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Investors fear Verizon may overpay to compete

Verizon is under rising pressure to take full control of its wireless venture with Vodafone to compete with larger rival AT&T, sparking investors’ fears that it may end up overpaying for the stake.
/ Source: Reuters

Verizon is under rising pressure to take full control of its wireless venture with Vodafone to compete with larger rival AT&T, sparking investors’ fears that it may end up overpaying for the stake.

Verizon Communications Inc. has openly expressed its desire to buy Vodafone Group Plc’s 45 percent share in Verizon Wireless, and last week repeated this ambition after AT&T Inc. announced a roughly $65 billion proposal to buy BellSouth Corp. and take over their Cingular Wireless joint venture.

If Verizon had full ownership of the mobile unit, it could boost earnings and help the phone company sell discount wireless and wireline service packages — something AT&T is expected to do more easily with Cingular under one roof.

But some investors are worried a knee-jerk rush to make a deal may prove too costly.

“I just don’t think they need to do anything,” said Kurt Lauber, a portfolio manager at Thrivent Investment Management, which has about $67 billion assets under management.

Lauber argues that since Verizon already has management control of Verizon Wireless, there is no urgency for full ownership.

Lauber also dismissed another idea — that Verizon and Vodafone should merge — saying this would mean a big strategy change for both firms.

Some shareholders have pressured Vodafone, the world’s biggest mobile service, to pull out of the United States but it has been reluctant to sell the Verizon asset, which is lauded by analysts as the best performing U.S. mobile provider.

“The wait and see option so far has been an extremely profitable way for Vodafone to play this,” said UBS analyst Paul Ruddle in a teleconference with clients about Vodafone and Verizon this week.

Vodafone may be re-examining its global strategy, according to Ruddle, but he does not believe it is in a hurry to sell the U.S. unit, which makes investors worry that Verizon would have to overpay if it wants to buy it soon.

Vodafone’s stake in Verizon Wireless could sell for as much as $50 billion excluding debt, according to analysts who include in this price the exchange of Verizon’s holding in Vodafone’s Italian arm. They value the Italian stake at $8 billion to $10 billion.

The price tag implies a valuation of eight times 2006 estimates for 45 percent of Verizon Wireless’ profits before interest, taxes, depreciation and amortization (EBITDA), according to Stifel Nicolaus analyst Chris King.

In comparison, rivals Sprint Nextel Corp. and Alltel Corp. trade at 7.6 and 7.8 times EBITDA respectively.

While Thrivent’s Lauber noted Verizon Wireless could command a higher premium because of its strong growth and low customer cancellation rates, he believes Verizon Communications’ shareholders should demand a bargain.

“If you pay a high multiple like everyone’s saying, you’re providing no upside for the Verizon shareholders ... if they can get a valuation like Sprint and Alltel, then go for it,” he said.

Jean Liu, an analyst for Victory Capital Management, which owns Sprint but not Verizon shares, said a $45 billion to $47 billion deal would make sense as long as it boosts Verizon’s earnings per share for 2007. But she said: “There is no rush .. The question is are they going to pay above that.”

Lehman Brothers analyst Blake Bath expects Verizon to reach an agreement with Vodafone this year and said a deal should boost Verizon’s earnings per share by 5 percent to 10 percent in 2007 and 2008, and improve revenue growth by 1.5 percent.

“Under most likely scenarios, such a buyout would be accretive to Verizon’s earnings and its revenue and cash flow outlook,” Bath said.

UBS’s Ruddle also considered whether it would make sense for Vodafone to buy all of Verizon Communications in order to get hold of the wireless asset, but he said wireless is too small a part of the company to justify this.

His colleague John Hodulik noted that a merger of Vodafone and Verizon would mark a big change to Verizon’s strategy of selling international assets.

“The attitude of management thus far has been that they’ve been moving away from international investments ... It would be a departure of its recent strategy,” he said.