Vodafone (VOD) has announced that it has reached an agreement to sell its 45% stake in Verizon Wireless to Verizon Communications (VZ) for $130 billion. It issued a press release on Monday afternoon which details the composition of the total consideration, and how it intends to use the proceeds.
The total consideration of $130 billion would comprise of:
1. US$58.9 billion in cash;
2. US$60.2 billion in Verizon shares;
3. US$5.0 billion in the form of Verizon loan notes;
4. US$3.5 billion in the form of Verizon's 23% minority interest in Vodafone Italy;
5. US$2.5 billion through the assumption by Verizon of Vodafone net liabilities relating to Vodafone's U.S. Group.
The tax liability for Vodafone in the U.S. is estimated at approximately $5 billion; and the transaction is not expected to be taxable in the U.K., following the 2002 changes to U.K. tax law. This represents a major victory to Vodafone's management; as it would have achieved a sale of its stake with minimal tax implications, and for an 'attractive' valuation for its shareholders.
Vodafone has announced that its intention is to return a total value of $84 billion to shareholders following completion of the deal. This "Return of Value" would comprise of all the Verizon stock and $23.9 billion in cash. This represents 71% of the net proceeds from the sale, and 112p per share (equivalent to $17.47 per ADR). Assuming the transaction goes to completion, Vodafone shareholders should expect to see the "Return of Value" implemented by the first quarter of 2014. Vodafone also intends to raise its dividend for 2014 by 8% to 11p per share (equivalent to $1.716 per ADR).
The company intends to use the remainder of the proceeds to fund a £6 billion ($9.4 billion) organic investment program, dubbed Project Spring, and pay down its debts. Project Spring represents capital investment in addition to its existing plans to accelerate and deepen high speed data capacity in its core market. Vodafone believes that this would enhance its competitive positioning to deliver organic growth. Following the completion of the acquisition of Kabel Deutschland, the Group would maintain a strong balance sheet, by reducing net debt to approximately 1.0x EBITDA.
The announcement that Vodafone would return so much of the net proceeds to shareholders gives much comfort to investors who have been concerned about the company's overzealous acquisitions in the past. Although Vodafone is not intending to use any of the proceeds to fund future acquisitions, its management has not ruled out any large acquisitions. With net debt to be reduced to just 1.0x EBITDA, Vodafone could easily raise financing to fund large scale acquisitions, including a possible purchase of Liberty Global (LBTYA), a large international cable operator with operations in 11 European countries. At the time of writing, Liberty Global would cost approximately $70 billion, which includes taking on roughly $40 billion of net debt. Other cable and broadband operators, such as Spain's ONO or Italy's Fastweb, may be under consideration.
Nevertheless, the size of the "Return of Value" and the announcement of its intention to increase dividends into the future reflect that management is well aware over concerns of the destruction of shareholder value from past acquisitions, and emphasize that management is committed to maximizing shareholder returns. Hopefully, Vodafone would wait until it could show that offering bundled phone, broadband and television solutions to consumers is worth the premium it is paying for Kabel Deutschland, before it considers further large scale acquisitions.
How would Vodafone's valuation compare with its peers after the implementation of "Return of Value"?
Market Capitalization ($ bn)
EV / EBITDA1
EV / Adjusted OpFCF2
Net Debt / EBITDA
Forecast 2014 Dividend Yield (%)
1. EBITDA based upon last reported financial year, with the exception of Verizon Wireless which is based on the last twelve months.
2. Adjusted operating free cash flow (OpFCF) based upon last reported financial year, with the exception of Verizon Wireless which is based on the last twelve months. It excludes interest and taxes paid and license and spectrum payments, amongst other items.
3. 'New' Vodafone is estimated assuming completion of the Verizon Wireless transaction, "Return of Value" having been fully completed and Kabel Deutschland being incorporated within the new Group.
4. Market capitalization excludes the "Return of Value", expected to be implemented in Q1 2014.
5. Valuation of Verizon Wireless based upon $130 billion to be paid by Verizon Communications for Vodafone's 45% stake.
6. Intended 2014 dividend of 11p per share as announced.
7. Dividend corresponding to 2012 was cancelled, but Telefonica intends to pay a dividend of €0.75 per share corresponding to FY 2013.
When we remove the net proceeds from Vodafone's stock valuation, Vodafone's remaining assets are valued at a considerable discount to its 45% Verizon Wireless stake. Verizon Wireless is valued at 9.4x LTM EBITDA; and 14.2x LTM operating free cash flow (OpFCF); whereas 'new' Vodafone would be valued at just 4.3x EBITDA, or 7.8x operating free cash flow. This compares somewhat undervalued to European telecom players, such as Telefonica, Orange and Deutsche Telekom.
Although Orange is trading as a similar multiple on an EBITDA basis, and a lower multiple on OpFCF; Vodafone has a greater proportion of its revenues and profitability coming from Northern and Central Europe and emerging markets. It has less than a quarter of its revenues from Southern Europe. Africa, the Middle East and Asia generate an increasing proportion of revenues for Vodafone, and offers significant opportunities for greater penetration and capacity for higher speeds. Consequently, the company deserves a higher multiple on EBITDA and OpFCF than Orange.
Telefonica's valuation, which is generally considered to be low, because of its exposure to weakness in Spain's economy, is higher than Vodafone on an EBITDA basis and on an OpFCF basis. Telefonica also earns a significant proportion of its revenues from emerging markets, and especially in Latin America. Although Telefonica's presence in Latin America may be enviable, Telefonica is saddled with very high debt levels and is much more heavily exposed to Southern European economies, partly as a result of its fixed line assets in Spain.
Although Vodafone is returning an overwhelming majority of the net proceeds to shareholders, the risk of future acquisitions may still linger in investors' minds. The merger with Mannesmann and the acquisition of Hutchison Essar, its Indian wireless network, have been significantly overvalued; and have destroyed much shareholder value. As I mentioned in my previous article on Vodafone, cable operators are trading at a significant premium to wireless networks in Europe, and unless bundling television and broadband solutions can deliver the synergies promised, and greatly reduce customer turnover, we should remain skeptical over large scale acquisition in this industry.
Nevertheless, with a dividend yield of 5.36% post-"Return of Value", and low valuation multiples; Vodafone appears underappreciated, even when compared to its European peers. If the European economy improves significantly over the next few years, Vodafone would benefit greatly from its expanded capital investment and from valuation multiple expansions on EBITDA and OpFCF. With a net debt to EBITDA ratio expected to fall to just 1.0x, Vodafone is also much less risky than its European peers, whilst trading at a significant discount to American peers.