On August 30, 2013, the last trading day prior to the VZ-VOD merger announcement Press Release on September 2, the VZ shares closed at $46.85. On that same day, the shares of T closed at $33.38, leaving a spread of $13.07 between the two stock prices. The rise of the equity market in general has helped both stocks move higher since the August 30 close, but VZ has outperformed T since the announcement. At current prices, the spread between VZ and T has widened to over $15. We have charted the VZ-T spread (one/one not equal dollar amount) back to May 23, 2008, and the highest spread value was $16.59 on April 26 of this year, before the VOD announcement. The spread narrowed over the summer to the $12 area before widening to $13+ just prior to the VOD-VZ merger announcement.
The current spread reflects the market's view that VZ is about to reap the benefits of full ownership of its Wireless venture once the proposal closes in the first quarter of 2014. By reputation and performance VZ Wireless is superior to the T wireless operation, but the market may be taking an overly optimistic view of the two companies' relative values. The VOD transaction will require VZ to pay $58 billion in cash and $60.2 billion in new VZ shares. There is price collar on the VZ stock between $47 and $51, but the minimum issuance will be 1.17 billion new shares or 41% of the currently outstanding VZ shares. The VZ shares will be distributed directly to holders of VOD where they will be available for immediate trading. We also expect sophisticated holders of VOD stock to execute short VZ transactions to hedge their anticipated receipt of the VZ shares issued in the proposal. VZ has successfully completed the debt offerings used to raise the cash for the VOD transaction, and most observers expect the stock issuance to proceed without a major problem, as long as general equity markets hold up.
The T shares have risen with the market, but the spread between T and VZ has widened to the $15+ level, nearing the $16.50 level that is the high water mark over the past four and one-half years. While the analyst community has raised its VZ earnings estimates and maintained the T estimates, the T shares still trade at a higher yield and lower earnings multiple than the VZ shares. At current prices, for example, the T shares yield 5.1% with VZ yielding 4.22%. Consensus estimates for VZ earnings in 2014 with 100% of its wireless operations have risen to $3.45, giving VZ a forward P-E ratio of 14.6x. The T consensus EPS estimate for 2014 is $2.65 for a P-E ratio of 13.3x. Some T investors may be concerned about the rumors T may bid for VOD next year, after the VZ-VOD deal has closed so there may be a 'rumor overhang' on the T shares until that uncertainty is resolved.
As for VZ, the good news about the wireless control is out and disseminated, with the distribution of the new VZ shares still hanging over the market until the proposal is completed several months from now. With the VZ-T spread nearing its highest level in the past few years, it may be time to consider swapping out of VZ and into T. More aggressive traders may want to look at setting up 'pairs' trades with long T shares and short VZ shares. Such investors will benefit from the T yield advantage and lower earnings multiple and will be establishing the positions near the largest price spread between the two stocks over the past four and one-half years.
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.