Bulls Awaken to Verizon Calls Following Vodafone Deal: Options

Photographer: Ron Antonelli/Bloomberg

By ending the 14-year joint venture with Vodafone of Britain, Verizon Communications Inc. keeps all of the earnings in Verizon Wireless and gets more leeway to upgrade its mobile network. Close

By ending the 14-year joint venture with Vodafone of Britain, Verizon Communications... Read More

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Photographer: Ron Antonelli/Bloomberg

By ending the 14-year joint venture with Vodafone of Britain, Verizon Communications Inc. keeps all of the earnings in Verizon Wireless and gets more leeway to upgrade its mobile network.

Options traders are turning bullish on Verizon Communications Inc. (VZ), convinced it can wring extra profit from its wireless venture and that the stock will rebound after Vodafone Group Plc shareholders are done selling.

The price of bullish calls has climbed to the highest level in seven years compared with corresponding puts, signaling speculation the underlying stock will rise, data compiled by Bloomberg show. Shares of the New York-based phone company have fallen 12 percent since reaching a 13-year high in April in anticipation of the Vodafone transaction.

Verizon closed its $130 billion deal last week to gain full control of its wireless unit with the issuance of 1.27 billion shares to Vodafone’s owners, and some traders probably sold them, according to Jonathan Schildkraut, an analyst at Evercore Partners Inc. in New York. The decline gives investors the chance to purchase Verizon equity at a discount, he said.

“The deal adds a lot of long-term value to Verizon shares,” Schildkraut said by phone on Feb. 24. “You’ve got technical pressure, and you don’t know if that’s going to last a week or four. But the fundamental story actually gets better.”

By ending the 14-year joint venture with Vodafone of Britain, the U.S. company keeps all of the earnings in Verizon Wireless and gets more leeway to upgrade its mobile network. The acquisition is Chief Executive Officer Lowell McAdam’s bet that the wireless market still has room for expansion even as growth slows in smartphone sales.

While most people already have smartphones and data plans, McAdam has said the industry is on the cusp of a new surge in demand for mobile connections as customers seek to link their cars and home-monitoring systems to the Internet.

‘Risk-Free Bet’

Revenue will climb 4 percent this year, compared with 4.1 percent growth last year, Verizon said Feb. 24 in a statement, with profit margins forecast to expand in both the wireless and landline businesses.

The deal “is an execution, risk-free bet that wireless is the future,” Roger Entner, an analyst at Dedham, Massachusetts-based Recon Analytics LLC, said in a Feb. 26 phone interview. “If Verizon believes it can execute as well as it has in the past, it has basically integrated all the profits in Verizon Wireless into the company. That’s a massive positive.”

The stock trades at 13.6 times projected earnings, less than the 15.7 ratio for companies in the Standard & Poor’s 500, according to data compiled by Bloomberg. Analysts predict Verizon could climb to $54.15 in the next 12 months. The stock jumped 2.5 percent yesterday to $47.50.

Increased Shares

Verizon fell to $45.98 on Feb. 18, the lowest level since September when the Vodafone deal was first announced. The shares are down 7.1 percent from an October peak. The deal has increased the stock outstanding by 45 percent to 4.1 billion.

“What kept pressure on the stock is all these additional Verizon shares being issued to Vodafone shareholders,” David Heger, an analyst in St. Louis with Edward Jones & Co., said in a Feb. 27 phone interview. “There has been a thought that people would dump all of the shares once they got them.”

Puts with an exercise price 10 percent below Verizon’s stock cost 1.41 points more than calls betting on a 10 percent increase, according to three-month data compiled by Bloomberg. The price relationship known as skew fell to 0.67 on Feb. 26, the lowest since March 2006.

Ray McConville, a spokesman for Verizon, declined to comment on the company’s options trading.

Price War

Verizon is seeking to improve profit margins amid a mobile-phone industry price war. T-Mobile US Inc. (TMUS) has offered to buy out rivals’ customers from their contracts and introduced cheaper international calling plans, and AT&T Inc. and Sprint Corp. have mimicked its moves. Instead of cutting the cost of its wireless plans, Verizon has added features like bigger data allotments and free network storage.

Verizon’s LTE network speeds have fallen behind AT&T and T-Mobile’s in recent tests, while the company’s plans and costs are more expensive, according to Joseph Mastrogiovanni, an analyst at Credit Suisse Group AG who rates the shares neutral. Mastrogiovanni cut his 12-month target price on Verizon to $52 from $53 this week after Verizon’s revenue forecast was lower than the firm expected.

‘Competitive Landscape’

Verizon “noted that recent changes in the competitive landscape do not appear to be fundamentally different than competition it has seen in the past,” he wrote Feb. 24.

The Chicago Board Options Exchange Volatility Index, the measure of expected volatility on the S&P 500 also known as the VIX, fell 2.2 percent to 14.04 yesterday. Europe’s VStoxx Index added 4.6 percent to 17.91 at 12:01 p.m. in Frankfurt today.

Implied volatility, used to gauge the cost of options, for three-month contracts with an exercise price 10 percent below Verizon’s shares has climbed 6.3 percent to 21.92 this year, data compiled by Bloomberg show. That compares with a 21 percent gain to 20.51 for calls 10 percent above.

Eight of the 10 most-owned Verizon options were bullish. March $47 calls had the highest open interest, followed by calls expiring in March with a strike price of $49, 3.2 percent higher than yesterday’s closing price.

“Skew typically goes lower as stocks grind lower and protection becomes less in demand,” Kurt Ayling, a technology, media and telecom desk analyst at Susquehanna Financial Group LLLP, said in an interview Feb. 27. “In this case, with such a large overhang essentially being removed in the near term, the shift in skew and the recent influx of bullish activity that we’ve seen suggests investors believe the selloff may be overdone and shares appear to have bottomed out.”

To contact the reporters on this story: Callie Bost in New York at cbost2@bloomberg.net; Nick Taborek in New York at ntaborek@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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