Wednesday, August 20, 2008

A Verizon takeover of Vodafone

A speculation here. The biggest M&A deal in the world of the next 4 years is going to be a Verizon takeover of Vodafone. 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 - in 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 focussed on dividend yield and free cash flow yield. Verizon controls the board of Verizon wireless and it has argued against Verizon Wireless paying a dividend to its parents to reduce its leverage for years. 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 dividend from VZW, its cash flow statement doesnt 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 this that it is paying 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. Pound has started weakening, and if it continues to weaken further as UK falls off, UK takeover targets will become attractive in the next 3-4 years. Someday, Sprint will get its act 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, there is hardly anyone of scale left to acquire. VZW will spend 2-3 years integrating Alltel. That is when Verizon will pounce on Vodafone.

1 comment:

swas said...

Interesting article.

Do you think that actions like Stop Vodafone have any influence on the matter, whatsoever?
In a short time, over 400 unsatisfied Dutch mobile Vodafone customers have joined in order to file a claim against Vodafone. For months on end now, Vodafone, reputedly the biggest telecom company in the world, seems unable to live up to her online promise to always provide her Dutch mobile customers with data usage information in order to control their spendings. She claims technical problems. Unsatisfied customers claim that Vodafone is motivated by higher revenues to experience these "technical problems".