Tuesday, March 19, 2013

Verizon-Vodafone: it is time to go hostile

The Wall Street Journal is again suggesting that Verizon may buy Verizon Wireless from Vodafone. As noted in the previous post this is insane. It incurs a completely unnecessary twenty billion dollar tax bill.

The only deal that makes sense is for Verizon to buy Vodafone in its entirety.

If Vodafone will not sell there is a solution for Verizon: go hostile.

Background

As detailed in the previous post Vodafone has been had a decade of modest successes and abject failures made good by a single amazing success. The amazing success is that they owned 45 percent of Verizon Wireless - the best performed US Wireless company.

I noted that Vodafone's great success is the only substantial asset that they do not manage.

Several UK fund managers (reasonably) pointed out that this was not entirely fair. The history is instructive. During the tech-bubble Vodafone got properly carried away. Not only did they pay up for spectrum (which may not have been a choice given WorldCom competing at auctions) but they paid top-dollar for several assets entirely by choice. The biggest mistake was that they purchased Mannesmann at the height of the bubble for $170 billion USD. This deal is second only to AOL-Time Warner as the most stupid large deal of the tech-bubble era.

Over the next couple of years the delusional bubble-era management were replaced by bland mediocrities who did not do very much wrong at the cost of not doing very much right. Vodafone had completely "rogered" its balance sheet during the bubble and as a result did not participate in the cheap spectrum auctions around the world that happened during the 2002-2007 period. Getting carried away in a bubble has permanent effects (just ask Citigroup or BofA if you need more recent examples).

My UK fund-manager contacts thought that I was being harsh on Vodafone criticizing current management for their complete lack of spark. They thought the current management were chosen to be boring and fulfilled that task admirably.

By contrast, the Baby Bells did not participate much in the madness of the tech bubble - leaving that to the CLECs (anyone remember McLeod) and Worldcom and Enron Broadband, Global Crossing and the like. The Baby Bells were boring.

As befits the end of a bubble - the meek were left standing and inherited much of the USA. The Baby Bells consolidated to form Verizon and AT&T and have solid balance sheets, good businesses and the absence of insane competition.

Their cycle was the opposite of Vodafone. They were boring when Vodafone was exciting and they are now strong when Vodafone is weak.

In any deal Verizon deals from that strength - strength created more than a decade ago.

Hostile bids

Sir Brian Pitman once told me that the only real bids are hostile bids. He had a sort of logic: in a negotiated bid it is highly unlikely the acquirer is getting an outright bargain. Negotiated bids happen with a willing seller.

Hostile bids however change the world. The stock market is full of incorrectly valued securities. It is fairly common for stocks to lose 70 percent of their value or triple. As a corollary the stock market is full of securities trading at a third of fair value and three times fair value.

If we could pick which were which we would all be rich. Alas it is very hard to pick what is cheap and what is expensive - and the investing world is full of "if-only" statements. [If only I had purchased Citigroup below a dollar...]

Hostile bids are typically done without due diligence - and the range of outcomes is large. In a hostile bid you might pick up an asset for a third of fair value or three times fair value. These extreme outcomes don't happen so much in negotiated bids.

The result: hostile bids change the world. Extreme variation makes hostile bids either extremely good or extremely bad.

This bid does not require much due diligence

Hostile bids can be extremely good or extremely bad because you can't do due diligence.

However in this case if Verizon were to bid for Vodafone Verizon would know what they are getting. The WSJ story linked above suggests that the Verizon Wireless stake is worth between $106 and $137 billion. I have a slightly higher number.

The total market cap of Vodafone is $137 billion.

Vodafone is trading below what I think the stake in Verizon Wireless is worth.

Verizon can bid fair value for what the Wireless stake is worth and get the rest for free - and it is obviously worth more than nothing. Even the Australian asset has some value!

And Verizon obviously do not need to do due diligence on Verizon Wireless.

In other words Verizon can have all the pluses and very few of the negatives of a hostile bid.

A hostile bid is possible of course because the UK fund managers have little faith in the mediocrities that now run Vodafone. Vodafone is cheap because of management.

I know if there is an American bid for this UK champion there would be all sorts of nationalistic squeals in the UK. But the UK fund management community would donkey-like eventually just accept the bid. For Vodafone that is the cost of a decade of failures.

And the meek (the Baby Bells) would in fact inherit the earth.




John

10 comments:

Anonymous said...

Forgive me for being cynical, but is not the tax liability simply a kick back to the government by the company taking shareholders capital and just handing it to government.
That’s the way I see the Libor settlements/ London Whale et al, too; just the cost of doing business, and it is always good for business to hand the “Don” gifts now and then.
As you point out there really is no commercial sense for this transaction, and only shareholders will get soaked, so if it goes through it is kick back plain and simple.

