Although financing isn’t fully secured yet, earlier this week Verizon (click ticker for report: ) and Vodafone (click ticker for report: ) agreed to a $130 billion deal for Verizon to acquire Vodafone’s 45% stake in Verizon Wireless. The deal values Verizon Wireless at nearly $290 billion (or nearly 10 times EBITDA), and it could immediately boost earnings per share by 2%-10%.
Though this is certainly a large deal, we think Verizon acted quickly to capitalize on interest rates that have moved sharply to the upside in recent months (it didn’t want to wait for a further increase, which may have made the deal cost-prohibitive). As we noted in our prior discussion of the deal, rising rates and a declining landline business made now the perfect time for a deal to come together.
Financing Details
Image Source: Verizon Investor Relations
Even for a cash cow like Verizon, a $130 billion deal is a lot to stomach. Details of the financing reveal just how complex a deal this large must be. Verizon will issue $60.2 billion worth of stock to existing Vodafone shareholders, equal to more than 30% of the float. The $58.9 billion worth of cash will come in the form of a $61 billion Bridge Credit Agreement with JP Morgan, Barclay’s, Bank of America, and Morgan Stanley, but Verizon intends to replace the agreement with bond issuances. The balance will be paid with notes payable to Vodafone and the sale of Omnitel to Vodafone for $3.5 billion.
Never Ask Your Barber if You Need a Haircut
Verizon managed to pay for half of the investment in stock, but the additional debt financing is hard to fathom. JP Morgan CEO Jamie Dimon went out of his way to assure Verizon’s board that not only could the money be raised easily, but also that Verizon won’t be taking on too much leverage. Getting Dimon’s seal of approval would be reassuring in most situations, but his bank will probably collect billions of dollars in fees for the transaction, so we’ll take his insight with a grain of salt.
Prior to the deal, Verizon’s balance sheet contained $42 billion in long-term debt, and that figure will more than double after the deal closes. Still, the fantastic free cash flow generated by Verizon Wireless should allow Verizon to pay down debt relatively quickly—management estimates 4-5 years. CEO Lowell McAdam elaborated on this point, saying on the conference call:
“You have seen Verizon do this consistently over the years, whether it was buying ALLTEL or buying MCI, whether—no matter who the CFO was, we always had the priority of getting our leverage ratio down and getting and staying solidly in investment grade. So Fran and I have a priority that we’re going to get this paid down, we’re going to get into those levels [comfortable leverage]. We will have to see whether that takes us two years or three years, but it will be a very high priority for us.”
Given that Verizon Wireless posted close to $30 billion in EBITDA in fiscal year 2012 and had nearly $10 billion in net income attributable to non-controlling interests (Vodafone), the deal will materially improve total free cash flow. Verizon generated about $11.3 billion in free cash flow during 2012, so it is reasonable to expect an annual free cash flow run-rate in the low-mid $20 billion range going forward. Thus, we feel comfortable with the leverage Verizon will be adding to its balance sheet.
No Canada
After executing a deal for the remainder of Verizon Wireless, we do not believe the company will enter the Canadian market in the near future. McAdam went out of his way to squash any rumors, adding on the conference call:
“I just have to say that the press made a lot more of our interest in Canada than there was on the fourth floor of Basking Ridge. It is something that we look at, we look at a lot of different countries around the world, and we will continue to do that. But it was always on the fringe for us.
And as Fran and I have looked at opportunities to push the One Verizon that I talked about before, those are much better returns for our shareholders than going into Canada. So we never really seriously looked at this — I mean, we looked at it but we never seriously considered the move and it is off the table at this point.”
An entry into Canada wouldn’t move the needle for Verizon anyway, so we’re not disappointed with the decision to stay out of the market.
Dividend Boost
Even as it plans to enter one of the largest corporate deals ever, Verizon remains confident in its ability to generate fantastic free cash flow. In fact, the firm increased its quarterly dividend 2.9% to 53 cents per share. Shares now yield 4.6% (as of this writing). Still, Verizon’s dividend growth could be constrained in coming years as the firm opts to pay down debt.
South African Take
Armed with a more robust cash balance, Vodafone’s Vodacom may experience some changes. Vodafone could move to acquire a larger percentage of Vodacom while simultaneously upping capital expenditures in the region to make its service relatively more attractive. This would allow the firm to capture market share in a rapidly-expanding African mobile market.
Further, with Microsoft acquiring Nokia’s devices and services unit, we may see the deep-pocketed US tech giant create more phones for the African market. This, combined with Apple’s lower-priced iPhone 5C could lift overall smartphone demand, accelerating 3G/4G customer growth. Estimates suggest that Africa 3G subscriptions will grow rapidly from roughly 115 million in 2013 to over 200 million by 2015. Total subscriptions in Africa will likely expand at a mid-single-digit pace through 2018, to reach 1.25 billion. The strong pace of smartphone adoption is beneficial to the entire wireless carrier cohort, in our view.
Major African carriers: Vodafone, VimpelCom (VIP), MTN Group, Telkom SA, Orascom, and Maroc
Valuentum’s Take
From Vodafone’s perspective, the deal is hard not to like—the transaction values Verizon Wireless at nearly 10x EBITDA and creates a fantastic amount of value for shareholders. Of course, capital allocation remains key—what will management do with the $60 billion it will receive from Verizon?
After reviewing Verizon’s financial standing, we’re comfortable with the outsize leverage Verizon will be taking on, but its focus on reducing its now-hefty debt load will inevitably constrain dividend growth in the next few years. We plan to update our dividend report on Verizon once the deal is finalized, and we fully expect a lower Valuentum Dividend Cushion score.
Overall, we think the Verizon-Vodafone situation will work out favorably for both companies, especially if Vodafone creates value with its fresh cash hoard. We continue to evaluate Verizon for the portfolio of our Dividend Growth Newsletter, but the timing of any addition has inevitably been pushed back by this transaction.
Telecom Services: BCE, CLWR, CTL, DCM, EQIX, FTE, FTR, PT, S, T, TWTC, VOD, VZ, WIN