Verizon (VZ) and Disney (DIS)

A short while ago, rumors began circulating on Wall Street that VZ is interested in acquiring DIS.

Yesterday, the CEO of VZ said the company has no interest.

some sense…

The rumors made a little sense, in my view, for two reasons:

–the cellphone market in the US is maturing.  The main competitors to VZ all appear to be acquiring content producers to make that the next battleground for attracting and keeping customers, and

–the Japanese firm Softbank, which controls Sprint, seems intent on disrupting the current service price structure in the same way is did years ago in its home country.

…but really?

On the other hand, it seems to me that DIS is too big a mouthful for VZ to swallow.

How so?

–DIS and VZ are both about the same size, each with total equity value of around $175 billion.  If we figure that VZ would have to offer (at least) a 20% premium to the current DIS stock price, the total bill would be north of $200 billion.

How would VZ finance a large deal like this?  VZ’s first instinct would be to use debt.  But it already has $115 billion in borrowings on the balance sheet, so an additional $200 billion might be hard to manage, even though DIS is relatively debt-free.

Equity?  …a combination of debt and equity?

An open question is whether shareholders in an entertainment company like DIS would be content to hold shares in a quasi-utility.  If not, VZ shares might come under enough pressure for both parties to want to tear up a potential agreement.

dismember DIS?

VZ might also think of selling off the pieces of DIS–like the theme parks–that it doesn’t want.  The issue here is that all the parts of DIS, except maybe ESPN, are increasingly closely interwoven through cross-promotion, theme park attractions and merchandise marketing.  So it’s not clear the company can be neatly sectioned off.

Also, as the history of DIS’s film efforts illustrates, the company is not only a repository of intellectual property.  It’s the product of the work of a cadre of highly creative entertainers.  Retaining key people after a takeover–particularly if it were an unfriendly one–would be a significant worry.

From what might be considered an office politics point of view, VZ’s top management must have to consider the possibility that after a short amount of time, they would be ushered out the door and the DIS management would take their place running the combined firm.  Would key DIS decision makers want to work for a communications utility?

my bottom line

All in all, an interesting rumor in the sense that it highlights the weakness of VZ’s competitive position, but otherwise hard to believe.

 

 

 

Sprint and the cable companies

The Wall Street Journal reports this morning that Sprint, Comcast and Charter Communications are discussing an agreement for mutual support in providing a discount mobile telephone service.

Sprint is controlled by the Japanese conglomerate Softbank, whose chairman, Masayoshi Son, made his first mark in that country by launching a successful deep-discount mobile phone service that resulted in much lower prices for consumers there.  Mr. Son has already tried once to repeat this move in the US.  To gain the requisite size to offer a similar disruptive service in the US, he agreed to combine with T-Mobile.  This would have formed a third big mobile telecom group, after Verizon and ATT.  But the federal government ruled against his plan, on the grounds that joining Sprint and T-Mobile would reduce the number of big telecom companies in the US from four to three (violating an anti-trust rule of thumb that frowns on market shares above 25%).  The fact that Mr. Son wanted to provide more competition, not less, made no apparent difference to the regulators.

Hence, I think, Mr. Son’s very visible support for Mr. Trump, as a businessman who might see through regulatory clutter.

I’m not sure what will develop from talks among the three parties.  I don’t think this is simply a way for Son to extract himself from an investment gone wrong in Sprint, however.  My guess (as someone with too-high cellphone bills, my hope?) is that a viable mobile service with adequate national coverage will emerge from the talks.

If so, while this may/may not be good news for the companies involved, it is definitely bad news for both Verizon and ATT.

Verizon Wireless: who’s getting the better of the deal, Verizon (VZ) or Vodafone (VOD)?

I think it’s VZ.  The company says that even at a cost of $130 billion the buy-in of VOD’s 45% minority interest will add 10% to VZ’s earnings.  But VZ is also adding a significant amount of risk in leveraging itself financially.

a simplified history

In 1982 the federal government forced the breakup of the monopoly telephone service provider, ATT.  It separated the parts into a national long-distance provider, which retained the ATT name, and a bunch of regional local service providers, nicknamed the “Baby Bells.”  Each Baby Bell contained its area’s nascent mobile services.

