Verizon (NYSE:VZ) recently issued a public statement saying that it has no plans to bid for Vodafone’s stake in Verizon Wireless, quelling multiple speculations over the last few months regarding the future of the wireless joint venture. This week alone, there were fresh speculations about Verizon roping in AT&T for a joint bid on Vodafone which caused both Verizon and Vodafone’s stocks to make new multi-year highs. But the revelation has now put to rest investors’ hopes of seeing the U.S. telecom giant exert greater control over its wireless cash cow anytime in the near future. Verizon however maintained that it continues to harbor wishes of taking full control of the wireless carrier but has no intention of doing so right now. Going by Verizon’s statement, we believe that the carrier may have expressed interest in buying out Vodafone’s 45% stake in Verizon Wireless, but the parties could not come to an agreement over the valuation of the sale.
Valuation dilemma botches potential deal
By our estimates, Verizon’s wireless division contributes about 66% of its value. At Verizon’s current market capitalization of about $140 billion, that makes its 55% stake in the JV worth about $90 billion (assuming that total debt is also divided between the two in the ratio of their business value, though Verizon Wireless’ debt load is comparatively lower). This would put Vodafone’s 45% stake in the joint venture at about $75 billion (again depending on the debt allocation). However, rumors suggest that Vodafone was looking at something in the range of $100 billion for its stake, or a premium of over 30%. This was probably because a potential stake sale would have led to a huge tax liability for Vodafone, especially at a time when European governments are looking for every opportunity to cut down their deficits. Also, the fact that Vodafone has been able to draw two large tax-free dividends from Verizon Wireless last year would have made it a reluctant seller of its stake at a low valuation.
At the same time, justifying such a high premium would have required 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 significantly in the long run. However, with the wireless market getting increasingly saturated and smaller rivals Sprint and T-Mobile making aggressive moves in consolidating their market shares, both those scenarios seem a tad too optimistic. It is also tough to see how having greater control over the wireless division would help Verizon extract so much more value out of the segment.
At the same time, Verizon would have had to take on a huge debt in order to fully buy out Vodafone’s stake. At a consolidated EBITDA of about $29.6 billion last year, its net debt stood at about 1.6 times EBITDA. With an additional debt of about $100 billion, Verizon’s balance sheet would be saddled with a debt load of about 5x EBITDA, servicing which would have turned into a big headache for the management. All these factors considered, we think it was a wise decision on Verizon’s part to not go through with acquiring Vodafone’ stake if it was considering so in the first place – a sentiment that we had echoed in an earlier note as well. (see Verizon’s Potential Bid For Full Control Of Its Wireless Business Could Be Risky)