Last week Verizon (NYSE:VZ) and Vodafone (NASDAQ:VOD) reached the historic deal for Verizon to obtain sole ownership of the much coveted Verizon Wireless asset. Regardless of your position on the transaction, the stock action of the two stocks since the leak of the purchase discussions at the end of April tells the story.
In the couple of years prior to the news of the talks heating up, Verizon had easily outperformed Vodafone. Remember that Verizon owns 55% of Verizon Wireless while Vodafone owns the rest. Partially due to the focus on the better performing US market, Verizon had easily outperformed Vodafone over that time period. This fact was greatly enhanced due to Vodafone being focused on Europe and emerging markets outside of the Verizon Wireless ownership.
What really enhances the flip in returns since the original leak of a deal back in April is the research that suggests large companies that reduce assets outperform the market. Conversely, large companies that acquire assets and take on debt underperform the market. One way to look at it is that companies the size of Verizon and Vodafone become so large that additional assets become impossible to manage for maximum profit. The company is better off returning excess cash and profits to shareholders.
Deal Details - Verizon View
With any asset sale or merger it's always interesting to read the different press releases by the two companies involved. Each company naturally needs to spin the deal as beneficial to that company, while typically each deal has a winner and loser. In this case, the stock movements suggest that Vodafone shareholders won. Below are the details on the deal based on the Verizon press release:
- Immediately accretive to EPS by 10%, without any one-time adjustments.
- Paying $58.9 billion in cash to Vodafone by executing a $61.0 billion bridge loan.
- Issuing $60.2 billion of stock to be distributed to Vodafone shareholders.
- Selling the 23.1% ownership of Vodafone Omnitel (Italy) for $3.5 billion.
- Issuing $5.0 billion in equal 8 and 11 year notes payable to Vodafone.
- Increasing dividend by 2.8%.
The rationale for the full ownership of Verizon Wireless is that it provides opportunities to increase enterprise and wireline markets. While some possibility exists that a more seamless integration will exist, management didn't provide any concrete evidence that this is actually the case. Verizon already controlled the wireless unit and the company had every reason to already be fully integrated.
Deal Details - Vodafone View
Not that Vodafone has a different view than what Verizon presented, but the company has a completely different plan. Whereas Verizon expects to absorb nearly $60 billion in debt and issue stock to Vodafone, it plans to return a significant amount of the deal to shareholders.
- Receiving $58.9 billion in cash.
- Distributing $60.2 billion in Verizon shares to shareholders.
- Receiving $5.0 billion in notes from Verizon.
- Receiving Verizon's 23% minority interest in Vodafone Italy.
- Investing approximately $9 billion in Project Spring, a plan to increase investments in 3G and 4G networks.
- Distributing $23.9 billion of cash to shareholders.
- Increasing 2014 dividend by 8%.
In total, Vodafone plans to return 71% of the net proceeds to shareholders. Another interesting part of the deal is the plan to invest more in 3G/4G services in the five main European markets bringing 4G service to 90% of those markets by 2017. Another interesting part is the deal to get full control of Vodafone Italy that has 29.1 million subscribers and a 35% market share.
The ability to sell the US market with 4G services deployed and the market saturated while at the same time obtaining more access to the European markets provides an attractive buy low, sell high scenario at the highest level.
When attempting to analyze large corporate deals, it is always worth knowing what the research of past deals suggests. The research by Michael J. Cooper, Huseyin Gulen, and Michael J. Schill, titled Asset Growth And The Cross-Section Of Stock Returns, found that corporations that contract capital tend to perform better than those that attempt to expand assets. The research found the following basic corporate moves lead to either periods of abnormally high or low returns as follows:
Abnormally High Returns: events associated with asset contraction such as spinoffs, share repurchases, debt repayments, and dividend initiations.
Abnormally Low Returns: events associated with asset expansion such as acquisitions, public equity offerings, public debt offerings, and bank loan initiations.
Considering the details on this deal, one might quickly assume which company sits on the right side of this research. The basic conclusion of the research is that a bias exists in the capitalization of new investments leads to a host of potential distortions that are economically meaningful.
Charts Speak Volumes
The below chart speaks volumes about the impact of a major merger for a large company. Prior to the end of April, Verizon was easily outperforming Vodafone over the previous year. After the leak of the deal heating up, Vodafone shareholders have been the big winners.
As with most deals, the valuation Verizon paid appears reasonable when considering the meaningful accretion to earnings per share. Not to mention, the company will be able to raise the dividend. History though suggests that the acquired assets requiring the additional debt and issuance of shares will lead to meaningful negative returns for a period. Naturally, after closing the deal, Verizon can take on the process of paying down debt via the significant cash flows of Verizon Wireless. At that point, Verizon could move back onto investors' radar, but until then the research suggests that Vodafone will provide the better return.
Disclosure: I am long VOD. 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.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.