Soon enough, the Baby Bells began to merge with one another, ultimately forming into a Western US group (which subsequently acquired “new” ATT and took on the ATT name) and an Eastern group, which subsequently renamed itself Verizon.  Proto-VZ wanted to keep its mobile assets.  Proto-ATT didn’t.  To keep the mobile assets out of the clutches of prot0-VZ, Airtouch, the proto-ATT mobile operation, sold itself to VOD in 2000.

VOD promptly struck a deal with VZ in which it merged Airtouch with the VZ mobile operations to form Verizon Wireless.  VZ had operating control and a 55% interest.  VOD had veto power over some decisions and held the other 45% of Verizon Wireless.

Got all that?

culture clash

VOD is a British company.  It apparently believed in the old-style colonial European way of doing business, according to which a firm with global pretensions could get more bang for a buck (or quid, in this case) of capital by taking large minority interests in important foreign  firms.  Through superior intellect/management technique, or force of will, or sheer European-ness, it would dominate the board of directors.  It would thereby get the benefits of 100% ownership without the capital outlay.   The resulting network of companies would move in lockstep with its European leader, buying the capital equipment suggested (getting discounts for all) and perhaps paying management fees to the European company for its advice.

VZ, an American firm, would have thought that no one in his right mind would accept a minority stake.  If would have figured that VOD would soon see the light and be persuaded to sell.

Or maybe that’s just how the two parties rationalized the unhappy partnership that they entered into.

what each party gets from the deal

Verizon

–when the deal closes early next year, VZ will have access to the cash flow from Verizon Wireless for the first time.  US tax law   requires that a parent have an 80% interest in a subsidiary before cash can flow tax-free from it to the parent

–VOD will no longer have an operational say in Verizon Wireless

–the very mature fixed-line telephone business will be a significantly smaller proportion of the whole

–the deal is accretive to earnings by 10%

Vodafone

–VOD extracts itself from its awkward minority position

–ir gets a big payday, even after distributing the bulk of the proceeds to shareholders, which it will presumably use for EU acquisitions

–VOD believes it can use a provision in UK tax law regarding transactions between conglomerates to pay only about $8 billion it taxes on this deal

Verizon (VZ), Vodafone (VOD) and flowback

VZ is buying the 45% of Verizon Wireless that VOD owns.

VZ, which owns 55$ of Verizon Wireless, recently agreed  to buy the other 45% from VOD for around $130 billion.

From what I can tell so far, the deal will be good for VZ.  And, at the very least, VOD gets a boatload of cash and stock.  In hindsight, VZ would have been a lot better off striking the same deal in March, before the Fed began hinting that it was thinking of ending the current post-recession period of extra-super-accommodative money policy in the US.  The interest rate VZ would have paid on newly issued bonds would have been lower.

More on this topic in future posts.

There may not be a great need to load up on VZ ( which I own) immediately, however–even if you think the deal is a spectacular coup for VZ (too enthusiastic for me).  The reason is flowback.

what flowback is

VZ is going to issue over a billion shares of new stock to VOD as part of the purchase price.  VOD has already announced it will distribute to its shareholders all of the VZ stock it receives.  That’s something like one VZ share for every 40 VOD shares held (the exact ratio isn’t important).

What is important is that VOD is a UK corporation whose stock is traded in London.  The bulk of its shares are held either by UK or Continental European institutions.  US institutions hold only about 15%.

Put another way, early next year almost everyone who owns VOD will receive shares in a foreign stock, VZ.

What will they do with it?

For index funds, the answer is clear.  If it’s not in the index, it has to be sold.

For institutional managers in the EU, the answer depends, in the first instance, on what their contracts with customers say.  They’ve presumably been hired for their expertise in EU equities.  Management agreements probably stipulate that they’re not allowed to hold non-European securities.

Even if they are permitted to hold VZ, why do it?  Why take the risk of holding a stock that’s outside your area of competence–and which will require considerable research effort to get a firm grasp on.  Selling is a much safer option.

