My situation summary:
Like many holders of VOD, I regard the possibility of the sale of VZW as a double-edged sword. On one hand, the value of VOD’s stake in VZW is so large that even a sale where full value is not achieved and on which some taxes are paid still should result in a higher stock price for VOD. This is probably even true after earmarking some portion of the proceeds for M&A which will likely destroy value (you need look no further than their Cable & Wireless deal a year to see how significant that can be--I put the loss at $1 billion on a $2 billion deal). To add insult to injury, even if the strategic rationale of these likely future acquisitions is sound, they will be paying multiples of cash flow 2 to 4 turns higher than they will realize on the superior asset they are selling in VZW (i.e., one rumored target Kabel is trading at 12x EBITDA).
So all in all, this is simply not even close to a scenario in which VOD shareholders maximize value and for confirmation simply compare the respective stock performances of VZ and VOD as the press reports and public comments have heated up in the last couple of months. The market clearly believes that the majority of the value from the deal anywhere close to the figures rumored will disproportionally accrue to Verizon, not VOD.
Based on the recent reports, the bid for 45% of VZW is $100bn and the ask from VOD shareholders is $130bn. Assuming the deal gets done at the “mid,” it’s not hard to see why the market loves this deal for VZ as it represents approximately 8x time trailing EBITDA (which grew nearly 20% last quarter) for what is perhaps the premier wireless franchise in the world operating as half of an effective duopoly. For VOD, some portion of these proceeds will be taxed, may consist in part of Verizon stock and even could be paid over time per the media reports. So not only does the value seem less than full, it’s not tax-efficient or necessarily even immediately paid.
What makes this especially grating is that despite the conventional wisdom all of the leverage in this situation resides with VOD, and it only increases with each passing day. The Verizon spin parroted by the media is that their eagerness for a deal is about opportunism (cheap and available financing, valuable currency from appreciating stock price) while in reality it’s out of desperation.
Verizon consists of 55% of Verizon Wireless and a declining wireline business with almost zero free cash flow. They have $42 billion of long term debt and a $34 billion pension liability, with annual interest expense of $2.6 billion and dividend payments of $6 billion. They simply can’t meet their obligations without distributing the cash flow from VZW, 45% of which flows to VOD. In fact, in the last 2 years, VZW has paid out $18.5 bn in dividends to its two owners.
The other misplaced bit of conventional wisdom is that VOD needs to dispose of their stake because they don’t have direct control of management or cash flows. This is practically irrelevant (perhaps even a positive based on the VOD track record) as they own 45% of an asset that is well-run and growing where the majority owner has no option but to dividend out a large portion of its free cash flow on an ongoing basis. It’s hard to see how any rational, economic party would sell this for anything other than full value. On the other side of the table, Verizon continues to watch another party receive nearly half of the growth in intrinsic value (and cash flows) from its crown jewel, while its fully-owned wireline business wastes away.
Now most VOD holders seem to recognize that this outcome is less than ideal, though there exists some disagreement about the significance of the negatives and management’s capability to deploy the proceeds. Generally there just seems to be resignation to the inevitability of a deal like this due to the lack of other options. The best outcome is a sale of all of VOD to VZ, but VZ understandably doesn’t want the remainder of VOD.
While VZ’s contention that VOD lacks leverage and should accept a highly discounted value even though they don't have to sell is absurd (here is the latest where the VZ CEO transparently and comically threatens to withhold a dividend from Wireless this year that VZ needs more than VOD to pay the bills http://on.wsj.com/18yQXr7), it is true that if VOD must monetize the stake there is only one buyer in VZ. However, if management’s objective is shareholder value maximization then they do have other options to monetize this stake that should deliver greater value to its shareholders than VZ’s inadequate offer.
What Would John Malone do if he were Chairman?
The media/telecom investor has used financial engineering to create extraordinary value for shareholders in many transactions in this industry, including with large minority owned stakes. In order to maximize the value of this asset, Malone would have one objective--receiving the highest possible after tax value. Acknowledging that there is only one potential buyer but also that there would be tax leakage in a sale, he would then look to the market and ask what value it would place on a minority stake in Verizon Wireless as an alternative to a captive, one bidder process.
I think it’s immediately obvious that it would be far higher than $100bn, even before adjusting for tax. There are multiple ways to evaluate this but simply consider that VZ has a current enterprise value of around $250 billion. The market is assigning that value to the following trailing twelve months numbers:
Wireless (55% owned)
$31 billion EBITDA
$23 billion Operating Income
$22 billion EBITDA – Capex
Wireline (100%)
$6.2 billion EBITDA
-$84 million Operating Income
$2.1 billion EBITDA – Capex
Generously applying 6x EBITDA to the wireline business (nearly 20x its shrinking free cash flow), you’re left with an implied market value for 55% of Verizone Wireless of more than $210 billion. Extrapolating this to VOD’s 45% stake even with a control discount yields a value higher than even the rumored “ask” of VOD shareholders. And that is BEFORE paying any tax due on a sale which even the most optimistic speculation places at several billion dollars.
