Vodafone Group (VOD) stockholders will likely have some decisions to make in early 2014: what to do with Verizon Communications (VZ) shares provided as a result of the sale of its 45 percent stake in Verizon Wireless. My current plan is to sell the shares when issued, while seeking to start a position in AT&T Inc (T) stock.
I'll hold my original Vodafone investment, unless the ADRs break $34.
Part I: Why I Plan to Keep the "New" Vodafone
At the time of this writing, Vodafone ADRs are priced at $32.89 each. One ADR equals 10 Vodafone shares.
As part of the Verizon Wireless sale, Vodafone stockholders will receive about $4.85 per ADR in cash, and $12.20 in Verizon Communications common stock. Subtracting these expected disbursements from the current price, the remainder is $15.84 per ADR. Please note that it's anticipated there will be a reverse split (referred to as "consolidation of capital) included as part of deal, but let's shelve that for now.
Is Vodafone less VZW worth at least $15.84? To answer, I say "yes."
Vodafone Valuation Analysis
Business segment EBITDA for the fiscal year ending March 31, 2013 was found on Page 41 of the most recent Vodafone annual report. Sans Verizon Wireless, the global total was approximately $20.2 billion, or $4.10 per ADR. The figure represented a single digit drop from the prior fiscal year. However, continued weakness in Europe was somewhat offset by strength in the AMAP region (Africa, Middle East, and Asia-Pacific). My view is that the EU is bottoming out after a long recession. Therefore, I suggest that Vodafone's FY 2013 results are at or near the trough.
Is at least $20 billion a year EBITDA worth a stock price of $15.84?
If we divide $15.84 stock price by the $4.10 EBITDA per ADR, Vodafone's trailing twelve month P / EBITDA multiple is 3.9x.
How's that multiple stack up?
Please find below the Price / EBITDA multiples for several large telecom companies. I've included Orange SA (ORAN), the big French carrier; Telefonica SA (TEF) a dominant Spanish telco; Deutsche Telekom AG (OTCQX:DTEGY), the largest German telecommunications company; and U.S. based Verizon / AT&T.
The results indicate that Orange, Telefonica and Deutsche Telekom carry roughly a 3x multiple, or about a point less than their U.S. counterparts. However, Orange, Telefonica and Deutsche Telekom are highly Euro-centric - and the European communications market has been in the dog house for years. On the other hand, Vodafone will generate nearly a third of its revenues outside Europe, even after the VZW divestiture. These revenues are concentrated in some fast-growing regions, names India, Turkey and parts of Africa.
In addition, Vodafone plans to retain about $46 billion cash after the stockholder return of value is complete. Some will be used to pay down debt and reinforce an already solid balance sheet: VOD already sports a better debt-to-capital ratio than its peers. Another $9.4 billion will be used to develop the business (Project Spring).
Finally, Vodafone management has stated that investors may anticipate a post-close 8 percent bump in the dividend.
As a bonus, there are rumors that AT&T may have interest to acquire what's left of Vodafone. Indeed, I would not hold VOD stock based upon that rumor. However, I do like this breakup story kicker in conjunction with the overall storyline.
All told, a higher multiple versus European peers may well be appropriate. I believe 4x on ttm operating EBITDA is reasonable. That would place a post- VZW sale $16.40 fair value on the ADRs. Rounding out the math, $16.40 plus $17.05 (the expected Vodafone distributions) equals $33.45. Therefore, prior to the disbursement of cash and shares, I plan to sell no Vodafone shares for less than $34.
Part II: Sell the Verizon Stock Distribution
Vodafone stockholders should anticipate more or less 0.25 shares of VZ stock per Vodafone ADR as part of the transaction. I plan to sell immediately, assuming I can recoup the value of the stock distribution in cash.
Between AT&T and Verizon stock, I believe the former represents the best comparative value today.
Whenever a corporate transaction includes a stock disbursement, my default position is to sell it. My VOD investment thesis has been predicated upon Vodafone ownership, not Verizon Communications. Any VZ investment must stand on its own. While I continue to believe that its a good company and a sound stock, it must compete with both "new" Vodafone shares, or its big cousin in the U.S. telecom duopoly....AT&T.
Part III: What's So Good About AT&T versus Verizon?
In a nutshell, I like AT&T over Verizon based upon a review of key fundamentals, the dividend yield, and business backdrop. I've computed the figures below via 2013 1Q and 2Q reported financials. First half results were annualized, where appropriate.
What's in the Numbers?
To begin, both telecoms are cash machines. While Verizon edges AT&T on some return and margin metrics, it's not enough to override a significant delta dividend yield. On the other hand, AT&T is less levered. Indeed, as part of the Verizon Wireless purchase, Verizon Communications is taking on a lot more debt and diluting its stock. Notably, Verizon already reports VZW as a consolidated entity. The financial statements reflect the full result of the enterprise, not just Verizon's 55 percent ownership.
Focusing upon the dividend, AT&T has achieved the Dividend Champion status. The company has raised the payout for 29 years in a row. Over the past five years, management has increased the dividend by 4 percent annually. Verizon management has the same dividend growth record over the past five years, too.
The best argument for Verizon over AT&T has been underlying stock performance. VZ has bested T for several years. However, I'm not sure that past performance will guarantee future results. Credit agencies have already knocked back its debt rating, and the expected equity issuance will dilute current shareholders by 1.33 billion shares, or some 45 percent. I contend that Verizon management may have paid too much for VZW.
Meanwhile, AT&T shares are trading around a 52-week low for no particular reason. Recent quarterly reports haven't been stellar, but neither have Verizon's. Nonetheless, cash flow has been rising. Here's a ten-year FAST graph showing historic Funds From Operations (FFO) as a function of price. FFO is a close cousin of Operating Cash Flow.
A reversion to the mean (6.4x FFO ratio) indicates that AT&T may be a $46 stock, or nearly a 40 percent upside to the recent close.
courtesy of fastgraphs.com
AT&T is expected to grow FFO, too. Here's a related FAST graph summarizing Street analysts' five-year expectations. While the forward growth rate (6 percent) is expected to slow versus the prior ten years (9 percent, see above), I found this reasonable given a maturing of the U.S. communications market.
courtesy of fastgraphs.com
I find AT&T Inc shares at $30 to $32.73 quite compelling. That's a 5.75 to 6.00 percent yield.
Summary and Conclusion
Based upon my current expectations, a post-distribution, pre-consolidation of capital Vodafone is worth about $16.40 per ADR, or about four percent above the a recent close. Vodafone offers investors reasonable go-forward global growth prospects, particularly in the developing world; a sound balance sheet; and an eight percent dividend boost. The expected yield should remain north of five percent. I plan to hold the shares, only trimming back if they top $34 each.
I plan to sell Verizon Communications stock when issued, not because there's anything wrong with the company; I simply believe the VZW purchase will take time to digest and payout. Meanwhile, I find the AT&T dividend history and yield very compelling, as a result of what appears to a share price that's fallen significantly below fair value.
Please do your own careful due diligence before making any investment decision. Good luck with all your 2013 investments.
Additional disclosure: I may initiate a long position in T over the next 72 hours.