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SA Editor Samir Patel
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I joined Seeking Alpha as a Senior Editor in September 2012. I work closely with company leaders on content and publishing initiatives, primarily the SA Pro and SA Buyside platforms. A little about me: - I'm a native Texan. - I'm a value investor; I always enjoy reading well-constructed and... More
  • The Rumors Are Over, But The Story's Not: Vodafone Has 20%+ Upside 9 comments
    Sep 3, 2013 6:48 PM | about stocks: VOD

    Executive Summary: Vodafone ex-VZW appears to be trading at a significant discount to fair value; shares have multiple paths to 20% upside or substantially more.

    (note: images and tables keep disappearing for some reason I don't understand. If there's a random gap and/or a seemingly missing paragraph, that's why)

    (note 2: caveat emptor. This was written in 48 minutes and as such, calculations are not precise. this is a rough overview.)


    Investing 501, a great source of advice for young analysts (not to mention an excellent SA contributor), is a proponent of something they call the one-hour analysis. In their own words,

    The purpose of a one-hour analysis is to quickly evaluate the positive and negative attributes of a company. The key question is how much more time do I want to spend on this company. The job of a generalist is make quick decisions about when further investigation is warranted, and when it is best to move along.

    News broke over the long weekend of Verizon's (NYSE:VZ) $130B cash-and-stock buyout of Vodafone's (NASDAQ:VOD) 45% stake in Verizon Wireless. Rumors leaked Friday, VOD shares went up; deal was announced monday, shares went down today. As a Vodafone shareholder, I was obviously interested in determining whether it's a case of sell-the-news, and if there's any value left here. However, it's a Tuesday evening and I don't have time to analyze everything in-depth, so instead, I'll do an analogous "one-hour analysis" to figure out what's going on here. It's not exactly what Gregg and Tim were discussing, but it's similar enough. Ready, set... go!

    So. There are three major documents I'll be using here. First is Vodafone's press release regarding the deal. Second is Vodafone's 2013 results, third is their quarterly update.

    After reading through the majority of each document, I extracted a few "key" portions. A more thorough analysis would go in-depth on everything, but the whole point of this exercise is to keep it brief. The relevant details are presented below.

    Exhibit 1: Details of Verizon's Payment

    The consideration comprises:

    - US$58.9 billion (GBP38.0 billion) in cash;

    - US$60.2 billion (GBP38.9 billion) in Verizon shares ;

    - US$5.0 billion (GBP3.2 billion) in the form of Verizon loan notes;

    - US$3.5 billion (GBP2.3 billion) in the form of Verizon's 23% minority interest in Vodafone Italy; and

    - US$2.5 billion (GBP1.6 billion) through the assumption by Verizon of Vodafone net liabilities relating to the US Group.

    - The VZW Transaction represents an attractive valuation of 9.4x EV / LTM EBITDA and 13.2x EV / LTM OpFCF.

    Also relevant: the deal, subject to regulatory/shareholder approval, should close in Q1 CY '14.

    Exhibit 2: Vodafone's Plans For The Money

    At completion, Vodafone shareholders are expected to receive all the Verizon shares and US$23.9 billion of cash (the "Return of Value") totalling US$84.0 billion (GBP54.3 billion), equivalent to 112p per share and representing 71% of the Net Proceeds.

    Good to know that shareholders will be getting a substantial portion of the cash back - that de-risks the possibility of poor utilization of the cash through overpriced M&A, etc.

    Exhibit 3: Vodafone's Pro Forma Guidance

    The Group is, therefore, providing revised pro forma guidance(3) for the 2014 financial year, which excludes VZW and includes 100% of Vodafone Italy for the whole year. In addition, this revised pro forma guidance reflects equity accounting for its remaining joint ventures (principally Australia and Indus Towers) consistent with IFRS requirements.

    On this revised pro forma basis, the Group expects to deliver adjusted operating profit of around GBP5 billion and free cash flow of GBP4.5-5.0 billion for the 2014 financial year.

    Exhibit 4: Vodafone's Balance Sheet

    As of July 19, 2013,

    Net debt including joint ventures £24.9 billion... net debt, exluding joint ventures, was £23.0 billion.

    Exhibit 5: Vodafone's Performance By Geography

    From the annual:

    Exhibit 6: Vodafone's market cap:

    $156.6B USD.

    Exhibit 7: Quick Stats on Peers

    (click to enlarge)

    I would note that I don't really like peer comparisons for several reasons: first, being the "best of a bad bunch" (or worst of a good one) hardly says anything about valuation, since the valuation of entire sectors can be out of whack for long periods of time. That being said, this is supposed to be a quick and dirty analysis, and the main point here is that, as Einhorn said, 10-12x cash earnings isn't an unreasonable valuation for a European telco.

