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Is Verizon a Buy After the $130 Billion Deal with Vodafone?

September 04, 2013 | About:

Verizon (VZ) and Vodafone (VOD) finally sealed off the $130 billion deal that will make Verizon in full control of the top wireless carrier in the U.S. Verizon agreed to pay Vodafone $130 billion to acquire its 45% stake in Verizon Wireless. The said agreement consists of $58.9 billion in cash, and $60.2 billion in Verizon stock to Vodafone shareholders. The cash component, dubbed as the largest amount of cash payment ever in an acquisition, will be financed by JPMorgan, Barclays, Morgan Stanley and Bank of America.

Also included in the deal is the sale of Verizon’s 23% stake of Vodafone’s Italian unit amounting to $3.5 billion back to Vodafone. The stock component includes $5 billion in notes payable to Vodafone, while the rest will be subject to a collar where shares are issued within the floor price of $47 to a ceiling price of $51 per share until the transaction is complete.

Moreover, Verizon will further assume Vodafone’s liabilities to the U.S. business amounting to $2.5 billion. This amount can be quickly written off by Verizon, if it plans to do so, using the $3.5 billion proceeds from the sale of its Vodafone’s stake.

Positive Impact on Verizon

While the said deal will have little or no effect on the subscribers and the industry, it can tremendously affect the company’s financial and future success. The acquisition is important for Verizon because its future growth heavily relies on its wireless unit, which accounts for two-thirds of its total revenue of $116 billion last year. Hence, this will infuse additional income to the company since it will now have full access to the earnings of its wireless unit.

Last year, Verizon posted net income of $10.6 billion, but majority of the amount or about $9.7 billion belonged to its joint venture partners such as Vodafone. As a result, Verizon’s bottom line profit ended only at $875 million. But with complete ownership of its wireless unit, it will now have full access to the net earnings.

Verizon wireless produces operating income of $21.8 billion every year. This can help finance the company’s future network investments to make it more competitive. At this yearly income level, Verizon can quickly get the returns of its present investment within five years. Moreover, the buyout will also boost Verizon’s earnings per share, and the management sees an increase of 10% on its EPS once the transaction is close.

Negative Impact on Verizon

While the potential rewards are great, the company is also pushed towards the riskier side. The addition of more than $60 billion in debt will double Verizon’s debt load, thereby limiting its future investment flexibility.

Aside from the rising debt, the financing fees and miscellaneous costs of acquisition that could amount to $500 million add up to the load. A high debt-to-equity ratio will put the company on an unstable ground. But an insider revealed that Verizon will strive to pay down its debt load within the first two years. If this is true, this will minimize the exposure of Verizon to the volatility of the economy.

Moody’s downgraded its rating on Verizon due to the increase in debt leverage brought about by the rising debt. But despite the downgrade, analysts remain optimistic that Verizon will maintain its investment grade rating.

Moreover, the acquisition also comes at a time when the economy in the U.S. is slowing down. Due to rising competition, the annual growth of subscribers slowed down to only 2%, which is a far cry from the annual growth of 15% back in 2004. Its competitors are also upgrading their technology by heavily investing in technologically advanced networks. This will continue to pose threats to Verizon’s market share.

But at present, Verizon is not yet in panic mode against its competitors. It has already launched the LTE network to its subscribers that gave it a year or two lead versus its rivals. On top of that, about 94% of its subscribers are under locked contract. This provides a sort of shield to Verizon’s subscriber-base level.

The Bottom Line

Verizon’s quest to gain full control of its wireless unit comes with such a high price. It is risky, as well. However, it will also improve the earnings per share of the company, thereby making it a self-sustaining deal.

While its debt exposure will increase in the ensuing months, the management’s next step is to reduce its debt load in order to make Verizon still robust and quick to grab investment opportunities as they arise. This makes Verizon, today, more lucrative for investment in order to enjoy the expected ride up as it continues to maintain market leadership in wireless subscription in the U.S.

On top of that, the company recently increased its dividend by 2.9% to $0.53 per share, coming from $0.515 per share during the previous quarter. At the current dividend yield of 4.47%, it is attractive for dividend investing, as well.


Rating: 4.0/5 (4 votes)

Comments

batbeer2
Batbeer2 premium member - 1 year ago
Some thoughts:

1) >> At the current dividend yield of 4.47%, it is attractive for dividend investing, as well.

FWIW I believe a company that is issuing debt shouldn't be paying a dividend. At the end of the day you are borrowing cash from bondholders to pay shareholders. You pay interest on the bonds and taxes on the dividends so it destroys value.

If you did that with a business you owned outright, everyone would immediately point out that such a policy isn't sustainable. You would only do that in a liquidation scenario to screw bondholders and/or roll over the business to someone else with a pile of debt on the balance sheet after extracting the cash.

In the case of VZ you are looking at a monumental pile of debt and a huge dividend stream so management is destroying a lot of value every day.

2) VZ is buying 45% of Verizon Wireless and in the process, giving away to Vodafone 30% of their company. If you like VZ, buy VOD. As before, it is a MUCH cheaper way to own Verizon's assets. VOD is better managed too. They are retiring debt and paying a dividend. That is the sustainable long-term policy.

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