A short statement on Monday lunchtime from Vodafone stated, quite clearly, that the British mobile phone group has no plans to bid for Verizon, its US counterpart. It followed news earlier on FT Alphaville saying Vodafone has been considering a $160bn offer.
So here, and in subsequent posts, we will happily explain what was missing from that Vodafone announcement.
In its latest, detailed analysis on whether it could afford (and fund) a takeover of Verizon, Vodafone and its advisers began with their own evaluation of what Verizon is actually worth - a cool $172bn, on their figures, including debt, or $147bn in terms of equity. That compares with a current stock market value of $125bn. So Vodafone could immediately see a 17 per cent uplift — higher than just about all published analysts’ reports.
But how could Vodafone possibly finance such a large acquisition? Three scenarios were analysed:
1. Merge the two companies and immediately sell Verizon’s fixed-line business to private equity
Verizon’s traditional phone business makes money, but the business is declining and requires heavy investment - revenues are likely to be flat over the coming years, while much of its free cash flow will be eaten up with a plan to upgrade its network to fibre optic cable. As currently run, the business is not a natural buyout candidate.
Undeterred, the Vodafone team looked to see whether the PE maths could be squared by simply halting the fibre optic project. Suddenly the business could be configured to throw off close to $5bn a year in cash. While the lack of fibre optic infrastructure might damage revenue over the medium term (and lower the likely exit premium for a PE buyer), the simple numbers seemed to work in terms of covering debt: total borrowings of $78bn could sit on equity of $15bn.
Yes, a buyout of this magnitude would stretch the credit markets, but despite recent wobbles Vodafone’s people concluded that it was feasible. Indeed, such a sale of the fixed line business might raise up to $93bn, they figured.
But even by pulling off the world’s largest LBO, if Vodafone were to offer a typical 30 per cent premium to Verizon shareholders, their own shareholders would be looking at close to $14bn of value destruction once various costs, such as tax, were taken into account.
2. Issue a a tracker stock linked to Verizon’s fixed line business
It now emerges that just as Vodafone executives were busy rubbishing the suggestion of some of its rebel shareholders that the company issue a tracking stock linked to its holding in Verizon Wireless, the company was actively considering its own tracking idea — in this case linked to Verizon’s traditional phone business.
The attraction of the idea lay in the fact that Vodafone would effectively limit its exposure to the wireless business. At the same time, with Verizon’s existing shareholders continuing to own the fixed line business, regulatory concerns over a foreign company owning such a big chunk of American telephony might have been mitigated. The move should also have limited the flowback of Vodafone stock issued to pay for the bid.
Against this, the Vodafone camp were acutely aware that if Verizon management wanted to issue a separate tracker stock linked to the company’s declining fixed line assets it could simply do this itself.
By loading more debt on to the “tracked” fixed line business, Vodafone reckoned it could offer Verizon shareholders a premium of close to 30 per cent and simultaneously limit the damage to its own shareholders to about $6bn.
3. A full on merger with Verizon, 100 per cent financed by new Vodafone stock
This was the simple, straightforward approach — buy Verizon with pure equity and then de-merge the fixed line business as and when the opportunity arose. But certain problems were manifest: existing Vodafone shareholders would probably throw a fit, much of the newly issued stock would flow back across the Atlantic, the required premium for the entire group would be difficult to justify with cost savings and there might also have been regulatory issues concerning foreign ownership of the assets.What’s more, the Vodafone camp were aware that if they publicised the fact that they were planning a later spin off of the fixed line business, a hefty tax bill would probably follow.Nevertheless, the idea was pursued further, including work on two alternative versions of the full merger.
As well as the above plan to perhaps float the fixed line business at a later date, Vodafone also examined an alternative “dual headed” structure. This would have involved Verizon Wireless first being de-merged from Verizon and Vodafone then merging with the newly independent mobile business - giving Vodafone control of the mobile business, but no exposure to the fixed line interests. Unfortunately, the idea was seen as too complex.
It was also assumed that Verizon would resist the move. We now know that the whole takeover plan was subsequently dropped.
Paul Murphy and Neil Hume
