LONDON -- Reports that Verizon Communications (NYSE:VZ) may buy Vodafone (LSE:VOD) (NASDAQ:VOD) out of their U.S. joint venture has seen buyers rush to pick up Vodafone shares. This morning, the shares are up 2.6%.
After a disappointing 2012, Vodafone is one of the biggest winners so far in 2013. Since the beginning of the year, share in the telecom's titan are up 5.3% versus 2.9% for the FTSE 100 index.
How big might a bid be?
Currently, Vodafone owns 45% of Verizon Wireless (VZW). Verizon Communications (Verizon) owns the majority balance. Verizon's chief executive officer, Lowell McAdam, recently discussed VZW with The Wall Street Journal, saying how Verizon would "love to own all of that asset." McAdam also emphasized not just the desirability of a deal but also its feasibility.
This has led to speculation on how much Verizon would have to pay Vodafone for its stake in VZW.
In 2012, VZW paid Vodafone a total of 5.3 billion pounds in dividends following what Vodafone called a "strong performance." The growth that the VZW business is enjoying suggests that these payments to Vodafone could increase in future years.
I expect that VZW is paying out close to all of its profits to its owners. Applying Vodafone's current price-to-earnings ratio of 10.3 to that 5.3 billion pounds of cash flow gives an estimated price tag of 54.6 billion pounds for Vodafone's stake in VZW. That is significantly ahead of the 50 billion pounds that commentators are currently speculating on. Verizon would need to undertake a massive fundraising to buy out Vodafone at those kind of prices.
Currently, Vodafone only receives its dividends from VZW because Verizon is voting for a payout from VZW itself. I don't think that dividends from VZW to Vodafone are in any real danger. Without dividends from VZW, Verizon's own dividend and share price would be under threat.
If Verizon does not want to pay cash for Vodafone's stake, it could structure a deal that would allow VZW to be spun out of the current joint venture. In this scenario, Verizon would own 55% of a separately listed VZW and Vodafone shareholders would get 45%. Verizon might increase its stake in VZW by offering Vodafone shareholders a price for their shares at IPO.
What to do?
I continue to hold shares in Vodafone. The company is a reliable dividend payer. The shares come with an expected yield of 6%, while the company is also using its dividends from VZW to buy back shares in the market, which will help support future dividend growth. There is also the possibility that the buyback will push the shares higher in the short term.
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David O'Hara owns shares of Vodafone. The Motley Fool recommends Vodafone Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.