Is Verizon Heading South?

AT&T's planned purchase of BellSouth leaves Verizon in a distant second place in U.S. telecom. Does it need to bulk up in response?

Last year, Qwest Communications (Q) became an expensive thorn in the side of Verizon (VZ) when it sparked a bidding war for MCI. Verizon eventually bought MCI, but not before competition from Qwest jacked up the price by more than $1 billion. Now, in the wake of AT&T's (T) proposed $67 billion BellSouth (BLS) takeover, some telecommunications watchers are wondering if Verizon is going to pull a Qwest on AT&T and launch a hostile bid for BellSouth.

The deal would clearly face some tall hurdles. For starters, Verizon would be hard pressed to convince shareholders that BellSouth's 40% stake in Cingular would be better off anywhere but in hands of AT&T, which owns the rest. And the joint venture is structured in such a way that it wouldn't be easy for BellSouth to sell its Cingular stake without AT&T's blessing.

What's more, government regulators wouldn't want to see Verizon, owner of the No. 2 U.S. mobile-phone company, with a sizeable chunk of Cingular, which ranks as the nation's biggest. Verizon could try to mollify regulators by selling the stake, or convincing Vodafone Group PLC to swap its 45% stake in Verizon Wireless for BellSouth's 40% stake in Cingular. "It's possible but unlikely," says Scott Cleland, an analyst with research firm Precursor. "It is probably a little too cute."


  Even if AT&T's proposed takeover doesn't prompt Verizon to go after BellSouth, it's still fueling talk Verizon will be forced into making a similarly bold move. Verizon CEO Ivan Seidenberg could set his sights on Qwest or wireless operator Sprint Nextel (S), though a more likely option is the smaller wireless company Alltel (AT).

As of March 6, Verizon spokesman Eric Rabe says the company is sticking to its current business plan. That includes integrating MCI and divesting its directories business. Still, Verizon's not ruling anything out. "We would always look at anything," Rabe says, when asked about the prospect of chasing Alltel. "But I don't think we feel compelled to jump at anything."

Alltel, a Little Rock (Ark.) company with a market capitalization of about $25 billion, is splitting off its wireline operations in a deal expected to close this summer. "I think Verizon would certainly be interested," says Precursor's Cleland. Harry Radovich, an analyst at the Merrill Lynch Basic Value Fund, which owns Verizon shares, says an Alltel deal would help Verizon build mass in rural and smaller metro areas. "This would be the cleanest deal from a regulatory standpoint," says Radovich.

Standard & Poor's telecom analyst Todd Rosenbluth also sees the rationale. Verizon Wireless already has a roaming agreement with AllTel, and both companies use the same technology to power their networks. What's more, Alltel's significant presence in landlines in Georgia, North Carolina, South Carolina, Georgia, Alabama, and Florida could give Verizon an entrée to the lucrative business market in a region that AT&T hopes to lock up with its BellSouth merger. Rosenbluth says Alltel has carefully cultivated its compatibility with Verizon -- perhaps with an eye to a future deal. "It's a fact that Alltel has a complementary mix," Rosenbluth says.


  In a public statement, Verizon said it would also continue to pursue one of its long-held yet unrequited aims: acquiring the 45% of Verizon Wireless owned by Vodafone (VOD). Verizon, which owns 55% of the mobile operator, has long said it's interested in owning all of the company. AT&T's BellSouth deal only increases pressure on Verizon to make good on that goal.

Past efforts by Verizon to buy out the Vodafone stake have been rebuffed. But the time may be right for Vodafone to finally sell out. On Feb. 28, Vodafone forecast slower revenue growth and shrinking profit margins for its fiscal year ending March 31, 2007, amid increasing competition in key Western European markets such as Italy and Germany. American depositary receipts of Vodafone, which traded above $28 last September, closed at $21.90 on March 6. Vodafone's declining performance and stock price have prompted some investors to call for the U.K. wireless giant to sell its stake in Verizon Wireless.

And on March 3, when Vodafone said it would sell its struggling Japanese business Vodafone KK to Internet conglomerate Softbank, some analysts took that as evidence of a new pragmatism (see BW Online, 3/6/06, "Softbank-Vodafone Deal Has Promising Ring"). "If you look at how the stock has performed in the last year, then they are under pressure to make some shareholder-friendly moves," says John Hodulik, an analyst with UBS. "The deal to buy out Vodafone will remain front and center."


  Sprint Nextel could also find itself in Verizon's crosshairs, though that's a less likely scenario, analysts say. Regulators would put the kibosh on such a deal because Sprint, as the No. 3 wireless operator, is too big to combine with either of the top two players. "It wouldn't pass antitrust muster," says Cleland.

Verizon could also pursue Qwest to bulk up in the Western mountain territory. The outfit, which has a market capitalization of about $12 billion, is the smallest of the regional phone companies. It serves customers in 16 Western and Mountain states and lacks a wireless arm. But analysts say Qwest's massive debt and weak growth prospects make that deal unlikely as well.

So far, investors seem to like the fact that Verizon did not issue a knee-jerk response. While AT&T's stock declined 3.5% on March 6 on the news of the takeover, Verizon shares held steady, rising a mere 0.5%. Some investors say Verizon is on the right track and that it's large enough as is. "I'm not sure they need to do anything immediately," says Radovich. "They should focus on the things they are focused on." And if it can wrangle the rest of its wireless company from Vodafone, all the better.

    Before it's here, it's on the Bloomberg Terminal.