Vodafone’s US ambitions might be short-lived

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By most measures, Verizon Wireless, the US mobile joint venture between Verizon Communications and Britain’s Vodafone Group, has been enormously successful.

Since its formation in 1999, when Vodafone merged its US mobile assets with those of Verizon, the largest telecoms group in the US, Verizon Wireless has proved a powerful engine of growth and value creation for both partners. Arun Sarin, Vodafone’s chief executive, says that over the past two years Vodafone’s 45 per cent stake in Verizon Wireless has increased in value by $20bn, while Ivan Seidenberg, his counterpart at Verizon, says the US wireless carrier has “created a lot of value for both sides”.

So why has there been so much speculation about the future of the Verizon Wireless partnership over the past 18 months?

Ironically the answer lies at least in part in the stellar performance of the venture – in the latest quarter Verizon added a record 2.03m subscribers to end the year with a total of 51.3m.

But it also has its roots in the bid battle 18 months ago between Cingular Wireless and Vodafone for AT&T Wireless, a battle that Vodafone lost at the 11th hour when Cingular’s joint venture partners trumped Vodafone’s offer.

Had Vodafone won the bidding, Verizon would have acquired the UK company’s stake in Verizon Wireless. Not only would that have enabled Verizon to reap the full rewards of wireless growth at a time when its traditional fixed-line local phone operations were in decline. It would also have enabled Mr Seidenberg to achieve a long cherished aim and dissolve a partnership that, despite protestations to the contrary, has reportedly sometimes been fractious.

Nevertheless, in the aftermath of the battle for AT&T Wireless, Verizon and Vodafone both declared their desire to hold on to, if not increase, their existing stakes. At least that was the position until last month.

In recent weeks Vodafone has come under pressure from some of its biggest shareholders, who are un-happy with the company’s poor share price performance and last week Arun Sarin, Vodafone’s chief executive, hinted for the first time that the board might consider selling out of the US. “Up until now the board has chosen to keep the asset and I have to say that is absolutely the right decision from a shareholders point of view,” he said, adding: “That is not to say the board won’t change its mind as it looks forward.”

Mr Sarin said the US mobile market was less mature than in Europe with penetration levels running at 70 per cent: “Clearly some shareholders would like us to sell now. We will take that input and discuss that at the board level.”

Certainly the nuance of Mr Sarin’s comments was not lost on Mr Seidenberg. He said last week: “To the extent that there is a change of view coming from Vodafone, we clearly would be interested in increasing ownership of Verizon Wireless, whether in stages or actually acquiring 100 per cent of it.”

Most analysts in the US believe the Verizon Wireless partnership will dissolve, but they also believe there are a number of hurdles that need to be addressed.

As Jason Armstrong of Goldman Sachs wrote in a recent note to investors: “Given the low comparable multiples in the US, it may be difficult for Verizon to justify a significantly higher valuation, which Vodafone would clearly push for.”

In order to produce a seven times value for Verizon Wireless internally, Goldman Sachs calculates that the implied value of Verizon’s legacy wireline business is just three times 2006 earnings before interest, tax, depreciation and amortisation. “That seems too low for the wireline business,” says Mr Armstrong, adding: “This would seem to limit Verizon’s ability to match a price point that Vodafone may be seeking.”

Another significant barrier to any deal is the tax bill that Vodafone would face if it sold its stake to Verizon. Vodafone has declined to reveal what value it is carrying the stake in Verizon Wireless on in its books, but Andy Halford, chief financial officer, says any sale will incur a “multi-billion pound tax bill”.

One way to reduce this tax liability would be to use Verizon’s 23.1 per cent sake in Vodafone Italy as part payment, a move that Verizon’s Mr Seidenberg has indicated he would be happy to consider. He says any transaction would need to be structured to be “efficient for both sides [so] we can maximise value for both parties”.

“I think we need to give Vodafone some room to think through what they want to do,” Mr Seidenberg said last week. “But our position has been what it’s always been. If the opportunity came to be, we would stand ready to work with them and would pay with as much cash as possible.”

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