British telecom giant Vodafone (VOD) agreed to sell its stake in Verizon Wireless to Verizon Communications (VZ) in one of the biggest deals in history.
That’s the headline.
But the question no one seems to be asking is “Why was Verizon that eager to spent $130 billion on a capital-intensive business in a saturated market with cutthroat competition from cheaper upstarts?”
Seriously. Mobile phone penetration is the United States was 102% as of the end of last year, and this is a conservative number using the entire population of the United States and its territories as the denominator. Removing small children, the elderly and infirm and the prison population, the number would be significantly higher. Not only does every American already have a cell phone, but many of us have two or three.
But hey, even though everyone already has a phone, there’s still growth in the smartphone market, right?
Not nearly as much as you might think. Already, more than 61% of all American mobile phones are smartphones. Even among Americans aged 55 and older, the rate of ownership is 42%.
Will the baby boomers adopt iPhones and Androids in larger numbers going forward? Probably. But the low-hanging fruit was picked a long time ago. And to the extent that the over-55 demographic adopts smartphones, those people are likely to buy entry-level data plans that are highly competitive on cost.
It’s hard to see a lot of room for margin expansion in a saturated market where the “stickiness” of consumer loyalty is being steadily eroded by falling switching costs to the consumer. Add to this the body blow that T-Mobile US (TMUS) dealt to the industry with its adoption of transparent pricing and the elimination of the carrier phone subsidy, and it’s hard to find much to like here.
Don’t underestimate the effect of that last point. Carriers have offered “free” or highly discounted phones for a long time as a way of enticing you to pay up for a Cadillac voice and data plan. It was a terrible deal for the consumer, but the pricing was opaque enough that most had no idea just how bad of a deal it was. T-Mobile’s transparent pricing has been something of a wake-up call.
All of this is a long way of saying that Vodafone got the better end of this deal. It rids itself of a profitable but soon-to-be no-growth business, has the means to pay off all company debts nearly three times over, and has the financial firepower to expand its emerging-market presence, which is already one of the largest among Western carriers.
As far back as 2011, Vodafone’s CEO had publicly stated that Vodafone was an “emerging markets company” and not a European company. Emerging markets accounted for 29% of Vodafone’s service revenue last year and virtually all of its expected future growth. The company operates in 30 countries and partners with other carriers in 40 more.
So, what will Vodafone do with all of its cash? That’s a fine question, and the company hasn’t given a lot of specifics just yet. Some combination of debt retirement, share repurchase and a special dividend would seem likely.
But should you buy Vodafone now, after the Verizon Wireless divestiture?
Perhaps. Vodafone likely will release a large special dividend, but it’s harder to say whether its current generous 6% dividend will stay intact. Also, Vodafone is a great way to get “back door” access to the emerging middle class in India and parts of Africa.
But before I make a significant new allocation to Vodafone, I’d like to see a little more guidance from management on what it intends to do with its windfall.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.