    Tying Everything Together

    The first thing I want to do is put everything in terms of USD, because the deal's in USD.

      FCF low FCF high Debt
    GBP 4.5 5 23
    GBP/USD 1.54 1.54 1.54
    USD 6.93 7.7 35.42

    We'll set that aside for a moment.

    The first thing I want to do is explain why I believe it's justified to subtract the vast majority of the $130B Verizon payout from Vodafone's current market cap when calculating the pro forma value of Vodafone. First, roughly 45% of the deal is in cash, and roughly 45% is in Verizon shares. I won't get into the specifics of the collar, but suffice to say that a small change in the price of shares would not be extraordinarily material, unless you're talking about a market-wide plunge, in which case your holdings aren't prone to do too well anyway. Similarly, you'll note that the balance is for Italy as well as some Verizon debt; a thorough analysis would assign risk-weighted value based on bankruptcy probability, etc, but again, as Heitman/Jahnke lay out, a one-hour analysis needs to focus on materiality. The material point is this: all Verizon shares and a good chunk of the cash will go directly to VOD shareholders; the balance of the cash will be invested by VOD in emerging markets and/or LTE at a rate of return that will hopefully be attractive. In any case, the value of the cash will offset net debt, so here's what I'm going to do: I'm counting it as $125B to factor in the reported $5B tax Verizon has to pay. There are small nits to pick like change in exchange rate, etc etc - again, these are things which should be covered in a more thorough analysis, but are not likely to move the needle here for the sake of an initial go-round.

    Given Vodafone's closing market cap today of $156.6B, the value of Vodafone's equity minus the $125B adjusted payout from Verizon is $31.6 billion. Adding the $35.4B (roughly) in net debt, we find that Vodafone's pro-forma EV is $67B. What's left of Vodafone, as an enterprise, is trading at 8.7x - 9.5x forward FCF. Note that I'm not actually projecting pro forma EV, net debt, etc for VOD - I'm trying to figure out what the "residual value" is of VOD once you take away the adjusted payout from Verizon, so we can see whether or not VOD's current market cap properly accounts for its "standalone" value. This is an important distinction.

    Is that a reasonable valuation? You have to view it in context. EMEA is by no means a super-hot market, but core declines are being offset by strong growth in developing markets (see Exhibit 5). I'm not bullish on Europe, and I'm not going to pontificate about the macro, but I think it's reasonable to assume that Europe is in the "down" part of the cycle and will see better days at some indeterminable point in the future. On the other hand, emerging market growth hasn't lived up to promises, yet Vodafone has seen exceptional results thanks to secular tailwinds. So again - looking at it from a materiality perspective - a valuation of 10-11x on what I'd guess is depressed free cash flow does not seem unreasonable at all. Increasing data usage, a stabilizing situation in Europe, and consumer adoption in emerging markets all combine to mean that FCF shouldn't plunge dramatically. Again, I hate to use peer comps, but I don't think 10-11x is totally out of line. (I think it's on the low end, but I like to be conservative.)

    Assuming a midpoint of 10.5x FCF, it doesn't seem like there's a major delta between that and the current ~9.1x midpoint. Only 15% upside to the EV/FCF multiple. But here's where Vodafone's substantial debt load actually accelerates returns: even if you assume 10.25x EV/FCF off $7.4B in free cash flow, which is the midpoint of guidance, you get an enterprise value of $75.85B. Backing out the $35.4B in debt, Vodafone's market cap is now $40B. What's that against the current $31.6 billion ex-VZW pro forma market cap? A nice 26% gain. If you think Vodafone's cost-cutting and strength emerging markets can expand margins and re-ignite growth, it's not hard to argue for an enterprise value north of $80B. This scenario suggests the ADRs could be worth north of $40. A very quick DCF as well as EV/EBITDA and P/E suggest similar results.


    With my (admittedly very rough) fair value estimate at $38 somewhat conservatively, and ADRs trading at a mere $32, there appears to be a significant disconnect between the market's estimation of Vodafone and mine. Maybe investors think the deal won't close? Maybe they don't trust Vodafone's management to deliver on their promises? Maybe they think Europe will fall apart? Maybe they aren't willing to assign market value to Verizon shares? Maybe I'm just totally crazy? This is certainly not a risk-free thesis, but I'm surprised that shares didn't pop after the market finally received confirmation of what everyone's been expecting for a year.

    Finally, I won't say it's going to happen until I see it, but rumors are floating around that AT&T might be interested in picking at what's left of Vodafone. Vodafone's European ops certainly won't command the same premium multiple they got for their stake in Verizon Wireless, but in an M&A scenario, they would undoubtedly receive a higher multiple than the market's assigning them today.