There seem to be two options to realize this substantially higher value. The preferable method would be a full spin of the 45% stake to stockholders. SpinCo would simply be a holding company owning 45% of Verizon Wireless passing through dividend payments as received. This would preserve the ability for Verizon to eventually purchase the stake if it wished, provided it paid a satisfactory premium reflecting the full value of the asset as judged by the market. VOD could receive proceeds by IPO'ing a portion of SpinCo (which could also be subject to tax) or simply spinning it with some leverage if possible. (It has been correctly pointed out that this option would require VZ consent under the partnership agreement, which would obviously not be granted).
There seem to be two options to realize this substantially higher value. The preferable method would be a full spin of the 45% stake to stockholders. SpinCo would simply be a holding company owning 45% of Verizon Wireless passing through dividend payments as received. This would preserve the ability for Verizon to eventually purchase the stake if it wished, provided it paid a satisfactory premium reflecting the full value of the asset as judged by the market. VOD could receive proceeds by IPO'ing a portion of SpinCo (which could also be subject to tax) or simply spinning it with some leverage if possible. (It has been correctly pointed out that this option would require VZ consent under the partnership agreement, which would obviously not be granted).
The option from the Malone toolbox which could possibly be pursued without complications from tax or leverage is issuance of a tracking stock representing the wireless stake. If you’ve looked at any of the Malone trackers such as the current LVNTA, the assets and liabilities still legally reside at the parent but are “attributed” between the parent and the tracker in the financials. This allows the market to crystallize a value for each. So in addition to the wireless asset, VOD could easily attribute some of its existing or newly raised debt to the tracker. The tracker would simply pay dividends above its nominal expenses and interest expense to its holders. The market would set the price for each part of VOD and shareholders could decide which business they wished to own.
While a tracker would complicate any eventual purchase of the stake by Verizon, that could still be achieved with a collapse of the tracker under its terms (this has also been done by Malone) followed by a subsequent asset sale. At least following this step, the value would have been illustrated by the market and not this private negotiation between a conflicted management team and the only possible buyer.
Obviously there was a shareholder push for similar steps in the past, but this was a non-cash generating asset at the time of those efforts. The fact that regular dividends will be forthcoming based on VZ’s cash flow needs makes this much more doable today. That’s true even if the amount and timing of income from the asset is still not perfectly predictable.
Obviously there was a shareholder push for similar steps in the past, but this was a non-cash generating asset at the time of those efforts. The fact that regular dividends will be forthcoming based on VZ’s cash flow needs makes this much more doable today. That’s true even if the amount and timing of income from the asset is still not perfectly predictable.
Personally I believe there would be significant appetite for a liquid, pure play on Verizon Wireless in the market given its growth and income characteristics. Furthermore, whereas the current negotiations involve a control discount for VOD’s stake, there is adequate precedent to suggest that the market would not apply one, provided the SpinCo shares trade with liquidity. In both US and European markets, discounts in share classes usually result from lack of liquidity not control/voting rights. More liquid securities usually trade at premiums even where they lack or have reduced voting rights compared to the less liquid share class.
Bottom line I fear that VOD management is going down a road that will not result in maximizing shareholder value and is not nearly focused enough on creative solutions to do so. I further believe that even with a hint of a public suggestion from VOD management that they would consider alternatives such as this instead of a sale, Verizon’s bid would materially increase. A transaction of this type would be a disaster scenario for them as it not only would delay any consolidation of the stake but would raise the possibility of eventually paying a substantially higher price as set by the market while their situation worsens. Regardless, discussion of an alternative of this type would be the end of the silly notion that they possess the leverage in this negotiation.
Bottom line, VZ's recent orchestrations are designed to manipulate VOD holders to pressure management to accept what is a dramatically inadequate offer even though there is no urgent need to sell. The only urgency in this situation is VZ's need to buy. The real pressure from VOD shareholders should be on management to examine other available options instead of being held hostage to a flawed sale process that will never maximize value. The dynamic should be changed here.
Bottom line, VZ's recent orchestrations are designed to manipulate VOD holders to pressure management to accept what is a dramatically inadequate offer even though there is no urgent need to sell. The only urgency in this situation is VZ's need to buy. The real pressure from VOD shareholders should be on management to examine other available options instead of being held hostage to a flawed sale process that will never maximize value. The dynamic should be changed here.
If anyone who reads this has thoughts on the structure/tax/spin especially if they have done in depth work or talked to advisor/experts on these issues would certainly love to hear them.
