Fresh speculations regarding a possible Verizon Wireless stake sale sent Vodafone’s stock soaring by as much as 6.7% during the day. Citing people familiar with the talks, Bloomberg said that Verizon (NYSE:VZ) and Vodafone are discussing a wide range of options, including Verizon completely buying out Vodafone’s 45% stake in the joint venture.  If the talks succeed, it will help Vodafone meet its strategic objective of exiting a business that it doesn’t fully control while allowing Verizon to take full ownership of its most prized assets in the U.S. It would also decrease Verizon’s exposure to a declining wireline business, which has been left reeling by the ongoing trend of consumers increasingly shifting to wireless devices for their data needs.
Verizon’s stock has also reacted positively to these rumors, rising continuously for the last few weeks by almost 7.5% since mid-February. Considering that the highly profitable wireless JV accounts for almost two-thirds of Verizon’s value by our estimates, the company shareholders are visibly excited at the prospect of having a greater stake in the wireless division. Due to the positive sentiment surrounding the rumors, Verizon’s stock is currently trading at about 7% higher than our $45 price estimate. However, Vodafone could be looking at a premium over the current market valuation for its stake, justifying which would require Verizon Wireless to considerably improve its fundamentals in the coming years. This is a big risk that the markets seem to be not accounting for at the moment.
Why Buy Out Vodafone’s Stake?
The wireline business has been declining for a while and last year saw revenues decrease by about 2% over the previous year. The declining wireline revenues is an industry-wide trend with higher wireless penetration leading to customers increasingly disconnecting their landlines. Last quarter was especially rough as net additions for FiOS Internet declined by 28% and for FiOS Video by 31% over the same period in 2011. Together with the revenue decline, the wireline division also saw EBITDA margins fall from around 23% in 2011 to about 21% last year.
On the other hand, Verizon Wireless generated nearly $76 billion in revenues and accounted for 66% of the company’s total revenues in 2012. With EBITDA margins of 47% compared to 21% for wireline, wireless is a far greater contributor to the company’s total value. Moreover, the wireless carrier has been doing really well of late leveraging its LTE lead to add a record high of 2.1 million subscribers last quarter. At a time when a saturated wireless market saw competitors such as AT&T add only a little over a third as many subscribers, Verizon Wireless’ recent performance was impressive. Going forward, while subscriber growth may slow down, Verizon’s wireless ARPUs should continue to benefit from the proliferation of mobile devices as the industry undergoes a transition where wireline becomes less relevant.
However, under the current ownership structure, Verizon investors are sidelined from benefiting from the wireless growth. Last year, Verizon paid out nearly $8.3 billion to Vodafone and only $5.2 billion to its investors. For 2012, Verizon reported a net income of $10.5 billion, of which only $875 million or around 8.3% was attributable to Verizon. The larger share of the profits went to Vodafone, mostly because of the high net losses that were incurred in the wireline division, which is fully owned by Verizon. With the wireless segment expected to grow as wireline declines, Verizon’s investors will continue to receive a lower attributable net income if the ownership structure remains the same. Verizon is likely looking to mitigate the impact of a declining wireline business with a bigger stake in the wireless division. So far so good.
Apt Buyout Value For Vodafone’s stake
Where Verizon will face a dilemma is in arriving at a figure for Vodafone’s stake. By our estimates, Verizon’s wireless division contributes about 66% of its value. At Verizon’s current market capitalization of $135 billion, that would make it worth about $90 billion (assuming that the total debt is also divided between the two in the ratio of their business value). This puts Vodafone’s 45% stake in the joint venture at about $75 billion. However, rumors suggest that Vodafone could be looking at something in the range of $100 billion for its stake. This is a premium of over 30%, justifying which would require Verizon to improve its fundamentals by as much.
Currently, we estimate Verizon to increase its postpaid market share from around 30% in 2012 to about 32% by the end of our forecast period. Simultaneously, we expect Verizon’s data ARPUs to increase by about 50% from the current levels of $20 to over $30 by the end of our forecast period. However, in order to justify a 30% premium, Verizon will have to double its data ARPUs to about $40 by the end of our forecast period. Simultaneously, the carrier will need to increase its postpaid market share to about 35% by 2019. In order for both to simultaneously play out, Verizon will have to dominate the wireless industry the same way it has in recent years as well as hope for the increasing adoption of LTE and shared data plans to increase its data ARPUs in the long run. Whether having greater control over the wireless division can help Verizon extract this much more value out of the segment or not is the key question before shareholders right now.Notes:
- Verizon Seeks Full Control of Industry’s Leading Carrier, March 6th, 2013 [↩]