On September 3rd, 2013, Verizon (VZ) entered into an agreement with Vodafone (VOD) to purchase its 45% stake in Verizon Wireless for a total consideration of $130bn. There are strong signals in the structure of this transaction which suggest that VZ will be under heavy downward pressure on closing. Broadly, my argument is that
- the existing VOD shareholders will receive a substantial amount of VZ shares as part of this transaction
- they will quickly turn around and sell the VZ shares in the open market and
- this will push VZ share prices significantly lower, giving rise to a buying opportunity.
I will articulate my logic more in detail in the article below.
1) Transaction Structure
Verizon will acquire the 45% Verizon Wireless stake from Vodafone by paying a total consideration of $130bn, which is roughly composed of $60bn in cash, $60bn in Verizon stock and $10bn of other instruments (e.g. equity stake in Italy's Vodafone, loan notes etc.). Of these proceeds, VOD plans to return to shareholders all of the $60bn in VZ stock and $24bn in cash (the remaining ~$36bn in cash will be reinvested in the business). The following summary table is based on the Vodafone investor presentation of the transaction (p.3):
I would like to focus on the VZ stock component of total consideration. To finance the transaction, VZ will issue $60bn of new stock to VOD shareholders. Given VZ's current total market capitalization of ~$137bn (as of Jan 12th, 2014), this is a significant equity offering. According to the VZ equity offer prospectus (p.32), VOD shareholders will hold between 29-31% of total VZ equity post closing, and therefore what they will do with their shares will have a significant impact on VZ's overall share price.
2) Behavior of VOD shareholders
VZ's share offering will be allocated to VOD shareholders based on their current equity holdings. A quick analysis of VOD's shareholder base by type and geography reveals the following:
VOD shareholder base: %age of outstanding stock held by investor type and geography
(Source: S&P CapitalIQ data, author's analysis)
Simplifying a bit, we can say that VOD is a stock held primarily by institutional investors, split roughly evenly between the US & Canada and Europe. It is particularly interesting at this point to analyze the European shareholder base further, since many European institutions face strict portfolio composition mandates, and may indeed be outright forbidden from holding US equities. How will they react to suddenly owning a substantial portion of VZ stock? According to my analysis thus far, these investors will cumulatively hold 45% * $60bn = $27bn of VZ stock, which will be equal to ~14% of VZ's post-transaction market capitalization.
Top 20 individual VOD investors in Europe
(Source: S&P CapitalIQ data, author's analysis)
As can be seen from the chart above, the top 20 European VOD shareholders on average only hold ~7% of their assets under management in US equities (I did not extend the analysis to the remaining ~580 institutions because of the manual nature of this analysis). Such a group of investors is highly unlikely to hold $27bn of US equities on their books as a result of a corporate transaction. A much more probable outcome is for them to unwind their position in VZ, which will lead to a massive sell-off.
3) Impact on VZ share price
I will not attempt to quantify the impact of the sell-off effect on the VZ stock price, as the many unknowns would make such an exercise futile. I will instead focus on the data points that are known to help detect a sell-off:
a) Sell-off extent: Given that 1.2-1.3bn shares will be issued by VZ as part of the transaction (VZ prospectus, p. 32), European investors would be allocated 45% * 1.2-1.3bn shares = 450-485m shares. Let's assume for a minute that all European investors will indeed proceed to sell these off. This is clearly an extreme case, but given VZ's normal daily trading volume of ~11m shares, if even a fraction of this sell-off materializes over any time period, it will be very visible through trading volumes.
b) Sell-off timing: The closing of the transaction will occur on February 24th, 2014. This is the day on which VOD shareholders will receive VZ share distribution and the day on which I will start closely watching the trend of VZ for indications of stock sell-offs. VOD is offering its shareholders a dealing service to sell VZ shares free of charge up until April 4th, 2014, so I would expect the bulk of the sell-off to have completed by then.
The forced distribution of a large quantity of VZ shares to VOD's largely Europe-focused investor base will likely trigger a substantial sell-off in VZ shares between February 24th, 2014 and April 4th, 2014. This sell-off will create a temporary distortion in the market in the form of a depressed VZ stock price. I will be watching, and in case of a sufficient drop (5-10% at minimum), initiate a long position.