Verizon Communications Inc. (VZ): The Risk of a Hundred Billion Dollar Deal

It’s been a good week so far for U.S. stocks, but they opened lower today, with the S&P 500 down 0.10% at 10:10 a.m. EDT. (The narrower, price-weighted Dow Jones Industrial Average was up 0.24% at the same time.) That may have something to do with the fact that U.S. GDP growth in the first quarter of 2.5% (annualized) came in lower than economists’ expectations of 3%.

Verizon Communications Inc. (NYSE:VZ): Eye on the prize
At the beginning of the month, I mentioned a report that Dow components Verizon and AT&T Inc. (NYSE:T) were considering a joint bid for U.K. operator Vodafone Group Plc (ADR) (NASDAQ:VOD). While Verizon later quashed that notion, the telecom still wants something from Vodafone — its stake in Verizon Wireless — and it could now be preparing a $100 billion bid for it (Verizon currently owns 55% of its wireless joint venture with Vodafone).

According to a report from Reuters, Verizon has hired financial and legal advisors in an attempt to bring Vodafone to the negotiating table and get down to brass tacks. Verizon Communications Inc. (NYSE:VZ) has been open about its ambition to gain full ownership of Verizon Wireless and Vodafone has said it is opposed to the idea of a sale, so what’s the problem? Tax is the answer: Vodafone is concerned about the massive tax bill it would incur on the sale proceeds, which could add up to $20 billion, according to some estimates (an outright acquisition of Vodafone would have dispensed with this complication).

Still, there is no reason why this should remain a sticking point, as, in effect, it simply falls under the negotiation issue of the price to be paid for Verizon Wireless. Furthermore, you can bet that Vodafone Group Plc (ADR) (NASDAQ:VOD) would hire the best M&A/ tax lawyers that money can buy — Reuters’ sources suggest that a deal could be structured in such a way as to reduce the tax liability to less than $5 billion.

However, this highlights the real risk in this deal for Verizon Communications Inc. (NYSE:VZ) shareholders: that the company will overpay for the full ownership of Verizon Wireless it so openly covets. As a buyer, it’s rarely advantageous to telegraph to the seller just how badly you want what they have. Ultimately, this deal looks likely to get done. The question is: At what price? As its stands, I like Vodafone’s bargaining position over Verizon’s, and Verizon shareholders could end up paying the price, literally and figuratively.

And speaking of bad bargains… As of Thursday’s close, Verizon Communications Inc. (NYSE:VZ) is the second best-performing Dow stock this year (after Hewlett-Packard Company (NYSE:HPQ) and The Walt Disney Company (NYSE:DIS)), with a 23% year-to-date return. That has pushed the stock’s valuation to more than 18 times the estimate for the next 12 months’ earnings per share, which looks pretty rich. On the bright side for shareholders, if Verizon does a cash and stock deal with Vodafone, it will be paying with what looks like an overpriced currency.

The article Verizon: The Risk of a $100 Billion Deal originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned, and neither does The Motley Fool. You can follow Alex on LinkedIn.

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