Monday, September 2, 2013

Implications of the Verizon Wireless deal for Vodafone shareholders

Today it was announced that Vodafone (VOD) will be selling its 45% stake in Verizon Wireless to Verizon Communications (VZ) for $130 billion. There is a lengthy press release with details, but I wanted to break down some of the implications of this deal for VOD shareholders such as myself. Note that what follows is my interpretation of the press release, which I cannot guarantee is completely accurate (feel free to leave a comment if I have misinterpreted or miscalculated anything). In addition, some of the numbers depend on fluctuating exchange rates and share prices, so the final numbers will likely be slightly different.

Overview: VOD shareholders will receive a "Return of Value" of $84 billion (71% of the net proceeds), which is equivalent to 112 pence per ordinary share. Of that total, $23.9 billion (28.5% of the Return of Value) will be in cash and the remaining $60.1 billion (71.5% of the Return of Value) will be in VZ shares. At the current exchange rate of £1 = $1.56, the Return of Value equals $1.75 per ordinary share. However, 1 ADR share = 10 ordinary shares, so the Return of Value equals $17.47 per ADR share.

Cash payment: Given that 28.5% of the Return of Value will be in cash (effectively a special dividend), shareholders will receive a payment of $4.97 per VOD ADR share.

Verizon shares: Given that 71.5% of the Return of Value will be in VZ shares, shareholders will get $12.50 in VZ shares per VOD ADR share. The exact number of shares received will depend on the price at which VZ shares are trading before the deal is completed, but the transaction is structured such that the price will not be less than $47 or more than $51 per share. Thus, VOD shareholders would own VZ shares in addition to their VOD shares. Verizon pays a decent dividend and today the company increased its quarterly dividend by 2.9% to $0.53 per share.

VOD dividend increase: VOD shareholders still get to keep their VOD shares and receive dividends for them. In the press release, Vodafone announced they plan to increase their dividend by 8% for 2014 and the Board "intends to grow it annually thereafter."

My Return of Value: Given that I own 125 shares of VOD, I should receive a special dividend of around $621 ($4.97 x 125) and between 30 ($12.50 x 125 / $51) and 33 ($12.50 x 125 / $47) shares of VZ. At the current dividend rate for VZ, that would result in quarterly dividends of $15.90-17.49 or annual dividend income of $63.60-69.96. Plus, I will continue to receive higher semi-annual dividends from VOD. Finally, I will likely see further capital appreciation of my VOD shares.

The deal is expected to be completed and the Return of Value realized in the first quarter of 2014. All in all, it sounds like a pretty good deal for VOD shareholders. Once the deal is completed, I will likely hold my VOD and VZ shares, unless I find compelling reasons to sell either or both positions.

23 comments:

  1. Hey DGM,

    Looks like you're bang on; my numbers differ by pennies. As shareholders of VOD, we're definitely ahead of where we were just weeks ago. I just hope both companies benefit from the deal as I too plan on keeping most of my VOD shares and incoming VZ shares.

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    1. ADY: I'm glad to hear that your numbers agree with mine. In the short term, this is a big win for VOD shareholders. In the long term, I think VZ will benefit from having the very profitable Verizon Wireless all to itself.

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  2. DGM,

    I'm not quite as keen on this sale as you. I was comfortable with VOD having an undervalued asset on the books and collecting a stable and rising dividend as a shareholder. All that cash coming back in the form of cash via a special dividend and VZ shares is really nice, but they lost a hugely profitable, and growing, asset that they won't be able to replace.

    I don't understand how VOD will be able to raise the dividend from here? VZW accounted for about half of the group's profit last year, and the dividend didn't have a lot of room to grow as it stood with VZW on the books. I think that's why management changed from trying to grow the dividend by 7% annually to at least keeping the dividend stable. The dividend from VOD shares will have to decline significantly, only to be made up from the dividends from the VZ shares, correct?

    I'm quite happy that management is returning much of the windfall to shareholders, but I can't see how the dividend from VOD shares alone is sustainable.

    I honestly would have preferred VOD stay intact, but I can see how it was difficult to keep this arrangement up. VZ wanted 100% control of their wireless business and VOD couldn't control the dividend payout because they only owned 45%.

    I will say, however, that we obviously know HOW undervalued VOD was because the 45% stake in VZW is being valued at almost the entire market cap of VOD. That's pretty huge!

    I'll have to write an article on this pretty soon. Overall, I think VOD did the best they possibly could for shareholders based on the arrangement they had. Valuation-wise, they knocked it out of the park. Plus, they avoided a huge tax bill. And paying off debt with some of the cash is really smart.

    As far as your numbers go, they look spot on. I think this is a case of a great short-term reward at the detriment of long-term growth, however. Again, I don't know what else VOD could have done though. The issue I have with VZ shares is that they are already a heavily indebted company, and they're taking on more debt now in the form of financing part of this transaction and assuming some of VOD's debt.