    There are multiple paths to upside - improved investor confidence in the deal, an offer by AT&T, or just good results from Vodafone - but in any case, Vodafone got a great price for their 45% stake in Verizon Wireless. I think shareholders who stick around will be well-rewarded.

    Disclosure: I am long VOD.

    Stocks: VOD
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Comments (9)
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  • SA Editor Samir Patel
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    Comments (163) | Send Message
    Author’s reply » I should add that VOD's net debt pro forma will be lower than I'm presenting here, because they'll be keeping some of the cash from the payout. The way I've looked at it, that would reduce the amount of the VZW payout and increase the market cap to debt ratio, which would reduce the leverage effect some, so the discussion here isn't entirely precise. The broader point, however, still remains - there are obviously some complexities that you have to eliminate for a quick analysis, but no matter how you slice it, the market isn't assigning full value to what's left of Vodafone without the 45% stake in Verizon Wireless.
    3 Sep 2013, 09:11 PM Reply Like
  • SA Editor Samir Patel
    , contributor
    Comments (163) | Send Message
    Author’s reply » To that, I'll also add that EV will be somewhat different - again, as I laid out, this is a rough approximation. The point of this exercise was to figure out if the delta between VOD's current market cap and the $130B Verizon payout is too big, too small, or fair. The conclusion is it's too small - in my opinion, VOD's current market cap should be $190-$200B or more. How the exact numbers shake out post-deal-close will depend on how Vodafone chooses to reinvest the money, etc, but the overarching theme is VOD shares are undervalued.
    3 Sep 2013, 09:22 PM Reply Like
  • Ashraf Eassa
    , contributor
    Comments (9733) | Send Message
    Excellent article, Samir.
    3 Sep 2013, 09:52 PM Reply Like
  • SA Editor Samir Patel
    , contributor
    Comments (163) | Send Message
    Author’s reply » Thanks, Ashraf. Quite honestly, it was a bit nervewracking analyzing something so big so quickly... I kept feeling like I was going to miss something! It's obviously imprecise in a lot of areas, but given the point of the exercise, I think it went pretty well.
    3 Sep 2013, 10:06 PM Reply Like
  • Deep Value Investments
    , contributor
    Comments (3) | Send Message
    This analysis is good but you miss one thing if you go to vods accounts and look in a bit more detail you can see a number of exceptionals hitting cash flow - exclude these and you get much more upside!
    4 Sep 2013, 11:20 PM Reply Like
  • SA Editor Samir Patel
    , contributor
    Comments (163) | Send Message
    Author’s reply » Rob - thanks for pointing that out. I did see a few things but didn't dig into them since this was a fast look and I'd rather be conservative. Used mgmt's guidance as a quick and dirty estimate. As I mentioned in the post, I think long-term FCF will be higher than this. Which exceptionals are you referring to specifically?
    4 Sep 2013, 11:50 PM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1468) | Send Message
    Nice analysis. If VZ were to drop 20 percent to 40 or so what value would you assign to VOD?
    5 Sep 2013, 12:27 PM Reply Like
  • SA Editor Samir Patel
    , contributor
    Comments (163) | Send Message
    Author’s reply » I was planning to construct a more detailed/precise model, but MicroFundy did such a good job here that I'm not sure I need to:


    You can make a copy of the google spreadsheet and play around with the numbers on your own.


    The short version is there's substantial margin of safety here - even if you assume VOD horribly misallocates the cash they're keeping, and assign an NPV of zero to that cash, and factor in 15% cap gains taxes on the payout, and a few other discounts here and there, you end up coming to a fair value of roughly $34 according to MF's model.


    I did a little more precise calculations and still came to a fair value of $38-ish, and that's at a somewhat elevated discount rate with no free cash flow growth. Realistically, I think VOD has the potential to deliver higher FCF. I'm trying to work up a more comprehensive/thorough analysis but time is unfortunately short.
    5 Sep 2013, 08:53 PM Reply Like
  • Andrew Williams
    , contributor
    Comments (347) | Send Message
    Very nice analysis and I appreciate MF making his model available. My math is closer to yours as he has some haircuts for conservatism.


    As you probably know, VOD will acquire Kabel Deutschland. VOD's 2014 guidance doesn't include KDH's FCF (maybe 450 mm Euros?), but they do say Net Debt / EBITDA will be roughly 1x following close of this transaction.


    So (if I understand this correctly), if we look at the FY beginning next Mar 31st, VOD's P / FCF could be around 9.4x (assuming no change from the midpoint of their current FY guidance) with a relatively nice balance sheet and a healthy dividend.
    5 Sep 2013, 09:48 PM Reply Like
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