Sept. 2 (Bloomberg) -- Verizon Communications Inc.’s decision to buy out its wireless partner for $130 billion is a bet that the U.S. mobile-phone market still has room to expand even as competition intensifies and smartphone demand slows.
While owning all of Verizon Wireless -- the 14-year-old venture with Vodafone Group Plc -- will give Verizon a full share of earnings, the acquisition won’t result in reduced costs or bring new products or services. That means Chief Executive Officer Lowell McAdam will have to persuade investors and bondholders that the profit growth he’s getting will more than justify the heavy price tag in the deal announced today.
Verizon’s gamble contrasts with AT&T Inc., which is hunting overseas for acquisitions that would offer better returns than the U.S. McAdam already has used $5 billion in deals in his two-year tenure as CEO to invest in the American wireless business just as the industry’s revenue growth stalls. The Vodafone deal lays the groundwork for what McAdam is betting will be a demand boom for a broad range of telecommunications services.
“McAdam’s strategy is to move away from being a traditional phone company,” said Sam Greenholtz, a former Verizon manager now with SGTelecom Consultants in Westminster, Maryland. “He wants to make Verizon a mobile and fiber company, to provide the means of delivery for cloud services and broadcasts.”
Verizon agreed to acquire Vodafone’s 45 percent stake in their U.S. wireless venture for $130 billion, mainly in cash and stock, the New York-based company said in a statement released today. Vodafone, having seen how slowing growth and stiffer competition can squeeze profit margins in its European markets, is poised to take Verizon’s money and get out of the U.S.
Shares of Vodafone, based in Newbury, England, rose 3.4 percent to 213.20 pence at the close in London. Verizon fell 0.9 percent to $47.38 in New York on Aug. 30, and AT&T advanced 0.5 percent to $33.83. U.S. stock markets were closed today for the Labor Day holiday.
A look at Verizon’s two biggest transactions under McAdam, 59, shows what his company is up to. A year ago, the carrier completed a $3.6 billion deal to acquire wireless airwaves from Comcast Corp., Time Warner Cable Inc. and Bright House Networks, its nemeses in the competition for landline Internet users. The companies also pledged to work together on services for consumers.
Just a month earlier, Verizon acquired Hughes Telematics Inc. for $612 million, gaining technology that wirelessly links machines such as cars and medical devices to the Internet for monitoring and services.
McAdam connected the dots on the two transactions for investors in December at a UBS AG conference. Each device that accesses the Internet wirelessly -- a tablet computer, a TV, a car, an insulin monitor, a thermostat -- presents another opportunity to wring sales from Verizon’s network.
“If we can bring some video applications and some intelligent home and some health-care applications, the revenue per account we see trending upwards,” he said. “Somebody might pay 25 cents or 50 cents a month for a thermostat.”
While wireless growth has slowed in the U.S. because most people already have a phone and a data plan, McAdam said the industry is on the cusp of a new surge in demand because everyone will want their other products to work on the network.
“It’s just funny that we still talk about 90 percent, 95 percent, 100 percent penetration as a ceiling,” he said on a conference call with investors last year. “You start adding in all your appliances and your cars and your home and your security system and all that stuff, and I think we can keep growing. That’s part of our job.”
AT&T CEO Randall Stephenson has expressed a similar vision, and pursued his own $39 billion deal to acquire Deutsche Telekom AG’s T-Mobile USA in 2011, eventually getting blocked by regulators seeking to preserve competition.
While he has continued to snap up smaller wireless companies and airwave licenses, Stephenson’s attention has turned to Europe. He has said he sees a “fascinating” opportunity to invest in wireless Internet on the continent, which has been leapfrogged by the U.S. in mobile technology.
“AT&T has been looking elsewhere in the world to acquire assets, and Europe looks like the most attractive to them,” Craig Moffett, an analyst at Moffett Research LLC, said in an interview last week on Bloomberg Television. “Their strategy, instead of trying to double down in the U.S., is to look elsewhere.”
AT&T may consider bidding for Vodafone’s remaining assets, people familiar with the matter said last week.
Unlike Europe, where wireless revenue slumped 4.3 percent last year, North America is still growing and has even accelerated the past two years as the economy recovered, climbing 8.7 percent. Still, it’s been lower than the double-digit annual rate the industry enjoyed before the recession. Voice revenue has declined for four years, with data sales growth leveling off at 24 percent to 25 percent since 2010.
Slowing U.S. growth isn’t the only reason to be skeptical of McAdam’s strategy. He’s facing new competitive threats as smaller carriers embark on revamped strategies. Sprint Corp. is ratcheting up investment on its network after a $21.6 billion takeover by Japan’s SoftBank Corp. this year. T-Mobile US Inc., the product of a merger between Deutsche Telekom’s U.S. unit and MetroPCS Communications Inc., is offering European-style plans that separate phone costs from service contracts.
“Vodafone’s management may be looking at the U.S. and saying to itself, ‘We’ve seen this movie before,’” Moffett wrote last week in a research note. “There is little prospect for things getting materially better” for Verizon Wireless and “a meaningful chance that things get worse.”
Debt investors have balked at the potential deal, pushing up yields on Verizon bonds in an indication of the transaction’s risk. In today’s statement, Verizon said it entered into a $61 billion bridge credit agreement with JPMorgan Chase & Co., Morgan Stanley, Bank of America Corp. and Barclays Plc while it moves toward permanent financing. Yields on Verizon’s $1.75 billion of 2.45 percent notes due November 2022 rose to 4.13 percent last week, from 3.91 percent before Vodafone said it was in talks with Verizon about the stake sale.
The more optimistic argument is that Americans continue to want to be less and less tethered, even as they demand more digital services and video. That’s what Verizon is counting on.
“The world is going increasingly wireless,” said Howard Ward, chief investment officer at Gamco Asset Management Inc., in an interview on Bloomberg TV’s “Surveillance” last week. “This is going to be a very good business for a very long period.”
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