By Kate Holton, Chris Vellacott and Sinead Carew
LONDON/NEW YORK, March 22 Almost five years
after taking the helm at the world's second-largest mobile phone
company, Vittorio Colao doesn't want to be the third Vodafone
boss to be stumped by its seemingly intractable U.S. 'problem'.
The urbane Italian, who has streamlined a company built on
the foundations of aggressive expansion, is exploring what to do
with the one remaining asset he does not control - the stake in
U.S. operator Verizon Wireless, which makes up about 75 percent
of the firm's value.
On paper Colao has several options, each with pros and cons:
sell all or part of the stake to majority owner Verizon
Communications, maintain the status quo in the face of
Verizon's desire for a deal, or sell Vodafone in its entirety to
But with an asking price for Vodafone's 45 percent stake in
Verizon Wireless around $115 billion and a potential $20 billion
tax bill on the capital gain, Vodafone investors worry that
Verizon may not be willing to pay enough for a business it
already controls. And some say that without exposure to the
booming U.S. market, Vodafone would be just a collection of
shrinking European assets paired with India and African units.
Yet with sterling weak and Verizon's valuation multiples
higher than Vodafone's, conditions are favourable for a deal.
Verizon has long said it would like to acquire the stake, and
relations between Colao and his U.S. counterpart Lowell McAdam
are stronger than in the past when the two sides engaged in
long-running power struggles.
Vodafone has lawyers from Linklaters, bankers from UBS and
consultants from McKinsey looking at deal options and structure,
and for ways to reduce the tax bill, according to three people
familiar with the situation.
"Is (a Verizon stake sale) good for Vodafone shareholders?
Short term, undoubtedly yes," a fund manager at one of
Vodafone's 10 largest investors told Reuters, on condition of
"Long term it remains unclear. Verizon Wireless is their
best asset, and without it Vodafone is essentially operating in
an industry with structural decline, a falling free cash flow
and an uncovered dividend. Therefore the overarching question
is, what does Vodafone do with $115 billion?"
Chris Gent, the cricket-loving boss who built Vodafone into
one of the world's biggest companies, formed the joint venture
in 1999 in one of his legendary mega-deals, which he famously
used to conduct while watching his favourite sport.
Gent merged Vodafone's U.S. assets with Bell Atlantic to
form Verizon Wireless, but from the outset Vodafone was the
junior partner and it soon started to grate. Gent's successor
Arun Sarin at one point tried to buy rival AT&T instead
and was even linked with a deal for all of Verizon.
Finally, Sarin settled for the status quo, which paid off
handsomely as the value of Verizon Wireless rose along with its
dominance of the U.S. market. Profit margins and quarterly
subscriber growth have consistently surpassed its smaller rivals
and in recent years it has had a headstart in offering the
latest high-speed wireless technology.
But it was not always a happy marriage. From 2005 to 2011,
Verizon refused to sanction a dividend from the unit to either
parent in what was seen as a bid to force Vodafone out. It only
relented when it needed cash to fund its own annual payout.
Now Colao is mulling his U.S. options after cleaning up the
rest of the portfolio. He says the board reviews the stake at
least twice a year and has an open mind on whether to keep it.
He describes it as a nice problem to have, but analysts
suspect he will not want to move on from Vodafone with the issue
"Vittorio Colao is not the kind of person to shy away from a
challenge. And conditions have never been better," one former
Vodafone insider said. "But this would be huge."
Deal hopes have risen this year along with Verizon's
valuation, now at 17.5 times price to earnings, compared with
Vodafone's 12 times, making an offer that includes Verizon
shares more attractive.
A sale would enable Vodafone to return cash to shareholders
and to purchase fixed-line assets in Europe, though Colao has
said he does not need money from the U.S. to fund acquisitions.
And it would give Verizon, which is reliant on the Wireless
operations for growth, a lot more flexibility with its cash.
One of the main obstacles is the issue of the tax bill if
Some tax experts in the United States have said Vodafone
could structure the deal to reduce the tax obligations, but
analysts in Britain doubt they would want to be aggressive on an
issue that can cause a backlash among politicians and consumers.
"There are lots of smart people working on the tax issue,"
one sector banking source told Reuters. "There are ways to
minimise the leak, but it won't be a zero leak."
Deutsche Bank says a cash-and-share deal would require the
U.S. group to issue between 31 and 62 percent of existing
capital if it increased its leverage, leaving Vodafone with 24
and 38 percent of Verizon, giving it a regular dividend.
Erich Patten, portfolio manager at Cutler Investment Group,
a holder of Verizon shares, is open but cautious about a deal.
Being able to access all the cash would be a benefit but "if the
dividend was put at risk that would be a negative for us".
"If it's an expensive deal I'd expect the stock would be
Verizon has always said it would like to acquire the stake
but declined to comment for the story.
A lack of clarity about which holding companies within
Vodafone own which assets - for instance Vodafone America holds
assets in a number of other jurisdictions - means outsiders
cannot tell whether Vodafone could reduce the bill, a situation
that suited the company when it did not want to sell.
Vodafone could also lose the benefit it now derives from its
holding company structure, including a low-tax Luxembourg unit.
With a stake sale posing so many issues, sector bankers are
again looking at scenarios where the two parent companies merge.
While the problems associated with creating a firm with a
combined market value of $278 billion cannot be underestimated,
the chances of it happening have increased under Colao and
McAdam, who previously ran the Wireless business, and Colao
meet for dinner or coffee when in the same city, a person
familiar with the situation told Reuters, and the two firms now
work together on projects such as procurement and services to
However, for Verizon to consider a merger or acquisition of
Vodafone, McAdam would have to accept that the subsequent
exposure to Europe, India and Africa is a price worth paying to
access all of the Verizon Wireless cash.
There are also deal structure issues, such as whether to
keep market listings on both sides of the Atlantic so as not to
lose major shareholders from funds that are limited to U.S. or
European equities, and where it should be tax domiciled.
One of Vodafone's biggest 20 shareholders told Reuters that
while he could not rule out a merger this year, he wouldn't be
surprised if price and structure stymied a deal.
"Without (a merger or solution to the tax) you're probably
looking at the status quo, because I can't really see on the net
basis they could put up a big enough price to make it stack up
for Vodafone shareholders," he said.
"It's a problem people have been trying to unravel for a