Tuesday, September 3, 2013

Dividend Detective Work and the Verizon/Vodafone Deal

The biggest deal story of 2013 is Verizon (VZ) buying the remaining 45% of Verizon Wireless that it did not own from Vodafone (VOD). The specifics of the deal are interesting and include Verizon paying a mix of cash and its own shares. Vodafone is passing along the majority of the purchase price to its shareholders, which was somewhat of a surprising move.

For a US shareholder, receiving Verizon shares should not be a major hassle, Vodafone shareholders can elect to hold or sell any Verizon shares they receive. There are, of course, many Vodafone shareholders in the UK and elsewhere, and I am curious how this works for them since I do not believe that Verizon shares trade on the London markets. And then there are the FTSE indices and such where Vodafone is a major holding, so it will likely require a bit of market plumbing to really push the shares all the way through.

At any rate, this deal has been rumored for a decade or so. It heated up last winter, the rumored price at the time was $100B which seemed to undervalue Verizon Wireless' business. So it was good for Vodafone shareholders that their management was able to hold out for a ~30% premium. Two drivers held in Vodafone's favor to negotiate a better deal. First, likely interest rate rise, any rise in interest rates would cost Verizon (who financed $50B worth of bonds) in the hundreds of millions of dollars.

Secondly, there is the matter of Verizon's dividend. The main appeal for companies like Verizon, Vodafone, and AT&T (T) is income. In analysing Verizon's dividend profile, its readily apparent just how much it needs ongoing access to Verizon Wireless' cash and how its unable to support its dividend without it.

Verizon's payout ratio crested 100% in 2009 and has remained above that level since.

2009 2010 2011 2012
Payout Ratio  145% 214 232 654

As Herb Stein said "anything that can't go on forever won't." It was pretty obvious that from a dividend perspective, a multi year stay above 100% payout ratio, something had to give. Either Verizon probably had to cut its dividend (which was surely unthinkable) or it needed access to ongoing, reliable cash flow which it was able to secure via Verizon Wireless.

One of the appealing parts of dividend analysis is that it sheds light on the business dynamics from a different viewpoint, and adds another dimension to consider even in a story like Verizon Wireless which on the face of it isn't primarily about dividends.


Vodafone shareholders have some thinking to do at this point. They have to think whether Vodafone is worth holding going forward, absent its most valuable asset. They also have to think about what to do with the Verizon shares they will soon own.

If we look Vodafone, Verizon and AT&T and consider two important metrics - income (yield) and safety (debt/equity) - then Vodafone looks the most interesting on this basis especially since it plans to pay down its debt while Verizon's will increase substantially should the deal go through.

 VOD   VZ   T
Yield   6.4%  4.4  5.4 
Debt/Equity  0.4  1.2  0.8

There are many other factors to consider as the dust settles on all of this but on income and safety, Vodafone shareholders, with the highest yield and least levered balance sheet, may feel as though they had it pretty good.

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