For individuals, if form runs true, the first they’ll hear of the deal will be when their broker calls to tell them that shares of VZ have plopped into their accounts–and to urge them to get rid of this weird thing.

That’s flowback.

It happens in all cross-border deals that involve stock.  When shares of the issuing company leave the home country, some portion will be sold immediately by investors who are unable or unwilling to hold what is for them a foreign stock.

Where do these sales take place?   …ultimately in the home market of the issuer.

the VZ case

For VZ, average daily trading volume is around 10 million – 12 million shares.   Occasionally, volume can get as high as 30 million- 40 million shares without moving the stock too much.

Let’s make up a number and say that flowback will be 300 million shares.  That’s easily an entire month’s trading volume.  So this could be a serious issue for VZ’s price.

mitigating factors

There are three that I see:

–Verizon Wireless is the largest and most important asset for both VZ and for VOD.  Non-index investors in the EU must have wanted exposure to Verizon Wireless to be holding VOD shares.  Arguably, they will want to continue to have that exposure and will therefore be less inclined than normal to want to sell.  So maybe some will be able to wangle exceptions from their clients.

–trading volume in VZ over the past seven trading days (not including today) has averaged about 25 million, or–let’s say–12 million shares above normal.  If this is all merger-related short-selling, which it probably is, then this trading has already created demand for 80+ million shares of VZ when the shorts are covered.

–the stock has a current dividend yield of 4.6%.  At some point, this and other VZ fundamentals should provide price support.

my take

Worries about flowback are one reason large cross-world acquisitions involving stock aren’t that common.  This one was clearly too big for VZ to do any other way.

My guess is that anticipatory selling in advance of the acquisition will make it hard for VZ to go up for a while.  I also think, however, that downward pressure from potential flowback will abate long before the deal actually occurs.

At some point, an excellent buying opportunity for VZ will emerge from acquisition-related stock activity.  The trick is deciding exactly when.  The most prudent strategy, I think, is to establish a small position and await further developments.

 

 

Moffett Research, Vodafone’s financials, Wall Street’s security analysts

The “Heard on the Street” column of today’s Wall Street Journal talks about the purchase commitment Verizon Wireless had to make to Apple in order to be able to offer the iPhone on its network.

a footnote in the Vodafone financial statements

The information comes from newly-formed Moffett Research LLC, a venture headed by Craig Moffett, the truly excellent (former) telecoms analyst at Bernstein.  Mr. Moffett points to a footnote in the financial statements of  Vodafone plc, a Verizon Wireless co-owner, that implies Verizon Wireless has committed to buy a minimum of $44.7 billion worth of iPhones during 2011-2013.  The company spent only $18.5 billion on iPhones through the end of last year, however, and still had $2 billion worth (Mr. Moffett’s number) in inventory.

That leaves $26.2 billion worth of iPhones to be bought this year (my arithmetic–HotS says the shortfall is $23.5 billion).

I find three aspects of this story interesting:

1.  Neither Verizon Wireless nor Verizon disclose this information.  It took a sharp-eyed telecom specialist combing through the back pages of a UK company’s financials to spot the figures and realize their significance.

This example illustrates what security analysts do for a living, as well as the depth of information that traditionally has been at the fingertips of any professional investor who does business with the major brokerage firms who employ these analysts and furnish their research to customers.  In other words, no matter how dull-witted the pro and how smart we as individual investors are, the pro has a huge information advantage starting out.

2.  Mr. Moffett started up his new firm two months ago.  It may be that he’s decided he can make more money as an independent than as an employee of Bernstein.  More likely, if past Wall Street form follows true, is that Bernstein has started to dismantle its high-powered equity research effort.  Why do so?  Wall Street believes that research is a money losing business.

3.  What happens if/when Verizon Wireless falls short of its $44.7 billion purchase commitment?

HotS doesn’t say.

Using (very) round numbers, the shortfall will likely be $10 billion or so.  In contracts of this type that I’m familiar with, Verizon Wireless would have to pay that amount to Apple shortly after the end of the year.  Verizon Wireless would, however, get a credit against future purchases of a gradually declining percentage of the shortfall payment.

