Mobile giant Vodafone (LSE: VOD) and US cable group Liberty Global have announced a merger of their operations in the Netherlands. The combination of the FTSE 100 firm’s mobile business with Liberty’s Ziggo broadband and TV business in a €19bn JV will create the second-largest integrated player behind KPN.
Liberty’s operations are valued at €14bn, but with €7.3bn of debt they have an enterprise value of €6.7bn. Vodafone’s business is valued at €4.7bn on a debt and cash free basis, so the UK group will make a cash payment to Liberty Global of €1bn to equalise ownership in the JV.
The transaction is expected to close around the end of this year. It’s subject to regulatory approval, which shouldn’t be a problem.
The JV expects to incur €350m of integration costs in its first three years, but to generate annual synergies of €280m by year five and is looking to carry net debt of 4.5 to 5 times earnings, around twice as high as Vodafone has been familiar with. But both sides are apparently comfortable with the position.
Vodafone chief executive Vittorio Colao said: “Together we will be a stronger competitor in the Netherlands, benefiting customers of both companies and the market as a whole. This transaction marks a continuation of Vodafone’s market-by-market convergence strategy.”
Following on from its acquisition of cable operators in Germany and Spain, today’s deal marks further progress for Vodafone in the battle among Europe’s leading telecoms groups to offer combined packages to consumers, businesses and the public sector.
Muted response
However, the market gave a muted response to the deal at opening this morning. In fact, Vodafone’s shares have now ticked down a penny, as I write.
There’s a lot of hope of exceptional future earnings growth baked into Vodafone’s current 208p share price, with forecasts for the year ending March 2016 giving a sky-high price-to-earnings (P/E) ratio of 43. Analyst expectations of 18% earnings growth for the year to March 2017 still leave Vodafone on a super-elevated P/E of 36, while a price-to-earnings growth (PEG) ratio of two doesn’t scream growth at a reasonable price.
Vodafone’s high dividend yield of 5.4% may be part of the reason the share price is as high as it is, but I think another major factor is the market’s hope of a much bigger deal than today’s Netherlands news coming along at some point.
Bigger news ahead?
Last year, rumours of a fully-fledged merger between Vodafone and Liberty proved wide of the mark, but the two companies did embark on discussions about an extensive asset swap across Europe. However, those talks broke down in September.
Could the Netherlands joint venture be a precursor to a far bigger deal between Vodafone and Liberty? Both companies, as well as most analysts, see a marketplace logic and operational benefits of combining or swapping assets in key European countries.
Differences in valuation have apparently been the stumbling block, but comments on today’s deal by Liberty chief executive Mike Fries don’t rule out the possibility of bigger future transactions. He said he was looking forward to working with Vodafone, gaining “valuable knowledge and experience” and seeing “how this particular combination works”.
So, today’s news is encouraging for Vodafone shareholders, although I continue to think the P/E and PEG valuations are on the rich side and that Vodafone will have to beat analyst expectations to justify them.
