Verizon Shareholders Lose Big In The Vodafone Deal

Sep. 4.13 | About: Verizon Communications (VZ)

At $130 billion, Vodafone's (NASDAQ:VOD) announced sale of its 45 percent stake in Verizon Wireless to the U.S. telecom group Verizon Communications (NYSE:VZ) ranks as one of the biggest deals in corporate history.

While both stocks are down today, there may be an opportunity to make some quick trading gains on the short side of VZ, if you are inclined to be more aggressive.

Here's why VZ shares could trade at higher volumes and lower prices over the next few months, especially as we near the new shares distribution date:

#1 The tortoise and the hare

This is a little like the story of the tortoise and the hare - with an interesting role swap.

The secret to owning a slow and steady telecom like VOD is to reinvest cash dividends back into the stock. The total rate of return over the last five years from VOD shares was 70.7%, which equals a steady 11.3% annually. Without reinvestment those numbers barely reach a third of that.

In the case of the faster moving Verizon it sprinted to an 84.7% return during the last five years, while the non-reinvested returns measured half of that.

The historically higher numbers from VZ can be attributed to the fact it was considered the target of a deal and would be bought at a premium. That's not what's happening.

Instead now Verizon is the buyer and in the process the company is loading up on cheap debt to get this deal done. Verizon is destined to travel at a slower pace under this added burden.

So going forward with less of a speculative takeover premium in VZ and more cash at VOD the total return difference should favor Vodafone shares.

Tortoise wins!!

And that's without having to speculate if VOD itself would merge with another telecom.

#2 Horse of a different color

You can paint this horse any color but that does not change what it is.

There are some reasons for selling stocks that have nothing to do with valuations or future returns or whether the managements are doing their jobs or not - like where the company is located and whether a manager can legally hold that stock in the portfolio.

For example, managers with a European or global mandate are likely to sell all the shares they get from an American company and reinvest in non-U.S. stocks. On top of the regional differences, there are style and methodology differences too.

Looking at the composition of the top ten holders of VOD and VZ reinforces that there are a couple of common institutional holders but more differences in shareholder composition between these stocks than similarities.

Big money managers like these will have the ability to sell the VZ shares as soon as the when issued share market gets going.

Normally, the Exchange will initiate when issued trading when the percentage of additional stock distributed is 25 % or more of the outstanding. The current market value of VZ is about $130 billion so handing out $60 billion plus in new shares assumes a significant addition to the outstanding shares.

There is no fixed date for the commencement of when issued trading, but the Exchange will usually wait until such time as all corporate and official action requisite to the issuance of shares has been taken. The Exchange will also wait until the company's listing application for the distribution has been authorized.

If the VZ shares don't fit the characteristics of the portfolio they are delivered into then these shares have to go back to the stables to find new owners.

Will other Big Money investors line up on the other side of the VZ trade with enthusiasm to buy all these shares with enthusiasm?

Now this is really sounding like a fairy tale.

#3 M&A Merry-go-round

This year's surge in telecom deals was predictable, even if it is a bit dizzying. After the margin declines in 2011 and 2012, the large telecoms have made the transition into wireless and the faster systems growth that implies.

I'm not negative on the deal, which seems very logical. The US wireless business is still a growth business and warrants investment as proven by the SoftBank investment in Sprint (NYSE:S) and others lining up to make acquisitions.

The biggest issue here may not be valuation at all.

The big problem seems to be the amount of capital Verizon still needs to fund such a life-or-death acquisition and the courage for VZ management to make some tough calls for help after the struggle.

Basically, it's not a done deal and won't be until at least next year when they come back to the capital markets.

In their presentation this morning Verizon management stated they have the bridge facility in place and intend to reduce the majority of it with permanent financing prior to closing.

VZ management's promises to work down the debt reminds me of a pledge to quit smoking. Don't count on it to being so easy.

Do count on this additional capital showing up as more equity in some form or another creating sharing in cash flows. Maybe even another partner.

That may mean making a phone call to Carlos Slim for help. It's not surprising that the Latin American telecommunications giant América Móvil (NYSE:AMX) threatened on Friday to walk away from its proposed bid of $9.5 billion, for the Dutch cell phone operator KPN after a local foundation moved to block the takeover.

Just imagine what the opening line of such a series of calls might be.

My take on all this is there's a 15-20% valuation premium in VZ that should come off the stock for it to be fairly valued and that's before the new equity effect.

Strategically, the VZ Wireless transaction may be a great M&A deal, but current VZ shareholders are picking up the tab for the ride.

Happy Trading!!

Rudy

Acamar Global editorial team contributed to this post. Rudy Martin's clients own shares of VOD and are short VZ.

The opinions and forecasts expressed herein are solely those of Rudy Martin and may not actually come to pass. Information here should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: My clients are Long VOD and Short VZ