Vodafone Group Plc (VOD) recently announced the sale of it's 45% stake in the Verizon Wireless (VZW) joint venture it started with Verizon Communications Inc. (VZ) back in 2000. It seems almost from the start VZ has been trying to gain 100% control of it's wireless business. And who can blame them? This is a 13-year saga that has finally come to a close.
I have a fairly substantial position in VOD, as I currently own 150 shares of Vodafone worth $4,801.05 based on today's closing value of $32.01 per ADR share. It's important to note that VOD is based in the U.K., and as such I invest in the company through American Depository Receipt shares. Each VOD ADR is worth 10 ordinary shares.
I've long been a fan of Vodafone.
I've been a very happy investor in Vodafone, as it carried less debt than other major telecommunication companies, had much less exposure to legacy costs associated with wireline businesses because they're primarily a wireless company and they had broad geographic exposure to Europe, India, Africa, Australia and the U.S. (through 45% of VZW). In addition, it's always seemed that the market discounted it's assets, as they were usually cheaper than most of the other options and generally had higher quality assets that had broader exposure throughout the world.
But I'm not a fan of this sale.
I'll be completely honest and admit I'm not a huge fan of this transaction. As a value investor, I would have preferred Vodafone stay intact with wonderful telecom assets throughout the world, a healthy balance sheet, broad exposure and a cheap valuation. However, this sale was bound to happen sooner or later and the time seemed right. Interest rates are still low enough to provide VZ an opportunity to finance a good portion of the deal via newly issued debt and VOD had long had issue with not being able to control the dividend payout from the joint venture because it lacked majority control.
Management should be commended, however.
Furthermore, I believe management knocked it out of the park. Although I wish I would have preferred VOD retain it's ownership stake in VZW, they got a great deal. Think about this. VOD, as of today, is valued at ~$155 billion. They received $130 billion for just the 45% stake in Verizon Wireless. That means the market is essentially saying the rest of the company is worth around $25 billion. Obviously, this company is worth much more than that.
Management must further be commended for the recent announcement that they plan on a "Return of Value" of $84 billion to shareholders, which ends up being 71% of the net proceeds. This is a fantastic announcement, and in my opinion really shows restraint on the part of management. This is one of the biggest corporate sales in history, and what are they doing with that giant war chest? Giving most of it back to the investors. Great stuff. This Return of Value is split between VZ shares and cash. VOD investors will receive VZ shares because Verizon Communications couldn't raise all the cash they needed to finance the deal and paid for a portion of the transaction in shares. VZ shares will make up $60.1 billion (71.5%) of the Return of Value and the remaining $23.9 billion (28.5%) will be in cash. Vodafone will use the rest of the proceeds to pay down debt and invest in their networks (Project Spring). It should also be noted that the VZ shares have a fixed value collar, so that the exact number of VZ shares to be distributed to shareholders when this transaction fully closes in 1Q 2014 are fixed to not be priced less than $47 per share or more than $51 per share.
Short-term gain for long-term pain?
While I'm happy to get a nice payout and for VOD to realize the full value of this asset on the books, I also believe that shareholders are getting a nice payout today for less growth in the future. VOD will be a smaller company when this is done, with less geographic exposure and less hidden value. It is likely impossible to replicate the kind of asset they had in the 45% ownership of VZW, and VOD has been struggling for the past couple years with key markets in Europe. It was actually the Verizon Wireless profit (about 50% of the groups profit last year) that was really boosting Vodafone's performance of late. This is a huge asset to lose.
In addition, VOD will consolidate its shares to retain comparability of share price before and after the Return of Value and the loss of a huge asset. This will mean that VOD shareholders are left with less shares in VOD, meaning a smaller investment in aggregate (the company will be smaller). This smaller stake will be made up for by VZ shares and cash as part of the Return of Value. All in all, shareholders should come out ahead because VOD is worth much more than the ~$155 billion the market is pricing the company at based on the $130 billion they just sold VZW for. In addition, they'll have less debt on the books, some other assets (minority interest in Vodafone Italy) that were part of the VZW deal and the cash the company is retaining.
Income will still be significant after transaction.
VOD also surprised shareholders with a 8% raise to its FY 2014 dividend, and plans to continue increasing it on an annual basis. This language supersedes language used in last year's Annual Report which stated that the dividend will remain at least the same. The shares in VZ, if continued to be held after the transaction, currently have a 4.48% yield, and VZ recently announced a 2.9% raise to their own dividend. So strong income could continue from the legacy VOD shares, however VZ has a fairly substantial debt load that would need to be considered.
My Return of Value
I'm looking at a fairly nice payout from this transaction. The total Return of Value amounts to 112p per ordinary share. 112 pence equals $1.74 based on today's exchange rate. Since 1 ADR equals 10 ordinary shares, my Return of Value amounts to $17.40 per share. Since 28.5% will be in cash, that amounts to approximately $4.96 per share in cash via a special dividend. My cash payout will thus be $744.00 (on 150 shares). The remainder of the Return of Value via VZ shares amounts to $12.44 in VZ shares per VOD share. Since VZ shares are collared to be between $47 and $51 per share, this means I'll receive between 36 and 39 shares in Verizon Communications Inc. (VZ). My VZ shares should be valued at ~$1,866.00. That means my total Return of Value from the $130 billion sale of VZW totals $2,610.00. That's more than half of the total value of my VOD stake, so obviously that's pretty hefty. However, VOD will consolidate my remaining VOD shares, so it's difficult to tell exactly how far ahead I'll be when this is all said and done.
My conclusion.
I would have preferred VOD remain intact with a wonderful, undervalued asset on the books. An investment in VOD gave exposure to the U.S. wireless business via VZW without the debt load and legacy wireline expenses associated with the parent company VZ. Instead, I'll be forced to "cash out" some of my investment in VOD because they've sold off a significant part of the business and I'll receive cash and an investment in VZ in it's wake. One of my main reasons I consider selling a dividend growth stock is because the fundamentals of the company have changed. This change certainly qualifies, so I'll have to evaluate the totality of the situation after everything closes in 1Q 2014. However, Vodafone management absolutely knocked it out of the park, extracting every single penny they possibly could out of the joint venture knowing VZ was hungry for the asset and the time was ripe. Returning most of the monies back to shareholders further cements my favorable view of management and I think this is a much better use of the cash than going out and spending on overvalued assets. Paying down debt and investing organically is something I further approve of. Overall, for a situation I would have preferred VOD avoid they have done an excellent job in handling it and I think they did right by shareholders.
I'll be monitoring this holding from here. A circular will be sent to shareholders in December, and you can currently read FAQs regarding this transaction and the Return of Value directly from Vodafone.
Full Disclosure: Long VOD
How about you? A fan of this transaction?
Thanks for reading.
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