Why Verizon Will Take Over Vodafone

I'm speculating that the biggest M&A deal in the world of the next 4 years is going to be a Verizon (VZ) takeover of Vodafone (VOD). Verizon might then divest its landline business and become a global wireless operator - somewhat on the lines of what Vodafone did to Mannesmann at the beginning of the century.

It all boils down to Verizon Wireless - of  which Verizon owns 55% and Vodafone owns 45%. It is probably the best wireless operator in the world, with a churn of sub 1.2%, and is a crown jewel. Because of the way Verizon has manipulated the situation, Vodafone's stock has become relatively undervalued, while Verizon has become relatively overvalued.

Here is why. A lot of telecom investors are focused on dividend yield and free cash flow yield. Verizon controls the board of Verizon Wireless and it has argued for years against Verizon Wireless paying a dividend to its parents to reduce its leverage. This works fine with Verizon. It consolidates Verizon Wireless, so the consolidated cash flow statement includes all of Verizon Wireless's cash flow (including Vodafone's piece of it). So, the free cash flow calculated using cash flow statement overstates Verizon's free cash flow power. Besides, as debt reduces at Verizon Wireless, it makes consolidated leverage at Verizon look better (if one forgets to count minority interest as debt).

Vodafone has no such luck. It carries Verizon Wireless as an investment on its balance sheet. Because it doesn't receive any dividends from VZW, its cash flow statement doesn't include any benefit from VZW, and so its free cash flow is understated. Whatever free cash flow Vodafone generates today, it is from its properties other than VZW, and it is from these properties that it pays out its dividend.

So, on a free cash flow yield basis, Vodafone is cheap. A big cause of it is VZW. Verizon can capture this discount. The pound has started weakening, and if it continues to weaken further as the UK falls off, UK takeover targets will become attractive in the next 3-4 years. Someday, Sprint (S) will get its aact back in US and it will become difficult for VZW to grow by churning Sprint subs. Growth in US wireless through domestic M&A will be difficult - after Alltel (AT), there is hardly anyone of scale left to acquire. VZW will spend 2-3 years integrating Alltel, and after that, Verizon will pounce on Vodafone.

Comments

[DrMobius:]

I could not disagree more. While a potential M&A is possible between VOD and a US domestic carrier. I think it is more likely that US carrier will be none other then AT&T. AT&T over the last few years is coming back as the MA bell of old “in scale” and has made no secret of its international ambitions. Not only do they have the international network already in place to support such a purchase but they have the M&A experience with GSM wireless carriers to draw from.
The idea would be acquire VOD and create cash right away by selling back Verizon’s 45% stake as part of the required rules that will be set down by FCC. I am sure Verizon would be happy to provide a slight premium over market value for the shares just too wholly own VZW...

2008 Aug 20 10:00 AM

[stupid head:]

65 billions in debt.

2008 Aug 20 10:50 AM

[jhite:]

I agree and disagree with both of you, and I will do my best to explain, dumbing this down as much as possible. I am purposely typing slow, cause I know neither of you read very fast.

All this talk of VOD, VZW and AT&T and not one mention of the Redskins? Are you crazy or just ignorant? This is going to be the year of the Burgundy and Gold. You can call your friends and celebrate their victories on any phone, IT DOESN'T MATTER! Althought the new iPhone is pretty cool...

2008 Aug 20 10:58 AM

[AronLiv:]

Makes no sense whatsoever. VOD is about 40% bigger than VZ on a market capitalization basis, has more debt and wouldn't agree to sell the 45% of VZW that it doesnt own to VZ a few years ago for $70 billion. They aren't going to sell the whole company, and VZ wouldn't know what to do with a global company anyway.

2008 Aug 20 02:03 PM

[DrMobius:]

I agree AronLiv but I know AT&T would.

2008 Aug 20 02:38 PM

[mike R:]

Right idea, but VOD is $134B market cap and VZ is $98B...
Vodafone should be buying VZ...

VOD has a history of doing the "big one", like the $192B deal for Mannesmann in Feb 2000 news.bbc.co.uk/1/hi/bu...

VOD has an incentive to get their dividends and to broaden their foot-print... VZ is currrently enjoying VOD's cash so they're happy...

VOD's sales slowed from 4% to a bit over 2%... the stock tanked 17% on slower sales...

The Pound is stronger than the dollar, but off it's high...

VOD should move while the currency is in it's favor...

VZ won't sell it's 55% and they won't pay-up for VOD's 45%... why should they? They control the cash!

Besides, wireless companies are values at $2,100 per subscriber (ATT wireless, Rural Cell, ALLTEL)... with 65 million subs VZ Wireless is worth $137 billion... $40 billion more than the market cap... and the rest of VZ is worth more than $0...

2008 Aug 21 08:58 AM

[tipalia:]

all this talk leads us where? which position one must take? lots of good and not so good points but that leave the individual investor with what at the end? what are you buying?

2008 Aug 21 11:36 AM

[telecom guy:]

The undervalued company ripe for takeover is France Telecom (FTE) and not Vodafone.

2008 Aug 21 12:43 PM