Late Wednesday night, news broke that telecom giants Verizon (click ticker for report: ) and Vodafone (click ticker for report: ) are working on a deal for Verizon to acquire the 45% stake in Verizon Wireless currently owned by Vodafone. Initial estimates peg the deal at a whopping $130 billion, giving Verizon Wireless an implied value in excess of $285 billion.
The timing seems ideal for Verizon—its legacy landline business is in a gradual decline, and the US mobile market continues to undergo consolidation, which will likely boost industry profitability. Verizon Wireless is already the most profitable wireless carrier in the United States, and further strengthening fundamentals could boost the asking price beyond what Verizon is capable of paying.
With interest rates rising, this could be the last chance for Verizon to take on a large amount of inexpensive debt. The cost to borrow at prevailing rates remains near all-time lows, and any additional interest rate increases could make the deal significantly more expensive.
Timing also makes sense for Vodafone, for most of the same reasons. With Verizon’s wireline business declining, the firm needs the wireless business to compensate for declining profitability. With the cost of borrowing manageable, Verizon will be able to make a much stronger offer than it would be able to make in a higher interest rate environment, thereby benefiting Vodafone shareholders.
The question for Vodafone is: what will the company do with all of this cash? Special dividends, share repurchases, or another acquisition have all been rumored uses. Share price performance since the turn of the century has been less than ideal, and we think a special dividend would be the best way to compensate patient shareholders.
Valuentum’s Take
Overall, it seems like the timing of the purchase is very favorable for both Verizon and Vodafone thanks to the prevailing low interest rate environment. US wireless fundamentals may improve as the industry undergoes further consolidation, but Verizon may not be equipped to make a suitable offer if the price gets too high or if interest rates climb too much. It looks like this may turn out to be a very rare opportunity for a deal to be completed.
Verizon continues to be a name under heavy consideration for the portfolio of our Dividend Growth Newsletter, but with this potential blockbuster deal on the horizon, we’ll need more information on financing before adding it. We think the debt-service costs associated with any potential deal may eat into what otherwise could have been hefty dividend increases. In any case, we expect the deal to be highly accretive to earnings.
As for Vodafone, the company’s Dividend Cushion will improve materially if it doesn’t make any transactions after finalizing the deal. This would be very welcome news for dividend growth investors. Still, we think shares look fairly valued at this time, so we aren’t considering the name in either of our actively managed portfolios.