Given the popularity of the competing Samsung Galaxy phone line, I imagine the shortfall payment will be a prominent element in negotiations over supply arrangements in 2014.

On another note,  I wonder how Apple and Verizon have been accounting for the minimum purchase contract.   HotS says the minimums for 2011-13 are:  $13.7 billion, $14 billion, $17 billion, respectively.  The actual purchases have been $8.4 billion and $10.2 billion in 2011 and 2012.

Both firms are most likely using the actuals, not the contracted minimum amounts.  Might be a little awkward for Apple, though, if it isn’t.

net neutrality: Google, Verizon and the FCC’s “Third Way”

FCC call for comments

In mid-July, the FCC called for comments on its latest ideas on how it would oversee the internet and deal with net neutrality.  Formulated in May, the agency calls the proposal the “Third Way.”

What made the Third Way necessary was a Federal court decision in April, one I’ve commented on in an earlier post.  In 2008 Comcast had slowed the speed of customers’ access to BitTorrent, a peer-to-peer file-sharing service that Comcast said was hogging too much bandwidth.  The FCC ordered Comcast to stop doing this.  Comcast complied, but sued.  In the April decision, the court said that Congress had not given the FCC the power to issue the kind of order it did.

The first two “ways” the FCC thought it might proceed, but rejected, after the court ruling were:

–continue to issue orders to ISPs concerning their internet service, and run the risk it would lose in court again and again, or

–declare that it no longer considered ISPs to be “information services” but were actually public utility communication services like fixed-line telephone companies, thereby putting the commissions legal authority over ISPs on a firmer legal footing.

The first would be an exercise in futility.  Congress appears to have told the FCC in no uncertain terms that the second alternative was unacceptable.

Hence, the “third” way.

The Third Way

To my mind, the key clause in the wordy Way is:

” Protecting consumers and promoting healthy competition by, for example, providing greater transparency regarding the speeds, services, and prices consumers receive, and ensuring that consumers—individuals as well as small businesses—are treated honestly and fairly;”

In other words, the FCC’s job is to make sure the ISPs make it clear how much they are charging for what service, and that these rate and speed differences aren’t crazy.  This seems to me to be putting the best face possible on the court finding that the FCC doesn’t have the authority to regulate how ISPs control their traffic.  That’s because Congress hasn’t given it to them.  That situation could be changed in an instant,  but by Congess granting the FCC authority. But congress hasn’t done so.

rumored Google-Verizon deal

The story surfaced in the New York Times last week, and is amplified in a Wall Street Journal blog.  I think it’s likely to happen.  The purported agreement would have GOOG paying VZN a fee so that Android-based phones would have priority access to the VZN wireless system.

How is this consistent with net neutrality.  The explanation will turn in what, in my mind, is a semantic trick.  In the Comcast-BitTorrent instance, Comcast was implicitly offering two levels of service–regular and slow.  BitTorrent got the second, everyone else the first.  Although it’s understandable why Comcast would act the way it did, and the court said the company was within its legal rights to do so, advocates of net neutrality worry that this is the thin end of a wedge that would allow IPSs to slow down anyone’s access.  That would be a bad thing.

GOOG-VZN seem to want to define a third tier of service, call it “premium” or “extra-fast” or something like that, that’s faster than regular.  They will presumably argue that for GOOG to pay for this for Android phones is not a violation of net neutrality because no one in particular is being singled out for getting slower service.

The FCC Third Way manifesto suggests this argument will fly with it.  Newspaper reports suggest Congress will give a thumbs-up as well.

investment implications

First, let’s see if this actually happens.

It seems to me that a development like this is bad for AAPL’s iPhone, by giving the already attractive Android platform another positive attribute.  One might even imagine circumstances where GOOG would be willing to pay ATT for premium service on that network, forcing AAPL to either follow suit or maybe try to preempt with a larger payment.

In my earlier post on the court decision, I said that as a growth investor, my preferred way to try to benefit would be to buy makers of internet access devices.  If a GOOG-VZN deal emerges, an equally good (or maybe better) path will likely be through cash-rich content providers or through healthy ISPs.