NEW YORK (TheStreet) -- Verizon (VZ) just announced it will acquire AOL (AOL) for $50 per share or $4.4 billion. The acquisition will be funded by cash on hand and commercial paper. Verizon stock was down slightly pre-market while AOL stock surged 18%.
Investor's should expect AOL stock to rise close to $50 as investors anticipate the coming acquisition. The market is less enthusiastic about Verizon's position in the deal.
Peter Lynch, best known as the legendary investor who pioneered the price-to-earnings-to-growth metric, also coined the term 'diworisifcaiton.' The term suggests that a business is diversifying too widely or into non-profitable areas. This can be very negative for shareholders as management's attention and strategic focus is divided.
Verizon Wireless has a strong competitive advantage in wireless. The industry has high barriers to entry which limits competition. Verizon has supplanted AT&T (T) and grown to become the largest player in wireless. The company should focus its capital expenditures and strategic initiatives directly on strengthening its wireless segment. The AOL acquisition only partially supports wireless.
AOL Acquisition Rational
The strategic rational behind the AOL acquisition is to boost Verizon's presence in online video. Verizon calls this its "over-the-top video strategy." Mobile video viewing is growing faster than video viewing on television and personal computers. Verizon wants a stake in that action.
The company's long-term goal may be to sell a subscription like service of premium internet video properties (like the AOL-owned TechCrunch and Huffington Post). This could potentially be something like cable for mobile phones.
Currently, the deal has little synergy for Verizon's core business. Yes, Verizon will get ad revenue from AOL's high quality Web properties. The move does not complement Verizon's core business, however. It only gives the company an additional revenue source. Verizon profits from its wireless subscription plans which rely on the data used by wireless content consumers. AOL benefits when people visit their sites. The two companies are in similar businesses, but lack synergy outside of the usual combining of back-office operations.
Good News for Verizon Shareholders
Fortunately for Verizon shareholders, the company spent only $4.4 billion on the deal. This is about 2.2% of the company's market cap at current prices. Verizon did not bet the farm on the AOL transaction.
Verizon did not issue new shares and dilute its current shares in the transaction. The deal was funded entirely by cash on hand and short term debt. The company will not take on any long-term debt in the deal.
The good news for Verizon shareholders is the company did not spend an exorbitant (proportionally) amount of resources on the AOL acquisition. The bad news is the acquisition shows a drift in strategic focus. Verizon's management had previously been very disciplined in focusing on its wireless segment and slowly monetizing the assets in its slower growing wireline segment. The AOL transaction is a step in the opposite direction.
Other Recent Verizon Deals
In February of 2015 Verizon struck deals with Frontier Communications (FTR) and American Tower (AMT) . Verizon agreed to sell and lease wireline assets to these companies for a total of $15.54 billion. The move generated cash from the company's slower growing wireline segment for share repurchases and the wireless spectrum auction.
The Frontier Communication and American Tower deal sharpened Verizon's strategic focus on its faster growing wireless segment operations.