Why Would Verizon Pay $27 Billion for Alltel?

Just when you thought Verizon (VZ) stock couldn't go any lower, the money rumor mills believes the company is deep in talks to acquire Alltel (AT), the nation's fifth largest wireless carrier, for roughly $27 billion, There are some reasons behind this and there is more to it than meets the eye.

Part of the mystery of all this is that Alltel was only recently taken private by TPG and Goldman Sachs Capital Partners in a $27.5 billion deal. That deal, announced in May of last year, closed in November. This isn't helping the multi-year slump of Verizon's stock (see chart below, compliment of Big Charts at Marketwatch.com .

For almost 10 years now Verizon has been on a downward trajectory that makes even patient investors swoon.

We are told that Verizon (NYSE: VZ) seems likely to pay no more than did TPG and Goldman, and will be doing so for a company that has increased its earnings before interest, taxes, depreciation and amortization (Ebitda) by 10 percent since the leveraged buyout was announced last may.

Verizon is expected to pay roughly 8 times Alltel's current Ebitda, in contrast to the 9.2 times Ebitda that TPG and Goldman paid last year when they put in roughly $4.6 billion of equity and lined up $23.8 billion of debt financing to get the deal done. Not surprisingly, Verizon hasn't made any public comments so far.

Verizon has long been looked at as the epitome of a compatible purchaser of Alltel, but it failed to bid when the company was auctioned in the spring of 2007. According to people involved in that auction, Verizon believed Alltel's valuation was too high.

Of course, that was a far different time in the credit markets, when financial buyers were routinely outbidding strategic buyers despite the cost savings and revenue synergies available to the strategic buyers. One year later, Verizon stands ready to take advantage of those cost advantages with this expected purchase. Are synergies and cost advantages what this is about?

A recent CNBC report stated that Alltel's network "... is contiguous with Verizon's own and will allow the carrier to save the roaming charges it pays Alltel."

The addition of the Alltel network is also expected to bring significant cost advantages in other areas. One of those cost advantages might have to do with the continuing threat from AT&T (T) to take wireless customers away from VZ.

The fact that Apple's (AAPL) upcoming new and improved 3G iPhone continues to give exclusivity to AT&T as the service provider might also have a bearing on Verizon's decision to go after Alltel.

We've heard that sources told CNBC that TCP and GS Capital Partners are willing to sell only six months after they closed the deal because they'll get a slight premium to their equity investment, and there is a broad desire within private equity these days to generate a return when one is available.

While the premium for the equity may be slight, given the enormous leverage in the deal, the returns would seem to be good ones for TPG and Goldman. The big question remains. Is this really good for Verizon and the VZ shareholders?

Verizon's wireless unit is a dominant carrier in the United States and contributes the vast bulk of the company's cash flow, so that might be the most imperative reason that VZ is taking this route.

We think this is all about Verizon's determination to create a company that would overtake AT&T Inc as the No. 1 U.S. mobile service. Evidently sources familiar with the talks told Reuters this on Wednesday, according to their report on this late-breaking story.

The Reuters story said, "Verizon Wireless and Alltel, which said it had more than 13 million customers at the end of the first quarter, together would have more than 80 million customers." That gives them a big leg-up on AT&T and the potential they have to accelerate past VZ. The competition here is so intense that this makes sense to us.

Could the upcoming annoucement by AAPL that has the potential to increase the number of subscribers that AT&T? The other real fact is that many loyal Verizon wireless subscribers might be willing to switch to their biggest competitor (remembering that T has an exclusive arrangement with AAPL and their coveted iPhone).

As a long-time happy Verizon Wireless customer who switched to Verizon from AT&T because I thought AT&T customer service was lousy, I wouldn't risk losing the excellent customer service we've experienced with VZ just because I wanted to try the iPhone. Apparently though there might be millions of other Verizon customers who might not be as loyal.

If you are a VZ stock investor, don't jump to too many conclusions on how this deal to acquire Alltel will impact the price of the stock. If the final details of the transaction looks favorable to VZ, and if the Alltel deal is likely to be accretive to earnings, then this might actually help the price of the shares.

Frankly it is too early to say. All we can say is if these rumors are substantiated, VZ is going to be perceived as a proactive wireless leader that might be a bit paranoid. But considering the upcoming media blitz that the new iPhone will generate for AT&T, perhaps a bit of paranoia makes good sense and this acquisition will be viewed as a smart move.

Disclosure: None

Comments

[Johnathan S...:]

Strategically, it's a smart move for VZ Wireless. Alltel is a well-run carrier which dominates the rural market of the U.S. In acquirring Alltel, VZ Wireless increases its chance of expanding its net earnings, saves the roaming charge expense that it would pay Alltel. It may also create some advertising value by becoming the largest wireless player in the U.S. market.

2008 Jun 05 03:33 PM

[oldcurmudgeon2:]

Verizon benefits by not having to pay Alltel roaming charges. Alltel -- now part of Verizon -- loses the roaming charges. How is this a cost saving?

2008 Jun 06 09:59 AM