For several months, Wall Street has recognized the hidden value in Vodafone Group Plc (ADR) (NASDAQ:VOD) due to its 45% stake in Verizon Wireless, and it has been speculating about the chance that Verizon Communications Inc. (NYSE:VZ), Verizon Wireless’ 55% owner, would purchase the remaining 45% from Vodafone.
Now, the rumor seems to come closer to reality. Although Verizon Communications Inc. (NYSE:VZ) has not made any official bid yet, the company has hired advisers to make a move to take full control of Verizon Wireless.
According to Reuters, Verizon Communications Inc. (NYSE:VZ) intended to offer a 50/50 cash and stock bid, and it was ready to take the bid public if Vodafone Group Plc (ADR) (NASDAQ:VOD) did not want to discuss for the Verizon Wireless buyout. However, Reuters’ source said that the possible offer price might be around $100 billion. I personally think that a $100 billion price tag is not a fair price for Vodafone.
Verizon Wireless – an important part of Verizon Communications
Verizon Wireless is considered the largest wireless service provider in the U.S., with around 98.2 million in retail connections. In the past three years, Verizon Wireless has experienced a steady growth in its top line, from $63.4 billion in 2010 to $75.9 billion in 2012.
Most of its revenue, $63.7 billion, was service revenue, while equipment revenue was only $12.1 billion in 2012. In 2012, Verizon Wireless generated around $21.77 billion in operating income. Indeed, Verizon Wireless is becoming a very important part of Verizon Communications’ business.
Verizon Communications Inc. (NYSE:VZ)had $115.84 billion in total revenue, and Verizon Wireless accounted for 66% it. Verizon Communications’ operating income came in at $13.16 billion in 2012, while net income attribute to non-controlling interest (in this case 45% of Verizon Wireless’ stake is owned by Vodafone) was nearly $9.7 billion. As Verizon Wireless generated more than $29.7 billion in EBITDA, Vodafone’s 45% stake would be equivalent to $13.36 billion in EBITDA.
Vodafone is cheap when its stake in Verizon Wireless is factored in
If we apply an EBITDA multiple of 9, Vodafone’s 45% stake in Verizon Wireless should be worth at around $120 billion. According to The Wall Street Journal, if the cash flow multiples of comparable industry players were used, Vodafone’s stake should be worth around $130 billion.
Indeed, famous hedge funds manager David Einhorn pointed out that when Vodafone Group Plc (ADR) (NASDAQ:VOD) was worth around $120 billion on the market, the market placed no value on its 45% stake in Verizon Wireless. He said that being a minority owner, Vodafone had suffered, as Verizon Communications Inc. (NYSE:VZ) had restricted Verizon Wireless to pay dividends for years.
Unlike Verizon Communications, Vodafone does not rely on the contributions of Verizon Wireless. It was previously trading at a comparable level to other European peers. However, because of the buyout rumor, Vodafone’s share price has risen significantly, from $25 per share at the end of February to nearly $31 per share.
At $31 per share, Vodafone is worth around $150.7 billion on the market. The market values Vodafone at around 9 times EV/EBITDA and 12 times its forward earnings. The company also pays a decent dividend with a yield of 3.4%. Verizon Communications is trading at around $54 per share with a total market cap of $153.8 billion. The market values Verizon Communications Inc. (NYSE:VZ) at 6.2 times EV/EBITDA and 17 times its forward earnings. It also offers investors a good dividend yield at 3.9%.
Deutsche Telekom is moving ahead with MetroPCS
Their German peer, Deutsche Telekom AG (ADR) (OTCMKTS:DTEGY), is the smallest company among the three and has the cheapest EV multiple. The company is trading at $12 per share, with a total market cap of $50.5 billion. The market values Deutsche Telekom AG (ADR) (OTCMKTS:DTEGY) at only 5 times EV/EBITDA. Its trailing dividend yield was as high as nearly 7.5%.
However, towards the end of 2012, the company announced that it would reduce its dividend by nearly a third in 2013 and 2014 so that it could reinvest in the business. In the next two years, Deutsche Telekom AG (ADR) (OTCMKTS:DTEGY)’s dividend would be $0.64 per share, resulting in a yield of 5.3% on the trading price of $12 per share.
Recently, MetroPCS Communications Inc (NYSE:PCS) shareholders have approved the merger agreement between MetroPCS Communications Inc (NYSE:PCS) and Deutsche Telekom’s T-Mobile USA. In the merger deal, while MetroPCS Communications Inc (NYSE:PCS)’ shareholders will receive a 26% ownership and $1.5 billion in cash, Deutsche Telekom would take a 74% stake in the combined company. The combined company would have as many as 40 million customers and it would allow Deutsche Telekom to move much more aggressively in the U.S. market.
Timotheus Hottges, chairman of the combined company and the CFO of Deutsche Telekom said: “The merger adds valuable tailwind to our Uncarrier Strategy in the USA. We have radically changed our business model and launched drastically simplified tariffs. Together with MetroPCS, we will make considerable improvements to our competitive position with our combined state-of-the-art network, more powerful sales model and top devices like the Apple iPhone 5 and the Samsung Galaxy S4.”
My Foolish take
What makes both Verizon Communications and Vodafone valuable are their stakes in the growing and cash generating Verizon Wireless business. If the buyout turns out to be true, Vodafone, including its 45% stake in Verizon Wireless, should be worth more than $220 billion, or more than $44 per share, on the market. Indeed, Vodafone could be a good telecom stock for investors to play the buyout at its current trading price.
The article Playing the Verizon Wireless Buyout originally appeared on Fool.com is written by Anh HOANG.
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