Should AT&T buy Vodafone? Link to article {http://on.ft.com/1eO4TCz}
Vodafone chief executive Vittorio Colao must be tired of being asked: “What exactly is AT&T doing?” For investors in the UK telecoms group, whether AT&T will mount a takeover bid is the only strategic question that matters, now that Vodafone has agreed the $130bn sale of its Verizon Wireless stake. AT&T shareholders are likewise intrigued by the US group’s very public interest in the European mobile telecoms market. Both Mr Colao and Randall Stephenson, his counterpart at AT&T, have been tight-lipped. AT&T has looked at options, according to people with knowledge of the group, even if detailed work is unlikely to begin until after Vodafone completes its Verizon stake sale next year. Mr Stephenson will need to weigh the pros and cons of what would be one of the biggest ever UK buyouts. Should AT&T buy Vodafone?
* The case for an AT&T bid for Vodafone Ready and waiting Vodafone’s full-year results in May are likely to show the biggest post-tax profit ever for a UK company, of up to £70bn according to Citi. Not a bad start for a company that would inevitably be portrayed as a work in progress should it be acquired.
AT&T wants to make transformational deals across Europe’s mobile markets. Vodafone fits the bill like no other – or at least no contender that could realistically be acquired given governments’ reluctance to allow the sale of national infrastructure owners such as Telefónica’s O2 or France Telecom’s Orange. There is no state or corporate poison pill within Vodafone. Indeed the company has made itself more attractive financially by recently consolidating £18bn of tax assets into its balance sheet. Management strategy is broadly aligned: both want to invest heavily in next-generation mobile networks to deliver high-speed internet connections.
Mr Colao already attempted a US merger less than a year ago when he tried to persuade Verizon to combine rather than buy the US business, and is not seen as philosophically opposed to a merger. “If somebody comes and says, ‘You have really beautiful assets,’ then I will agree,” Mr Colao told a conference last month. “We have beautiful assets.” The shareholder base has moved against those wishing to keep Vodafone independent, with US hedge funds betting on an AT&T merger displacing some European funds reluctant to own Verizon shares. Other shareholders may prefer a merger to the hard grind of an independent Vodafone making huge future investments.
* Sector shifts
The European economy is improving, and telecoms services will likewise recover as people become more comfortable with buying higher-priced mobile and broadband plans. Europe is only at the beginning of a shift to 4G networks that allow rapid mobile internet services. As Mr Stephenson noted in a speech where he described Europe as “fascinating right now”, mobile internet has not yet taken off as in the US. “If somebody were to invest aggressively in mobile broadband in Europe would the demographic not lead to the same type of result as in the United States? And I believe fundamentally, yes, it will.” Any deal would be part of a wider consolidation of the European telecoms market accelerated by money coming to the region from groups such as Liberty Global and Hutchison Whampoa. Regulations could also turn in favour of the sector, with recognition among Brussels lawmakers that the industry needs help to bolster investment, and the hope that competition authorities will allow consolidation in Germany. A favourable decision will be a game changer for the sector, which has long lobbied that regional strength would only result from mergers.
* Cowboys, Brits (and Ninjas)
Analysts say AT&T believes in the importance of scale – and consequently of increasing earnings per share through acquisitions. This makes sense to an extent, with larger telecoms groups winning buying power with equipment providers and wider customer reach, and enabling technology services and content deals. There is also an argument for geographical diversification at a time when the US market could slow down. The basic figures look sensible. “A straight acquisition of Vodafone at a 7 times earnings multiple could be accretive for AT&T with fair value accounting and a lot of help from tax assets,” say analysts at Bernstein. Financial markets would also be supportive of this strategy at a point when institutional funds are awash with investors’ cash that could be deployed in supporting a bid. AT&T would have little difficulty raising debt, meanwhile. Analysts also point to an “evangelical desire” to cure Europe of the sins of previous managements with some “American knowhow”. The cowboys, in the words of one analyst, are on their way. And if the Americans do not make their move fast, there is a growing belief among analysts of rival bid interest from Japan’s SoftBank.
* The case against a bid
Synergies and strategies
Some analysts question the extent of synergies from merging two businesses on different continents. They say AT&T already has sufficient scale and buying power with equipment makers, and larger telecom groups are not necessarily more profitable. Financially, Vodafone’s tax assets may not be useful unless the proudly American telecoms group relocates to Europe. Any repatriation of cash to the US may face tax hurdles. Vodafone is in the middle of a strategic diversification into fixed-line telecoms unlikely to be of interest to the mobile-focused AT&T. It is too late to reverse the acquisition of Kabel Deutschland in Germany, for example, while Vodafone is committed to fixed-line businesses in countries such as Italy and Portugal. Also questionable is how interested AT&T will be in Vodafone’s operations in India and Africa, as well as in Australia. There could be buyers such as América Móvil in India and Orange in Africa, however, while fixed-line businesses could interest Liberty Global. Even with possible disposals, Vodafone would not be bought cheaply – as the wily Mr Colao has made clear. AT&T will have to pay a premium to Vodafone shares already buoyed by M&A talk. Citi estimates a bid price of 290p, which equates to about £90bn for the whole of Vodafone after taking into account payouts to shareholders from the Verizon sale. Bernstein, meanwhile, prices a bid at between 240p-280p.
Here be Dragons!
Europe has been the undoing of many acquisitive international telecoms groups – most recently at América Móvil, which is nursing heavy losses after investments in KPN and Telekom Austria. This is not even the first time for AT&T, which worked with América Móvil on a failed buyout of Telecom Italia in 2007. AT&T could be wrong footed by the highly regulated markets of Europe at a time when the industry is arguing over reforms that will scrap roaming revenues. The lack of a single language or dominant regional authority undermines both marketing scale and organisational certainty, while AT&T’s management has already complained about local spectrum auctions that fracture the regional market. There is no certainty over consolidation rules. AT&T’s supply-side view of how to fix the European telecoms market could be wrong in the short term. Espirito Bank said last week that Europe’s mobile market was demand, rather than supply, constrained. Extra supply could therefore even undermine any nascent revenue recovery. The “build it and they will come” theory has yet to be proven for 4G mobile networks in Europe, even if there is evidence elsewhere in the world. The need for capital expenditure could drag down returns in the short term, with the danger that the £7bn earmarked for network expenditure by Vodafone is just the beginning of recurring costs. Any advantage from superior network investment could anyway be shortlived; telecoms companies tend to invest fastest when rivals are already doing so.
Defend the castle
Vodafone shareholders may vote to maintain the status quo given the prospect of a recovery in the company’s revenues. Financial performance should improve as regulated constraints on revenues from cuts to mobile termination rates and roaming charges fade and the economy improves. Vodafone may have sold its best business in the US, but the management has achieved a very good price and secured a considerable war chest to boost operations. Vodafone shareholders may want to see the outcome of the £7bn “project spring” plan to invest in rapid mobile data infrastructure and fixed-line broadband. And others may just want to see the company remain independent and UK-listed. Any latent nationalisation could be stimulated by politicians worried about the sale of one of the UK’s last global technology champions. Elsewhere in Europe, there are national security concerns about a US group buying its way into strong positions in markets such as Germany. Regulatory approval of the deal in all the many countries where vodafone operates could be arduous.