Verizon Eats Itself (And Why It Matters)
Ah, Labor Day. On that last, great, three day weekend of the summer, we can relax, reflect on the memories of the passing season, and enjoy one more barbeque. So maybe we can be forgiven if we missed the screaming headlines. … Biggest Deal Ever … Future of Telecom in U.S. … $130 Billion. There were screaming headlines, right?
On August 29, the Wall Street Journal (and the Financial Times) reported that Verizon Communications and Vodafone were again talking about a buyout of Vodafone’s stake in Verizon Wireless. ‘Sure, Lucy,’ we thought, ‘we’ll try to kick the football again.’ When you’re in the Headlines business, you get a bit leery of the ones that repeat every couple of months. This particular dance dates back to at least 2004. But slowing growth, cheap financing and the prospect of tougher price competition, particularly in the more mature mobile markets where economies of scale are vital, have helped to spur a surge in telecoms transactions which already total over $80 billion this year. Could we have another big deal?
Yes, Vodafone confirmed that it was in talks with Verizon. But the two companies have talked ad nauseum over the years over the fate of the largest wireless carrier in the United States. What could be different this time? Verizon has sought for years to buy out Vodafone's 45% stake in Verizon Wireless, but the companies have never been able to agree on price. They remained far apart earlier this year, with Verizon looking to pay around $100 billion and Vodafone hoping for more like $130 billion. The motivator now? With interest rates rising and new competition emerging in the U.S. wireless market, the companies appeared to have moved beyond their earlier stalemate out of concern that the window for a deal could be closing. Verizon's growth and future prospects are weighted to its wireless side, which produced two thirds of the company's $116 billion in revenue last year. But shared ownership of Verizon Wireless has meant Verizon couldn't fully claim its cash and profit. Vodafone and its shareholders have been reluctant to do a deal because it would leave the company without its best asset and more exposed to troubled European economies.
Within hours, analysts were saying a deal, if agreed upon, could spark a new round of mergers across the telecom industry. It only took hours to put a number on the deal -- $130 billion. And the time between rumor and announcement gave analysts time to consider the ramifications: Will Verizon’s ability to do larger deals such as buying Dish Network be constrained? Will Verizon delay entry into the Canadian market? Would the debt incurred in the deal prevent Verizon from participating in upcoming spectrum auctions in the U.S.? What will the deal mean for AT&T?
But perhaps what industry analysts really wanted to know was how the deal would strengthen Verizon’s ability to defend its share of the U.S. wireless marketplace with increased competition coming from T-Mobile and Sprint? Owning Verizon Wireless will mean much higher cash flows for Verizon. But if margins fall and growth falters, $130 billion could look like a very high price indeed. And annual subscriber growth in the U.S. has slowed to 2% from 15% in 2004, according to Moffett Research. But Verizon figures it has a year or two lead on its rivals given it has already rolled out a fast, LTE network. Plus, 94% of Verizon's subscribers are locked into contracts, making it harder to peel them off.
On Labor Day, September 2, news broke that a deal, in fact, had been reached. Vodafone will sell its 45 percent stake in Verizon Wireless for $130 billion, in one of the largest corporate deal of all time (behind another Vodafone deal—the $172 billion acquisition of Mannesmann AG in 1999). Verizon is paying Vodafone with a mixture of cash and stock. To fund the $58.9 billion cash portion, Verizon is getting financing from J.P. Morgan Chase, Morgan Stanley, Bank of America and Barclays. It will issue $60.2 billion in stock, subject to certain price collars. It is also issuing $5 billion in notes to Vodafone, selling its stake in Vodafone Omnitel, and offering $2.5 billion in “other consideration.” Keep in mind, Verizon Communications' market cap is around $132 billion.
Verizon Communications formed Verizon Wireless in 2000 by merging its assets in the South and on the East Coast with Vodafone's business in the West and Rocky Mountains. Verizon took 55% of the company and had operational control. Vodafone owned the rest and could block major moves. Almost ever since then, Verizon has wanted to own the whole company. The lack of full control of Verizon Wireless limited Verizon's financial flexibility. The wireless side produced two-thirds of the company's $116 billion in revenue last year. Meanwhile, of the company's $10.6 billion in net income that year, $9.7 billion belonged to partners in joint ventures. Verizon Wireless has 100 million subscribers, a figure that has steadily climbed. Meanwhile, Verizon had about 22 million landline subscribers as of last quarter, down from 29 million in 2009, so landline revenue has shrunk.
In nearly every account of this deal, reporters and analysts included a standard line: “the roughly 100 million Verizon Wireless customers probably will not see any change in their services, at least at first.” Among Verizon’s plans is bundling mobile broadband services with wired offerings like high-speed, fiber-optic connections. But the deal represents Verizon’s bet that the American desire for cellphones and broadband services has not yet nearly sated. Many question if the U.S. wireless market – with its slowed growth and ramped up competition – may have already peaked. Verizon is betting the answer is no; Vodafone, on the other hand, seems to believe that the value of its stake did not have much further to rise.
