Vodafone faces choice over Verizon windfall

Ever since 24 April, when Reuters reported Verizon was preparing a possible offer of $100 billion (£64.5 billion) for Vodafone's stake, analysts have said a sale of the Verizon Wireless stake to Verizon would be advantageous to both companies. The deal would enable Vodafone to return cash to shareholders, purchase fixed-line assets in Europe or potentially make itself an attractive takeover target for other telecoms blue chips.

Meanwhile for Verizon Communications, which relies on the Verizon Wireless operations for growth, taking full ownership would provide much more flexibility as a result of the cash generated from the wireless business. It is also a good time to buy: debt financing is cheap and available, and Verizon's stock is near its highest level in a year.

However, analysts have voiced their discontent at the $100 billion figure. Bank of America Merrill Lynch calls the earnings multiple implied by that valuation "miserly" and stresses: "Vodafone won't sell at that price."

Analysts at Citigroup echo this view, calculating the $100 billion bid implies an EBITDA multiple of 6.5 times on 2013 estimates. "We doubt many Vodafone shareholders would support a deal at that price and continue to see any deal as more likely to be priced at seven to nine [times] EBITDA," they say.

Instead, they believe $108-$139 billion is "the most likely valuation scenario" range for Vodafone's stake.

What will Vodafone do with the proceeds?

Distribution to shareholders

According to Citigroup, a full distribution of net proceeds would come to between £64 billion and £85 billion, versus a current market capitalisation of £97 billion.

They are expecting a matching stock consolidation to accompany the large distribution, leaving the share count greatly reduced. As a result, they note the dividend becomes cheaper to pay and the payout ratio of free cash flow falls from around 100% to 30-40%, providing considerable room for growth.

"Distribution of all cash and stock proceeds to shareholders with a matching stock consolidation increases Vodafone's free cash flow per share around three-fold, greatly increasing the dividend per share the company could support, and is 8-30% accretive to earnings per share on our estimates," they state.

Buy Liberty Global

Alternatively, Vodafone could buy Liberty Global for a value of between $74 billion and $82 billion, or an equity premium of 15-40%.

The analysts at Citigroup explain: "John Malone, with 31% of Liberty Global's votes, has a reputation as a tough negotiator, assuming he is even prepared to entertain an offer, which suggests to us that a sizeable premium to the equity might be necessary to close a deal."

Liberty Global, an international cable operator, was referred to as a possible bid target for Vodafone in the Sunday Times on 21 April.

By revenue, two-thirds of Liberty Global's footprint, including Virgin Media, overlaps with Vodafone's operations.

"For Vodafone, Liberty Global could have strategic advantages giving it a strong portfolio of northern European cable assets, rebalancing the group away from southern Europe and providing it with a high-speed broadband offering, cost synergy, an upgrade path for its own broadband customers and network backhaul options," the Citigroup analysts point out.

This article was taken from our sister website, Interactive Investor.