NEW YORK (Reuters) - It’s not often that Wall Street shrugs off what amounts to a 30 percent price hike for an asset inside of four months.
But that is what happened to Verizon Communications Inc (VZ.N) when news broke that it is in talks to buy out Vodafone Group Plc’s (VOD.L) 45 percent stake in their U.S. wireless venture for up to $130 billion, up from the $100 billion price range that it was considering back in April.
Verizon shares closed 2.7 percent higher on Thursday as investors took in stride the prospect of the company taking on tens of billions of dollars in debt to fund such a deal.
For years, Verizon has made no secret of its ambitions to own all of Verizon Wireless - the top U.S. mobile service provider - because it has the best customer growth rate and profitability of any telecom company in the country. But concern around overpaying for an asset that it already controls has always gotten in the way.
Analysts saw three big motivating factors to support a deal now: rising interest rates, rapidly intensifying competition and a 12 percent drop in Verizon’s shares since April.
If these trends continue, and analysts expect they will, a deal gets that much more expensive for Verizon to pull off.
“With interest rates rising, Verizon and Vodafone are cognizant of the fact that they have a narrow window to get this deal done,” said New Street analyst Jonathan Chaplin.
Vodafone has confirmed it is in talks with Verizon but declined to give details. Verizon declined to comment.
The U.S. Federal Reserve has said it expects to begin scaling back its monthly purchases of government and mortgage-backed debt with an aim to eventually ending the practice next year. The expectation that this policy shift may come as soon as September has already lifted long-term interest rates.
In such a rate environment, a deal for Verizon Wireless will only get more expensive the longer Verizon waits. Already, Verizon can expect to pay several hundred million dollars more in annual interest rate payments today than it would have expected to pay in April.
The yield on the benchmark 10-year US Treasury note has risen about 1 percentage point to 2.76 percent.
Even with the higher interest rate costs, Macquarie analyst Kevin Smithen estimated that buying the rest of Verizon Wireless could still increase Verizon’s 2014 earnings per share by 14.7 percent. But if Verizon had done a $130 billion deal earlier this year, when its share price was higher and interest rates were lower, that increase would have been more like 21.8 percent, according to Smithen.
“If price was the only sticking point, we’re not sure why Verizon didn’t pull the trigger earlier,” said Smithen.
Verizon, which currently leads the U.S. pack in wireless customer growth and profitability, needs new ways to grow as the U.S. market slows because most people already own smartphones, and competition is intensifying rapidly.
Thanks in part to aggressive marketing, No. 4 U.S. mobile operator T-Mobile US TMUS.N started reporting net subscriber growth in the second quarter after years of losses to rivals such as Verizon Wireless. Sprint Corp (S.N) is also expected to become a tougher rival as it beefs up its network and now has the backing of majority owner SoftBank Corp (9984.T).
“Verizon would like to have total control of this asset, particularly as we’re getting into a more competitive environment,” said S&P analyst James Moorman. “When you look at the value of this asset it makes sense to get it in house.”
Still, such a deal is not without risk as it would saddle Verizon with a heavy debt burden that could tie up its cash flow. Craig Moffett of Moffett Research was more hesitant about the merits of such a huge deal at a time when growth is slowing in the U.S. wireless market.
Because the United States has been one of the best wireless growth markets in the world and Verizon has been a leader, it is unlikely to face much more improvement to its business, he said.
“There is little prospect for things getting materially better for Verizon Wireless, and a meaningful chance that things get worse,” Moffett said.
The downside to swallowing such a high price tag is it might make it tough for Verizon to bid in upcoming spectrum auctions, leaving the coast clear for rivals like AT&T Inc (T.N), noted New Street’s Chaplin.
But he said investors would likely still prefer to see Verizon buying “the best asset globally in telecom.”
“Its worth $130 billion,” he said.
Analysts also point out that full ownership of Verizon Wireless would automatically boost Verizon cash flow without it having to make any strategic changes.
With Verizon Wireless’ free cash flow of $28.6 billion last year, RBC Capital Markets analyst Doug Colandrea said Verizon has the ability to pay back debt “very rapidly.”
Additional reporting by Jonathan Stempel; Editing by Edward Tobin and Tim Dobbyn