There was a point in time, when QE2 & QE3 were mere speculations, that bad news (a bad jobs reports, a lower GDP number etc.) was considered good news for the markets. The theory was, that if the data came out showing that the economy was deteriorating, the likelihood of additional QE was higher. The markets responded in many of these cases by rising in the face of the worse than expected data.
I think we’re approaching a similar phenomenon with Vodafone ($VOD). I’ve written about “Vodafone’s crown jewel” back in September, and since then Verizon’s ($VZ) stock is literally unchanged, while $VOD has fallen by over 12%. The implied value of their respective Verizon Wireless (VZW) stake is getting out of hand.
Here’s David Einhorn’s take via marketfolly – in his Q4 Letter from last month:
We have also increased our Vodafone (UK: VOD) holdings, as the stock fell sharply on news that just doesn’t seem that bad. After achieving an August peak of £1.92, the shares ended the year at £1.54. At this valuation, it appears that the market is placing no value on VOD’s 45% stake in Verizon Wireless. And the Verizon Wireless stake is clearly quite valuable. Look at it from Verizon’s perspective: Historically, Verizon had a very profitable landline business, and Verizon Wireless owed it billions of dollars. Verizon received Verizon Wireless’s free cash flow as it repaid the debt. For years, Verizon used its control to try to starve VOD by refusing to allow Verizon Wireless to pay dividends. Today, Verizon’s landline business generates no cash and the debt from Verizon Wireless has been repaid. Verizon’s 55% control stake in Verizon Wireless is probably worth more than all of Verizon’s market capitalization, and Verizon has become wholly dependent on dividends from Verizon Wireless to fund its parent company obligations and shareholder dividends.
Excluding any contribution from Verizon Wireless, VOD stock pays a 7% dividend and trades at less than 12x cash earnings – roughly in line with other large European telecom companies. Meanwhile, VOD has never become dependent on Verizon Wireless distributions.
Given the huge valuation disparity between what the market thinks Verizon Wireless is worth to Verizon (at least a couple hundred billion dollars) and what it ascribes to VOD (about zero), combined with Verizon’s increasing dependence on Verizon Wireless, it wouldn’t surprise us if Verizon decided to buy all of VOD to gain full ownership of Verizon Wireless.
It could decide to become a global telecom leader or it could spin out parts of VOD that it’s not interested in owning. Maybe there is an investment banker with time on their hands reading this letter.
The most recent pullback in $VOD has been again attributed to the weakness in the EU, and to reports that $VOD might put in an offer to purchase Kabel Deutschland. The issue is that $VOD’s stock has fallen by over $12 Billion in market cap since the rumor floated, and the entire market value of Kabel is around $8 Billion.
The thesis here is simple. If their European biz turns around & improves, that should boost the stock price (especially since they’ve already written down a good portion of their troubled European assets). But even if it doesn’t revert and pickup, this “bad news” still might be “good news”. Whether it’s from shareholder activism or the need for cash to sustain their dividend and share repurchases, the longer the struggles in $VOD’s European businesses, the more likely there’ll be a deal done for (a portion of) their VZW stake.
Taking it to the extreme, based on Mr. Einhorn’s numbers (I think he’s being aggressive with his assumptions), if the European businesses start to improve, the stock’s upside might actually be less than if they stays weak.
Either way, from these levels, $VOD’s stock seems like a win-win.
Trade Idea: The most recent #FF list‘s addition @OptionsHawk‘s posted in yesterday’s daily freebies - a bullish option trade called a “risk reversal” where an investor bought 10,000 July $27 calls, financed by selling the July $23 puts (for a net credit of $0.14). The trade is under water a day later, but the worst case scenario is being forced to buy the stock at a net cost of $22.86. (There was also a huge buyer of July $25 calls today.)