Einhorn's Arbitrage Skills Tested With Vodafone (Update 2)

Updated from 11:30 a.m. to reflect closing share prices and GAMCO Investors comments.

NEW YORK ( TheStreet) -- Verizon ( VZ) late on Tuesday nixed speculation that it would buy all of British telecom Vodafone ( VOD), in what would have amounted to the largest corporate merger of all-time.

While Verizon's disclosure leaves open the prospect of eventually buying Vodafone's 45% stake in Verizon Wireless, in a deal Citigroup analysts recently calculated could reach up to $135 billion, it does put to rest a merger arbitrage that hedge funder David Einhorn of Greenlight Capital outlined in a January investor letter.

Verizon said in an 8-K filing with the Securities and Exchange Commission that it has no intention of buying Vodafone in full, even if the carrier remains interested in taking control of a Verizon Wireless joint venture.

"Verizon Communications Inc. notes the recent press speculation regarding a potential merger with or purchase by Verizon of Vodafone," the company said in the filing.

"As Verizon has said many times, it would be a willing purchaser of the 45% stake that Vodafone holds in Verizon Wireless. It does not, however, currently have any intention to merge with or make an offer for Vodafone, whether alone or in conjunction with others."

Verizon's disclosure curbs speculation by the Financial Times that it might team up with AT&T ( T) to buy and then split up Vodafone's assets.

According to the FT report, which cited "usually reliable people," Barclays ( BCS) bankers had been tasked with studying a potential deal that would give Vodafone an enterprise value of $245 billion, far above a $182 billion merger of AOL ( AOL) and Time Warner ( TWX) in 2000.

In a record merger, Verizon would look to take full ownership of Verizon Wireless, while AT&T would acquire Vodafone's extensive non-U.S. assets, the FT report said.

Such a scenario might have pushed hedge funder and Apple ( AAPL) activist David Einhorn further into the world of merger arbitrage, where competitors Paulson & Co., Carl Icahn and SAC Capital have shown proficiency.

"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, in the late January investor letter.

Unfortunately for Einhorn, Verizon's late Tuesday filing puts an end to speculation of a full merger and may indicate he miscalculated a well-publicized trade.

Einhorn said Greenlight has been adding to its holding of Vodafone given his expectation of a possible mega-merger.

According to SEC filings, Greenlight held 1.6 million Vodafone shares worth just under $50 million at current prices as of December 31, 2012.

General Motors ( GM), Apple ( AAPL), Marvell ( MRVL) and Cigna ( CI) are Greenlight's largest long stock investments, each valued at over $500 million at current prices, according to Bloomberg data that references Dec., 31 SEC filings.

The removal of Verizon as a buyer of all of Vodafone may cause alarm for investors like Einhorn.

Bernstein Research and Citigroup analysts noted in recent reports that after a prospective Verizon Wireless stake sale, Vodafone would be left with a deteriorating European wireless business and an even less exciting land line presence.

Nevertheless, Citigroup calculates both companies could see their shares benefit from what could be a deal in excess of $100 billion.

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, according to Citigroup.

" We still believe the most likely outcome is for Verizon to pursue a leveraged buyout of the wireless stake held by Vodafone, while we would be surprised if a joint bidding scenario emerged between Verizon and AT&T for Vodafone," wrote Citigroup analyst Michael Rollins on Tuesday.

Verizon is now likely searching for a tax efficient alternative to increase, if not, buy all of Verizon Wireless, said Mario Gabelli, head of GAMCO Investors, on Twitter. The fund owns less than 1% of both Verizon and Vodafone shares, with stakes of about $163 million and $58 million, according to data compiled by Bloomberg.

Some investors in Vodafone aren't optimistic about a deal for just Verizon Wireless.

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

It is to be seen if Einhorn changes his tune on Vodafone.

Jonathan Gasthalter, a spokesperson for Greenlight Capital, didn't immediately return an e-mailed request for comment.

Vodafone shares were down over 4% Wednesday trading, to $28.10 on Verizon's disclosure. On Tuesday, Vodafone shares gained nearly 4%, closing at a seven-month high of $29.41 on the FT report.

A heating of Vodafone's M&A prospects comes at a time when many Greenlight Capital investments take the spotlight.

Greenlight has maintained a short trade in rating agency Moody's ( MCO), which cost the fund its largest short portfolio loss in 2012. That investment and a newly opened short against McGraw-Hill ( MHP), owner of Standard & Poor's may yet payoff as the Department of Justice pursues fraud charges related to mortgage bond ratings.

Escalating scrutiny on the credibility of pre-crisis mortgage bond ratings could also throw Einhorn in direct contest with Warren Buffett of Berkshire Hathaway, who remains one of Moody's largest shareholders.

Einhorn may also have to address previously disclosed short positions such as a backfired trade against materials giant Martin Marietta ( MLM), which has risen sharply since Einhorn said the company's earnings would suffer from a withdrawal of government stimulus.

For now, Einhorn may not have picked the biggest merger in history as a first notable arbitrage trade. Still, the increasingly vocal hedge funder's investment in Vodafone may eventually bear fruit for Greenlight in the event of a Verizon Wireless deal.

-- Written by Antoine Gara in New York.

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