Jim Barthold, writing for FierceIPTV, predicts the deal marks the beginning of the end for Verizon’s FiOS as a competitive wireline tool. (FiOS is a bundled Internet access, telephone, and television service which operates over a fiber-optic communications network.) Sifting through industry earning reports, he sees little activity in wireline broadband – and tunnel-like vision on wireless. Barthold notes that more and more consumers are getting their video entertainment over the Internet and, increasingly, over wireless connections. He concludes:
Perhaps a more powerful Verizon Wireless will offer up a 4G wireless "cord" that delivers a competitive high-speed data service. More likely, though, if FiOS goes away, so does any relevant broadband competition. So yeah, realistically speaking, a consolidated Verizon Wireless is a reason to worry about the future of FiOS.
But GigaOm’s Kevin Fitchard offered a different take on the long-term implications of the deal on both Verizon and the industry. Verizon will no longer have to run its wireline and wireless businesses as separate companies, allowing it to break down the increasingly artificial distinction between a mobile service and a home or business broadband service. The wireless industry’s future growth is going to come from the Internet of things: tablets, cars, wearables, appliances and ordinary household objects. Some of them will link to home networks, some of them will connect to the mobile network, but many of them will need to link to both.
“In an increasingly saturated world, the value of bundling can’t be understated,” said mobile telecom analyst Chetan Sharma. “The ability to combine a series of solutions and services can lower churn significantly. Finally, given that 70 percent to 80 percent of the data traffic is indoors and on Wi-Fi connected to the wireline network, understanding the user behavior on non-cellular channels becomes important. If one has good wireline coverage, one can start to rethink wireless networks as well.”
Now Verizon can just sell connectivity — a single plan that links you to multiple networks.
How does that look? Fitchard offers this example:
A connected car when parked in the garage could remain in constant communication with a home Wi-Fi network attached to FiOS modem, automatically loading into your dashboard the most current maps and navigation destinations, new songs from your music library and the latest movies and TV shows from your video subscriptions. When that car leaves the garage LTE connectivity – either from an embedded chip or from you smartphone — takes over, but that link is only needed to connect calls, and provide real-time traffic updates or verify your content permissions. The bulk of the actual data traverses cheap Wi-Fi connections rather than expensive cellular airwaves. Smartphones and apps can then link to the car either directly through in-vehicle networks or remotely using telematics systems connected to the LTE network. Verizon’s cloud infrastructure (now owned by the wireline side of the house) could then manage all of the connections and intertwined devices, ensuring everything from last minute shopping to Dad’s expected arrival time home from work is synced across all of those apps, devices and networks.
How do we get there? Well, consumers are gonna have to dig deeper into more than just their wallets. Consumers and businesses will have to place a lot more trust (and money) into Verizon’s hands than they’re accustomed to today. And there’s going to have to be cooperation between device makers and Internet of things players.
The next step in realizing Verizon’s vision, whatever it is, is gaining regulatory approval for the deal. Antitrust regulators and the Federal Communications Commission will review the deal, but, observers say, that shouldn’t be a problem. "The deal should sail through," said Jeffrey Silva, a telecommunications industry analyst for Medley Global Advisors. He noted that unlike the purchase of Sprint by Japanese firm Softbank, the Verizon-Vodafone deal will result in less foreign ownership of the telecommunications industry. Silva predicted that some groups could try to use the regulatory review of the Verizon deal to push their own policy goals. "Any time there's a big transaction, there's enough attention to it that you could see entities come out of the woodwork to try to leverage their agendas," he said. "Typically, it's more for the exposure or the [public relations] effect."
Public Knowledge Senior Vice President Harold Feld said we should think of this FCC review “as more like a change of address notification than as a full on application” since Verizon already controlled the wireless company. But Feld goes on to warn that the deal does come with serious implications. In areas severely damaged by Superstorm Sandy, Verizon is trying to replace traditional landline service with Voice Link, a sorta, kinda, not quite as good wireless substitute. Verizon Communications, which owns Verizon’s landline business and 55% of Verizon Wireless, leases capacity from Verizon Wireless in order to provide Voice Link. If Verizon Communications owned 100% of Verizon Wireless, this would be a mere “transfer payment,” an accounting trick that makes no difference. But Verizon Communications currently loses 45 cents out of every dollar it pays to Verizon Wireless, because 45% of the revenue from Verizon Wireless goes to Vodafone. If Verizon is serious about switching millions of traditional landline customers it currently has from copper to Voice Link (and that appears to be the long term plan), this starts to add up real quick. Which explains the high valuation Verizon (and others) put on getting back that 45% from Vodafone. Forty-five percent of Verizon Wireless is worth nearly as much as the entire company today because a sizable chunk of the wireline revenue is being directly transferred to wireless, with a loss of 45 cents on the dollar.
So, one of the biggest deals ever. Billions of dollars in play. Huge implications for the future of U.S. telephone, Internet, and wireless service. We should be sick of Verizon news by now, right? To us here at Headlines, the story seemed a bit underplayed. Blame it on Labor Day weekend, or Microsoft’s desperate acquisition of Nokia, or CBS returning to Time Warner Cable ... or maybe the deal just needs a closer look, a look, that, unfortunately, will not come from regulators. But we’ll be watching and we’ll see you in the Headlines.