    I would appreciate your thoughts on VOD's dividend. Again, I can't see how they continue to pay out and grow that huge dividend after they lost about half of the business. And I do wonder how VOD shares are valued after the transaction finalizes in 1Q 2014. It'll be interesting to see, but I would guess they'd have to be slashed by at least 1/3 after losing about half of the company's profit generator, right?

    Best wishes.

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    1. DM: Thanks for your thoughts. I'll try my best to respond to various points.

      On the one hand, it's disappointing that VOD is selling its crown jewel. Verizon Wireless is very profitable and continues to grow at a steady clip, so VOD likely would have seen more special dividends down the road.

      On the other hand, those special dividends were not under its control (due to VOD being the minority stakeholder) and were somewhat unpredictable. Verizon was basically calling the shots as to when special dividends would be paid. Verizon was pushing for 100% ownership and Vodafone disliked not being in control of the operation, so it seemed like some sort of deal was inevitable.

      I agree that VOD did a good job for shareholders, netting a nice premium for their stake in Verizon Wireless. I also like the fact that much of the proceeds are being returned to shareholders, mitigating concerns about management blowing the money on too many acquisitions.

      Regarding the dividend, my understanding is that VOD has enough free cash flow from its own operations (about £4.9 billion, excluding Verizon Wireless) to cover its dividend (£4.8 billion), although not by a large margin, hence the previously expressed uncertainty about future dividend growth. Oddly, in the press release they mention that they expect "free cash flow of £4.5–5.0 billion for the 2014 financial year," which won't cover the increased dividend. Consequently, I think they'll be using a portion of the cash proceeds from the sale (that is, part of the £15.5 billion not paid out to shareholders as a special dividend) to fund the 2014 dividend.

      Obviously, this leads to your question about the long-term sustainability of the dividend. Management is using some of the proceeds from the sale for a new organic investment program, "Project Spring," which might boost their profits once completed. The CEO stated that this program would "underpin our intention to grow the dividend per share annually," so they seem optimistic about it; otherwise, it would be odd to announce a dividend increase at this time.

      In addition, as part of the deal, Vodafone gets the 23% minority interest in Vodafone Italy that was held by Verizon. Vodafone also gets some Verizon loan notes and has some of its debt (related to Verizon Wireless) assumed by Verizon, which should help cash flows a bit.

      I don't know how VOD shares will be valued once the deal is realized in Q1 2014. However, it's clear that before this deal they were grossly undervalued, with VOD trading at a market cap not much larger than the Verizon Wireless cost. I've read elsewhere that VOD's share price never accurately reflected its ownership of the Verizon Wireless stake, which is becoming increasingly evident.

      In summary, even though VOD will no longer own a sweet asset, at least it made a great deal in selling it. In the short term, I think this is a big win for VOD shareholders; in the medium to longer term (that is, beyond 2014), there is some uncertainty about VOD's dividend sustainability and growth, but investments arising from this deal might pay off and support a higher dividend down the road. In the case of Verizon, they're adding a huge chunk of debt onto an already hefty debt load and issuing a boatload of shares, so the short-term situation is not good. In the long term, though, they should be able to reap the benefits of full ownership of Verizon Wireless and use the profits to pay down debt and buy back shares.

      Unless additional information comes up that changes my mind, I plan to hold my VOD shares (and my eventual VZ shares) into mid-2014, then re-evaluate both positions.

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    2. DGM,

      Thanks for the thoughtful response. I really appreciate it. You're right on cashflows. They barely cover the dividend as is, and I realized the same: that some of the retained cash (not being returned to shareholders) will be used to fund the newly increased payout. Not bad, but the sustainability, as you point out, is questionable.

      I agree that further investments, notably Project Spring, will help with future cash flow growth organically. And management is being extremely intelligent with the cash. Paying down debt, investing organically and returning most to shareholders vs. going on a buying spree is most welcome. I can't applaud management enough.

      I agree with you that VOD scored a big win for shareholders in a difficult situation. This was going to happen sooner or later, and VZ wanted it now while interest rates were still low enough to make it realistic and VOD was in a great spot to maximize value.

      We'll see what happens. But, wow. That VZW ownership stake was significantly undervalued. I guess if you're looking for a great counterpoint to EMH, this would be it. :)

      Thanks again for your comment.

      Best regards!

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    3. DM: Thanks for your reply. I think it will be important to continue monitoring VOD's operating results, looking for indications that their new investments will pay off (and pay the dividend). At the moment, though, I'm fairly pleased with the deal and the return it will give me on my original investment.

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  3. Congratulations, sounds like a great deal for you! $600 is nothing to sneeze at and those VZ shares will be nice.

    Would you still consider purchasing additional VOD shares going forward?

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    1. CI: Thanks! The deal will definitely give me a nice return on my investment.

      I have no current plans to purchase additional VOD shares, given that it already has a medium-sized weight in my portfolio.

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  4. one little tweak.

    Vodafone will carry out a share consolidation to keep the market value of its shares approx. the same as pre-payout. So you will have fewer shares. All dividend forecasts are on the basis of existing share nominal value so there should be no difference in the amount of dividend you receive from Vodafone.. but instead of receiving 3.53 pence on each of 10 shares, you will receive 7.06 pence on each of 5 shares - or equivalent.