Wilfried said...

John, have you considered the possibility that Verizon simply does not want to become a global telco? If that is the case and they bought Vodafone to get Verizon Wireless they would have to dispose of the rest of the business. Surely the Verizon management has thought this through and must have decided against taking this route. And the taxes Vodafone will have to pay in case they sell Verizon Wireless do not bother the Verizon management at all...

Anonymous said...

Well, why not Verizon buy all of Vodafone and then spin-out through an in-specie distribution to existing shareholders all of the company except the Verizon Wireless piece? Does that avoid the tax?

That leaves two stocks out there:
1. All of Verizon including the wireless piece
2. Everything else currently in Vodafone

Ken Lorp said...

About 11 years ago I attended a talk by Joel Stern on EVA. Over a coffee afterwards, he said that Vodafone was the biggest destroyer of Economic Value in the UK. After they went public with that comment, Vodafone refused to meet with or speak with any of the Stern Stewart guys - even when they wanted to explain EVA and how Vodafone could turn it around.

They do, unfortunately, have a long track record of being a poorly-run business.

But What do I Know? said...

I would disagree with the statement that T and VZ have good balance sheets and good businesses. Both of them have been borrowing money to pay their dividends for years, their DB pensions will suck out profits for years to come, and they are utterly dependent on the government renewing their licenses (licenses are not ammortized on the balance sheet despite being extended only for a fised period of time.)

Anonymous said...

Deutsche Telekom trades at 3.4x EBITDA and if I assume a 24% tax rate on Verizon Wireless proceeds (probably too low) and 8x forward EBITDA then the rest of Vodafone trades at 4x EBITDA. Could argue that Vodafone ex-Verizon Wireless is fairly valued unless you put a higher multiple on Verizon Wireless. So you are right to campaign for Verizon Wireless to buy the whole entity as a Vodafone shareholder. Good luck.

John said...

Could they use something like a reverse morris trust?

http://en.wikipedia.org/wiki/Reverse_Morris_Trust

Benedict Evans said...

Hi John,

A couple of biggish holes in your history.

First, Mannesman was an all-share transaction: Vodafone swapped one pile of overpriced stock for another. One could argue the ratio was too rich, but on the other hand they'd previously got Airtouch very cheap on the same basis. Not really accurate to call that a stupid deal. And the end-point was that Vodafone has the best or best-equal mobile business in almost the important European markets

Second, they then sold Mannesman's Orange, for cash, for more than double what they paid for 3G spectrum. Vodafone effectively made a profit out of the whole affair. So actually, it was a brilliant deal.

You're flat wrong on Vodafone's balance sheet - it had one of the strongest in the industry. This was the period when France Telecom, BT, Telefonica and DT were brought to their knees by refinancing (~€30bn cash for Orange didn't hurt): Vodafone did just fine.

They didn't then sit on the sidelines: they bought into (or increased stakes) in Turkey, South Africa, Japan (didn't go well) and later India - which has gone wrong for everyone because the regulators are misguided, not because of specific Vodafone failings.

Meanwhile the strength of Verizon Wireless (and AT&T) is because the end-point of a very long period of consolidation turned out to be a two operator oligopoly with inflationary pricing and a supine regulator, whereas Europe has deflation pricing and a confiscatory regulator. VZW is very well run, but the environment is the reason for the profits.

I'm not the biggest fan of Vodafone's management, and I agree it could be more aggressive. But the picture you paint of a track record of uselessness really isn't very solid.

Anonymous said...

To Benedict Evans comment, India went wrong because of the regulators? They paid a massive EBITDA multiple for India right before competition picked up in a market that obviously had too many players. In Japan, Softbank purchased the asset, which was thought as having negative value at the time because it was so mismanaged, and now Softbank has a path to having more EBITDA than DoCoMo with that asset. John has documented how poorly their asset in Australia has been run.

They have done well in Africa, where the asset is managed by a separate management team. Turkey seems to be the only asset where they bought in and managed the asset to grow it well (and didn't massively overpay like in India).

Anonymous said...

Benedict Evans makes good points. The us mobile market is a joke. Not quite Mexico, but not far. And guess what even mexico is looking like they may go after Slim and break up his de facto monopoly. telcos are natural monopolies. As an investor, you bet as much on a management as on a regulator/government. All EU telcos have gorged on fat roaming fees, but the commission fought back and now it looks like roaming prices will come v close to in market pricing depriving telcos of billions.

You are obviously conflicted and it looks like you'd have a v nice payday if Verizon jumps across the pond. And while it sounds a tidy plan, and a banker wet dream, my guess is that it won't happen.


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