.
AT&T operates in both segments of the telecommunication industry - Wireline as well as Wireless. The FCC can put a cap on how much spectrum companies can acquire, which is why the company is focusing on wireline infrastructure as well.
AT&T has habitually striven for providing good returns to investors. The announcement to build fiber optic network in Austin comes on the back of its Project VIP (Velocity IP), a $14 billion investment plan over three years for enhancing its wireline and wireless IP broadband networks.
AT&T has a history of rewarding investors with handsome dividends (dividend yield: 4.69%) and good returns. It has positioned itself well to benefit from future growth areas such as wireless and wireline data and managed IT services.
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.