The Risks in a $100 Billion-Plus Verizon Wireless Deal

NEW YORK ( TheStreet) -- Speculation is mounting that Verizon ( VZ) may look to buy its remaining 45% stake in Verizon Wireless from Vodafone ( VOD) of Britain, in what could be the largest telecom sector deal since the reconstruction of AT&T ( T).

The prospective blockbuster acquisition may be financed in current markets and could give Verizon full control of the top wireless carrier asset in the world, while helping to save the company nearly $10 billion in wireless dividends that flow to Vodafone.

Still, the deal may pose under-appreciated risks for America's wireless leader.

Notably, analysis indicates a key reason the deal may be forthcoming is simply because of opportunism for the seller, Vodafone.

For Verizon investors, it might be wise to construe a large stake sale in the company's best asset as a reason for caution.

Given recent analyst comments and reports on the prospects of a full Verizon Wireless acquisition, it's important to note that many of the seeming benefits to the prospective deal are financial and not operational.

Citigroup, in a lengthy Monday analysis, highlights low-interest rate financing available to Verizon and a potential investment return above the cost of capital as reason the telecom giant might consider buying out its wireless stake.

On the other hand, Vodafone may be a seller because of attractive pricing, pushed up by today's financing environment, and the ability to structure a deal without a hefty tax bill.

"We believe the window of opportunity for Verizon to pursue an accretive buyout of Vodafone's Verizon Wireless stake, even at elevated EV/OIBDA multiples, is more open today from a combination of low-interest rates, favorable VZW performance, lower debt leverage at the VZ parent level, strong dollar vs. Sterling & the Euro, VZW already paying a dividend to its parents, & improvement in domestic Telco valuations," write Citigroup analysts Michael Rollins and Simon Weeden.

Citigroup's analysis indicates both companies could see their shares benefit from what could be a deal in excess of $100 billion, but the firm highlights Vodadone as standing to gain the most. " We believe Vodafone stands to be the greater beneficiary from a possible deal," the analysts write

Verizon's earnings per share and free cash flow could grow by 27% and 18%, respectively, in the first year after a deal is completed, according to Citigroup. Such a scenario would put Verizon's share value at between $50 and $60 a share.

For Vodafone, selling its stake in Verizon Wireless could improve the company's valuation multiples by between 17% and 46%, given the prospect of a deal price of between $105 billion and $135 billion.

But the potential deal may not be as impressive to Verizon or Vodafone investors as the $100 billion-plus pricetag.

After all, speculation of a deal truly re-ignited in October 2012 when Bernstein Research analysts led by telecom sector bear Craig Moffett noted pricing for Vodafone's Verizon Wireless stake may never be better.

Already, Verizon Wireless has faced a bull-bear battle as investors weigh the earnings impact of ongoing Apple ( AAPL) iPhone subsidies and the potential for wireless plan price competition on the heels of mergers among the likes of competitors Sprint ( S), MetroPCS ( PCS) and T-Mobile USA.

"With Verizon trading at all time high multiples; US investors appearing to suspend disbelief on the impending deterioration of the US wireless market; and an urgent need for major strategic change in Europe, there may never be a better time for Vodafone to relinquish its 45% of Verizon Wireless," noted Bernstein Research in an Oct. 24 research report.

Moffett, who left Bernstein Research earlier in 2013, held a "underperform" rating for Verizon, which was somewhat vindicated by fourth-quarter earnings laden with a multibillion-dollar pension charge and high iPhone subsidies that drained wireless profit margins.

A large seller of Verizon Wireless such as Vodafone may very well consider doing so opportunistically, as the Verizon's shares sit near-record highs and earnings trajectories in the ever-changing wireless market remain a question mark.

For Vodafone investors, a Verizon Wireless sale, meanwhile, may be the last thing investors want even if deal speculation has proven a catalyst for shares in 2013.

John Hempton of hedge fund Bronte Capital recently wrote in a blog post on Bronte's Web site that if Vodafone just sold Verizon Wireless and not the whole company, its entire board should be fired on the spot.

Bernstein Research and Citigroup analysts note that after a prospective Verizon Wireless stake sale, Vodafone would be left with a deteriorating European wireless business and an even less exciting wireline presence.

David Einhorn of hedge fund Greenlight Capital said in his fourth-quarter investor letter he's betting on Verizon's acquisition of all of Vodafone, given the prospect that the wireline business holds value at bargain basement prices.

In the letter, Einhorn said Greenlight's been adding to its holding of Vodafone given his expectation Verizon might make a play for the whole company.

"It wouldn't surprise us if Verizon decided to buy all of Vodafone 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," wrote Einhorn.

Analysts see differently, with Citigroup's analysis indicating that the prospect of a full merger is remote at best.

"Verizon's management has made clear that it is not attracted by Vodafone's non-US assets and so while a top company merger remains a possibility we now see it as less likely than an exit by Vodafone from Verizon Wireless, possibly in stages. We also do not believe that it would be beneficial to execute a topco merger first as a route to then separating," Citigroup wrote.

All told, there may be some underappreciated risks for investors to what could be a record-sized deal.

The prospect that Vodafone sells its stake in Verizon Wireless may augur poorly for the unit's continued earnings and margin growth.

For Vodafone investors, the quick payoff from a Verizon Wireless sale, were a deal to be executed, could quickly fade given the company's less attractive non-US assets.

Peter W. Thonis, a spokesperson for Verizon declined to comment for this article. Jonathan Gasthalter, a spokesperson for Greenlight Capital, declined to comment.

-- Written by Antoine Gara in New York.

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