In addition, why wouldn’t both sides consider a spinoff? That could get Vodafone and shareholders out of the tax issue, and while there would likely be a two-year waiting period on any buyout (to avoid these same tax consequences), Verizon would still control the asset and retain the ability to buy it out later. Of course, there may be other constricting legal and tax consequences that I’m not aware of.
Regardless of what form a transfer of ownership takes, Verizon Wireless is a valuable asset in its own right. If you buy Verizon, you’re paying a lot for Wireless; if you buy Vodafone, you’re paying little or nothing for that stake.
Verizon is already valued at 7.8 times EBITDA. The highest-quality part of its business is Wireless, so why should that go for less than 8 times EBITDA? With nearly $30 billion in EBITDA, Wireless should be worth at least $240 billion, bringing Vodafone’s interest to a healthy $108 billion. That prices the stub at $28 billion while doing about $13 billion in EBITDA — so a multiple around 2. But Wireless could go for more.
A multiple of 8 for Wireless is the low end of some of the estimates I’ve seen. Some analysts put Vodafone’s stake at greater than its market cap, which implies a multiple of 10 times EBITDA for Wireless. Then you get the stub Vodafone business at a low price. Regardless of which way you go, Vodafone is cheap.
Risks
I see a couple major risks. The first is the perilous state of the global economy, especially in markets where Vodafone owns companies. I’m less concerned about that because it should be largely baked in, but things could worsen. Europe just isn’t getting it together.
However, what I’m much more concerned about is management sitting on a mountain of cash and doing a dumb deal. Vodafone has already been sniffing around Kabel Deutschland and who knows what else? Moreover, are they going to do a sale of their own assets (in whole or in part) the smart way and protect shareholder capital from tax leakage? These bear watching, and to that end I’m glad that guys like investor David Einhorn are involved here and trying to hold management’s feet to the fire.
And finally, there’s the risk with the calls themselves. While I’m buying January 2015 LEAPs, in order to have lots of time for this thesis to play out, it may simply not happen in that time frame and so I’m exposed to 100% loss. In addition, I lose out on any dividends that will accrue, including Vodafone’s sizable 5%-plus dividend and any special dividends that come out, perhaps another couple percent worth. But ultimately, I think Verizon needs this deal too much to wait around much longer. With the LEAPs we have almost two years to see this thesis play out.
Foolish bottom line
So on the next market day, I’m buying four contracts of Vodafone Jan 2015 $27 calls in my Special Situations portfolio.
The article I’m Buying Options on This High-Yield Stock originally appeared on Fool.com.
Jim Royal owns shares of Vodafone. The Motley Fool recommends Vodafone.
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