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    1. Anonymous: Thanks for the clarification. I read the bit about share consolidation in the press release, but I didn't understand exactly what it would entail.

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    2. I am not convinced that this is such a great deal for share holders as it would appear that the 'return' is to be realised from the value of shareholders existing total Portfolio holding value based on the current share price of circa £2.10 and looks to be fairly nominal once the VF share consolidation (projected as a 50% reduction in current VF share holdings)is considered.

      My understanding is that shareholders will be presented with 28.5% of their stake from the £54b VZ Deal in cash( which may be subject to taxation if distributed as a "special dividend")71.5% in VZ stock valued in the deal at circa $47 dollars - the share price of which is likely to fall immediately upon completion as some UK Institutional investors that are precluded from holding US securities will have no choice but to sell them. In parallel there will be a 2 for 1 share consolidation which will in effect reduce investors current share holdings in Vodafone by 50%.
      The result seems to be more in the way of a forced Portfolio redistribution than any real material windfall for investors not withstanding all the hype. Worked example below :
      1000 shares in VF is currently worth £2083. Under terms of deal an investor with 1,000 shares could expect to end up with :
      Cash of 32p per share = £320 ( potentially taxable)
      26 shares in VZ ( based on VZ recent price of $47.34 and exchange rate of 1.55 = £30.54 per share)= £800 ( approx.)
      500 Vodafone shares following "consolidation". I hope that I am missing something ?!

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    3. Anonymous: I agree that the VZ shares will face some selling pressure from UK institutional investors that cannot hold US securities. Add in the extra debt that VZ will be issuing and I think the short-term outlook is negative.

      Regarding the VOD share consolidation, I think we need to await more clarity from management about what exactly this will entail.

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  5. Great write up, thank you! I was about to allocate some money to my current VOD position before the buyout was final. If VOD stock is purchased over the course of the coming weeks, will it be eligible for the special dividend, VZ stock, etc? Is there a deadline? And do you still consider it a buy? Thanks again!

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    1. Costa: You're welcome. I think if you were to purchase VOD during the next few weeks you would still be eligible for the special dividend and VZ shares. As far as I know, the record date for the transaction has not been set yet. Regarding whether VOD is still a buy, it's difficult to say -- this deal throws a wrench into valuation calculations. I considered VOD to be undervalued when I made my last purchase in February at the price of $24.65, but the stock has traded much higher since that time.

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  6. Just wondering if I bought Vodafone shares now would I still be entitled to the special dividend? Have Vodafone issued a special dividend record date yet?

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    1. Anonymous: To the best of my knowledge, no record date has been set yet, so investors should still get the special dividend if they were to buy VOD shares now.

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  7. Both my wife and I have separate portfolios with VOD shares. We are undecided to sell soon or hold on for the windfall. What i dont understand is, If this VZW deal is so good for VOD holders then why is there not a rush by the general public to buy in ?

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    1. Anonymous: To some extent, the VZW deal is already reflected in VOD's stock price. However, I don't know the motivations behind the decisions of others not to buy the stock.

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  8. This is a re-structuring, not in any way a windfall. The deal is spefically structured so that the pre-transaction value of old vodafone shares will be near as possible to the post-transaction value of (a much smaller number of) new vodafone shares, cash dividend and verizon shares.
    This is explained on vodafone's web site.
    So any gain from the transaction which we vodafone shareholders will enjoy will be any change in the vodafone share price bewtween the announcement of the transaction and the transaction date itself.
    I find the use of the term 'windfall' in this context misleading.
    Still, no complaints about it overall.
    Phil Sutcliffe

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    1. Phil: Thanks for this information. I read some details of the deal that were recently posted on Vodafone's website. I was disappointed to see that there will be some unfavorable tax consequences for VOD shareholders. The special cash payment will be taxable, which was expected, but so will the market value of the VZ shares received, which was unexpected. Overall, VOD shareholders will benefit from the deal, but I wish it were structured somewhat differently.

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  9. After skimming the 160 page "circular", I conclude that VOD shareholders
    will have a fewer number of VOD shares when the restructuring is complete.

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  10. I too agree with other commentators that this is not a windfall. Recent analysis shows the split from a £1000 investment will equate to the following returns: Cash £200, Verizon shares £ 264, Vodafone shares £536. Whatever perceived gain shareholders receive will be clawed back from a drop in the Vodafone share price. Personally I have already completed my W8 Ben form that will allow me to hold onto the Verizon shares in hope that the split companies will continue to find new growth in their regions of business. It astounds me how this deal is seen as a money maker for investors, it's just a re-distribution of wealth. Especially since AT&T pulled out of a possible takeover of Vodafone. I will hold onto my Vodafone and Verizon shares in hope they find new synergies for real value creation.

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  11. I have 10,000 shares of VOD Plc,
    It's equivLent to 1000 ADRs, so I will only get around $17 a share per ADR?
    At ex dividend date the stocks will go
    Down at least 10 Pts, so there's not much profit gain?

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