Vodafone to gain from Verizon waiting game

NEW YORK, USA: Vodafone, long frustrated by a dividend-bereft minority holding in top U.S. mobile operator Verizon Wireless, could stand to gain by waiting until its partner blinks in the long wait for a payout.

After the dividend issue is resolved, analysts say, the probability is growing of Vodafone and partner Verizon Communications merging to create a global telecom powerhouse.

UK-based Vodafone, the world's largest cellphone operator by revenue, owns a 45 percent stake in Verizon Wireless, while Verizon Communications owns the rest.

Vodafone has not seen a Verizon Wireless dividend since 2005, when it had a 923 million pound payout, though it has received some payments to cover tax on the holding.

Several shareholders and analysts have complained that the lack of a dividend has weakened Vodafone's share price and its Chief Executive Vittorio Colao recently told analysts this was the 'defining challenge' of his stewardship.

Analysts say cash needs at Verizon, which generated $23 billion cash from operations so far this year including Wireless, will become steep enough that Vodafone will strengthen its hand if it waits.

"I don't think it is in Vodafone's interests to go to Verizon and seek a solution at this juncture because at some point I think Verizon will go to them and say we need your help," said ING analyst Lawrence Sugarman said.

Analysts also believe that continued customer losses in Verizon Communication's traditional fixed-line phone business will increase pressure on the group to look for a payout to help fund its own dividend, a $5.4 billion annual obligation that is likely to increase.

"I think probably in late 2011 or 2012 Verizon will have to take some cash out itself to cover its own dividend and (by then) Verizon Wireless will be debt free," said Stifel Nicolaus analyst Christopher King.

Debt obligations

Verizon Communications has said that capital spending would come down once it finishes building its FiOS video network, helping to reduce its cash needs. A spokesman declined comment on Verizon Wireless dividend plans but noted that the venture looks at its dividend policy on an annual basis.

Verizon Wireless currently uses its cash to repay Verizon Communications and its external creditors for debts incurred from its January acquisition of smaller rival Alltel.

On announcing that deal last year, Verizon said it would not plan on any Verizon Wireless dividends, except the tax related payments, for about three years so that it has time to pay off debts now amounting to almost $18 billion.

But Investec analyst Jonathan Groocock thinks a dividend may come even earlier than 2011 and says that a cash return would be transformational for Vodafone as a $3.9 billion dividend in 2011 could lift its free cash flow by 35 percent.

But even if Vodafone does receive a hefty dividend in the next few years, it will not change the fact that it still has a minority investment without control in a crucial market.

Merger getting likelier?

Vodafone's 45 percent stake could be valued at $65 billion without any take-out premium, according to Investec. A sale would mean a huge tax bill for Vodafone and would rely on the only likely bidder, Verizon Communications, being able to afford it.

"There's very little chance of anything happening in the near term," Stifel Nicolaus' King said. "The tax liability for Vodafone would be in the tens of billions of dollars."

Several analysts believe the two firms could simply merge.

"A couple of years ago I would have said the likelihood of them merging was 10 percent and now I would say it's more like 30 or 40 percent," said Execution analyst Will Draper.

But many still need convincing.

"In the long term it will access Verizon Wireless's cash flows, it is simply a matter of timing," Investec's Groocock said. "Does Vodafone really want the distraction, the fixed-line exposure, and inevitable restructuring that Verizon would bring with it?."

Some analysts suggest that a Vodafone stake sale could be simplified if Verizon includes a swap of its 23 percent stake in Vodafone's Italy business as part of its payment. But even if this works out there may be other drawbacks to a Verizon buyout.

For example JPMorgan analyst Michael McCormack said that a Verizon Wireless purchase could have unintended consequences for Verizon because a big portion of its valuation comes from its Verizon Wireless stake. So if it buys the stake for a good price it could cause its own share price to fall.

Another wrinkle is that Vodafone is unlikely to want to leave the U.S. market, which is seeing strong data growth.

So some analysts believe it could follow a Verizon exit by partnering with a weaker rival such as Deutsche Telekom's (DTEGn.DE: Quote, Profile, Research) T-Mobile USA, the No. 4 operator.

Another option could be for a partial sale in return for a dividend, according to Bernstein analyst Robin Bienenstock. "They could give up part of it (in return) for a minimum floor to the cash dividend because what Vodafone wants is cash out of the asset," she told Reuters.

The firms could also decide on a public offering of Verizon Wireless shares or folding the venture into Verizon and leaving Vodafone with a stake in the larger entity.