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Where Does Vodafone Turn Now?

When Cingular Wireless announced on Feb. 17 that it had won the bidding war for AT&T Wireless, the news came as an anticlimax. The $15-a-share cash offer -- which adds up to $41 billion, plus the assumption of debt -- was more generous than the $11 a share most analysts expected. But Cingular, a joint venture between phone companies SBC (SBC) and BellSouth (BLS), had long been the favored horse in this race against Britain's Vodafone (VOD), whose final offer topped out at $14 (see BW Online, 1/13/04, "Cingular and AT&T Wireless Draw Nearer"). The same day, Cingular's victory was further sweetened when NTT DoCoMo, which holds a 16% stake in AT&T Wireless (AWE), announced it might sell its holding to Cingular.

Vodafone's shares jumped nearly 4% on Feb. 17, to close at $26.77 -- an indication that shareholders were anything but broken-hearted. Still, the British outfit may be more determined than ever to buy a player in the U.S. cellular market, though doing so now will be harder.

Vodafone's desire to be among the top dogs in the consolidating U.S. industry was a constant theme during the battle for AT&T Wireless. When it took a 45% stake in Verizon Wireless back in 1999, Vodafone agreed not to invest in another U.S. wireless carrier. But it ignored that restriction in bidding for AT&T Wireless. At one point, Vodafone speculated that it might buy all of Verizon (VZ) if the U.S. phone giant stood in its way.

RACE FOR SPRINT? That has made the already fractious Vodafone-Verizon relationship rockier than ever, prompting speculation that Vodafone won't rest without trying to establish itself more forcefully in the U.S., where developing overwhelming economies of scale is the emerging endgame. "There's no question that Vodafone has to find a solution to the U.S.," says Andrew Cole, an analyst with wireless consultancy Adventis in Boston.

Because Verizon is America's largest phone company, a Vodafone purchase might be tough to get U.S. regulatory agencies to approve, believes Rick Black, an analyst with Blaylock & Partners in New York. What's more, Verizon would likely have a price tag of $150 billion or so -- a big nut even for Vodafone, whose annual revenues are $61 billion.

Still, Vodafone may have a couple of alternatives. One would be to find an accommodation with Verizon that would see the pair mount a joint acquisition of Sprint (FON), which owns No. 4 U.S. wireless-service provider Sprint PCS (PCS). Sprint PCS and Verizon Wireless use similar network technologies, and the combined entity could enjoy plenty of synergies.

END OF A SWEET DEAL. Or, Vodafone could give up its 45% ownership of Verizon Wireless, a choice some analysts say makes financial and strategic sense for both players. One option is for Verizon to buy out Vodafone. Rolling Verizon Wireless into the parent company could add 11 cents to Verizon's projected 2004 earnings per share of $2.34, estimates Blaylock's Black. Under the current agreement, Vodafone can sell its 45% interest back to Verizon, which might have to pony up $29 billion to $34 billion to reflect the stake's current market value, Black says.

Vodafone might be amenable to this, if only because a sweet deal it now has with Verizon Wireless will soon draw to a close. Until February, 2005, Verizon Wireless is obligated by the partnership agreement to pay Vodafone $1 billion a year in cash dividends. Thereafter, Verizon Wireless's board will have the right to adjust that amount -- and will likely cut it significantly, says Jonathan Schildkraut, an analyst at S.G. Cowen.

Nextel could be an attractive target

Vodafone might use proceeds from a buyout to purchase assets abroad. Analysts have long whispered that it's in negotiations with Vivendi (V) for its majority stake in France's second-largest mobile operator, SFR. Vodafone also still has possibilities to explore within the U.S. One potential target: Nextel (NXTL), which will be the fourth-largest wireless carrier when the Cingular-AT&T Wireless merger is completed. Nextel is also the only wireless provider left in the U.S. not attached to a traditional phone company, which would make it less expensive to acquire.

MUTUAL WEAKNESSES. Finally, because Nextel has yet to make a significant investment in its next-generation networks, an acquirer could standardize Nextel on its own network technology, says Schildkraut.

Another scenario: After saying goodbye to Verizon Wireless, Vodafone might grab for the brass ring with an offer for the combined Cingular-AT&T Wireless, says Greg Gorbatenko, an analyst with Marquis Investment Research. Such a scenario might well be possible if the merged entity encounters as many difficulties as some analysts think likely.

For starters, neither one is strong operationally. After the wireless number portability law took effect last November, allowing customers to keep their cell-phone numbers when switching to other carriers in the 100 top markets, AT&T Wireless' churn increased from 2% a month to 3.3%, estimates Peter Firstbrook, an analyst with tech consultancy Meta Group in Ontario.

$1 BILLION BOOST. And Cingular has fallen behind other U.S. wireless heavyweights in rolling out advanced networks, says Firstbrook. Moreover, Cingular and AT&T Wireless both concede that the speed of their new network is far below that of Verizon Wireless. Essentially, the merger is combining "two poor operators," declares Schildkraut.

While the deal, which is expected to close in the fourth quarter if all goes well, could generate operational and capital-spending efficiencies of about $1 billion next year, those savings could be coupled with disruptions, at least for a while. Legg Mason analysts think the combined company may have to divest operations in markets such as Dallas and Miami to prove to the Justice Dept. that the merger won't stifle competition.

Thus, it's a distinct possibility that the combined company, which will bear the Cingular name and be marketed under that brand, will lose some market share. In fact, the integration pains will give Nextel and Verizon Wireless, in particular, a chance to boost their shares by three or four percentage points over the next year, estimates Jonathan Atkin, an analyst with RBC Capital Markets. Near term, price competition in the industry could heat up as other carriers scurry to grab a piece of the Cingular-AT&T Wireless pie, says Meta's Firstbrook.

JUST THE START. Existing contracts between AT&T Wireless and its Triton PCS affiliate, which provides wireless service in the Southeast, could force the new Cingular to purchase Triton, says Schildkraut, further exacerbating regulatory concerns. If Cingular stumbles -- or if the merged outfit goes public, as many observers expect -- Vodafone could perhaps mount a hostile takeover.

Of course, SBC and BellSouth would launch a formidable defense of their wireless venture. For one thing, Cingular CEO Stan Sigman insists his company won't go public. Moreover, its phone-company owners expect the merger to greatly increase their involvement in wireless -- one of their few growth markets. By 2006, estimates Cingular, wireless will account for half of U.S. household spending on phone services. SBC, which owns 60% of Cingular, expects wireless to increase from 19% to 32% of total revenues over time, thanks to the merger. And that should significantly boost earnings in a few years, once the expense of the integration is over.

Whatever else happens, the long-anticipated consolidation of the top six U.S. cellular carriers into three or four players has now begun. And if Vodafone wants to be among the final four, it'll have to be ready to play better offense next time. By Olga Kharif in Portland, Ore.

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