Verizon Mulls Cash for Its Lines
Verizon Communications (VZ) is evaluating the sale of about 5 million local phone lines in northern New England and the Midwest, part of a strategy to focus the telecom giant on higher-growth markets such as wireless and broadband (see BW, 05/24/04, "Verizon: Take That, Cable").
The sale of the lines could raise $6 billion to $8 billion. No deal is imminent, though. And it's far from clear that all of the lines in question can be sold. While there are plenty of buyers in the market, Verizon may not be able to find one willing to pay its price.
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Of the two possible deals, the sale of 1.6 million lines in Vermont, New Hampshire, and Maine probably would be the easiest to conclude on acceptable terms, given the overall strength of the economy in the Northeast. The sale of 3.4 million lines in Illinois, Indiana, Michigan, and Ohio may be more problematic. Michigan and Ohio, for example have been hit hard by tough conditions in the auto sector.
News of the possible sale was first reported on May 10 by The Wall Street Journal Online. Verizon spokesman Peter Thonis said the company was "evaluating" a sale of the lines, although he declined to confirm whether the New York company was in talks with potential buyers.
Though the local phone business is under pressure, there are acquirers in the market. Private-equity firms have shown interest because the operations generate a lot of cash. Verizon sold local phone lines in Hawaii last year to private-equity player The Carlyle Group for $1.65 billion. Strategic buyers such as CenturyTel (CTL) and Citizens Communications (CZN) are in the market for more local phone lines, too (see BW Online, 4/07/06, "Telecom's Merger Fever"). Sprint Nextel (S) and Alltel (AT) are spinning off local phone businesses, which could also play roles in industry consolidation.
The company has been reducing its exposure to the traditional phone business for some time. In 2002, it sold lines in Missouri, Kentucky, and Alabama. The Hawaii deal included 700,000 lines. Verizon CEO Ivan Seidenberg announced at an investor conference in October, 2004 that the company planned to sell up to 15 million of its access lines and focus more of its resources on broadband and wireless (see BW Online, 10/21/05, "Wireless Goes Boom"). It currently has 48 million access lines.
The price that buyers are willing to pay for local phone lines may be falling, though. The business is under competitive pressure, especially from wireless phones and the Internet. The lines in question appear to be valued at an average of 5.1 times earnings before income taxes, deprecation, and amortization, according to analyst David Barden of Banc of America Securities. That's below the current market average of 6.4 times EBITDA.
Still, Verizon may be inclined to take what cash it can off the table. Seidenberg reiterated last week to investors that he would like to take full control of Verizon Wireless. Vodafone (VOD) owns 45% of the highly successful venture. It's currently the second-largest wireless player in the U.S., now that rival Cingular, a joint venture between AT&T (T) and BellSouth (BLS), has acquired AT&T Wireless. However, Verizon Wireless still leads the industry in margins and operating performance. It has the lowest level of customer defections, and its fourth-quarter 2005 operating margins of 47% easily bested those of T-Mobile (35%), Sprint Nextel (32%), and Cingular (31%), according to a report by analyst Colette Fleming of UBS (UBS).
Vodafone CEO Arun Sarin is under pressure from investors to leave the U.S. market, scale back his global ambitions, and focus on core markets such as Europe. While he has indicated a desire to remain in the U.S., it wouldn't be a surprise if Vodafone exited Verizon Wireless this year.
Verizon will have to pay a sum at least in the low-$40 billion range to buy out Vodafone's share of Verizon Wireless. That assumes Verizon would pay eight times EBITDA for Vodafone's share. Recent wireless deals, such as Cingular's acquisition of AT&T Wireless and Sprint's acquisition of Nextel, have been in that range. But Verizon, with a market cap of $94 billion, has the ability to do the deal.
A sale of local phone lines would require approval from state regulators, too. That could present a challenge, because regulators are charged with protecting the public interest, not the interest of shareholders. If they believe that a new owner would fail to invest in the upgrade of rural phone lines, they might not welcome a sale.
However, those challenges have been faced before. And as recent transactions show, they can be overcome.