As a Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) shareholder, I have mixed feelings about the firm’s recent decision to sell its 45% stake in Verizon Wireless.
On one hand, I can see the logic of selling a major asset over which, as a minority shareholder, Vodafone had no control. I’m also happy that I’ll receive a return of around 112p per share sometime in the first half of 2014.
On the other hand, I’m rather concerned about what will be left, once Verizon Wireless is gone. Can Vodafone use the $35m of cash left over after the $84bn shareholder return to replace Verizon Wireless’ earning power?
Lost earning power
In 2013, Vodafone’s share of Verizon’s earnings was £6.5bn, while in 2012, it was £5.0bn. In each of these years, the firm received more than £4bn in dividend payments from Verizon.
For Vodafone to avoid being permanently downsized, it needs to replace these earnings quite quickly.
Vodafone says it will spend £6bn on organic investment in its existing networks, and it has also acquired Verizon’s 23% stake in Vodafone Italy as part of the deal. These two factors together should help generate long-term incremental growth, but are unlikely to be transformative.
The remaining cash — around £16bn — is expected to be used on acquisitions.
Can Vodafone acquire new growth?
Verizon’s $130bn purchase of Verizon Wireless represented an EV/EBITDA earnings ratio of 9.4 (enterprise value / earnings before interest, tax, depreciation and amortisation).
Given that Vodafone is returning most of the proceeds of the sale to shareholders, replacing the Verizon Wireless earnings could be difficult, even if Vodafone doesn’t overpay for acquisitions, which is a real risk.
For example, Vodafone is keen on acquiring fixed-line assets so that it can expand its range of data and voice services, but the firm’s recently-approved €7.7bn acquisition of German cable operator Kabel Deutschland represented an EV/EBITDA multiple of 12.4, equating to EBITDA of about £520m.
If Vodafone makes other acquisitions at similar valuations, the firm’s management is going to have to add a lot of value through cost-cutting synergies, new customers, and new services. I don’t think this is impossible, but it does require a lot of faith, plus an assumption that global economic conditions aren’t going to worsen further.
I’m not sure how confident I am that these two conditions will be met, which is why I’m considering selling my Vodafone shares.