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Deal Or No Deal For Vodafone Group plc And BT Group plc?

Vodafone (LSE: VOD) stock has been under pressure in the last few days as speculation emerged, once again, that the UK British behemoth may target Liberty Global.

Such an outcome is unlikely, in my view, yet investors seem to believe that there remains a chance Vodafone will pay up to $50bn to snap up Liberty. Either way, it’s almost certain Vodafone will end overpaying to bulk up via acquisitions in the next 12 months.

I would rather bet on BT (LSE: BT-A) right now. Its equity valuation continues to benefit from mergers and acquisitions (M&A) talk that could materialise in a deal of between £8bn and £12bn either for O2 or EE.

But should Vodafone and BT embark on multi-billion acquisitions at all?

History suggests that Vodafone ought to slim down to become a more palatable investment/asset, rather than making an attempt to grow in size. As far as BT is concerned, it must pay attention to its capital allocation strategy.  

BT Trades High 

The rise in BT share price is hardly surprising in this low-growth environment.

Investors must pay up to buy the shares of a company willing to embark on large acquisitions. BT stock, which trades at five-year highs. beats the market by seven percentage points since mid-October; the recent rally is mainly due to BT’s appetite for either EE or O2.

Is this a big risk for shareholders? Maybe, although one may argue that is also great news for BT and its M&A strategy.

Market talk suggests a deal could be imminent. The sooner the better for BT and its shareholders. The rise in BT’s stock price means it would be easier to finance any takeover by issuing less expensive equity capital. The right balance between debt and equity financing, say 60% and 40%, respectively, would keep leverage under control. In fact, whether BT stock will rise significantly — say 10% or more — from its current level depends on the structure of the deal.

BT’s M&A track record is not impressive, as focus has shifted on sorting out a stretched balance sheet in recent years. Now is a good time to pursue deal-making to boost value, although value can be easily destroyed via M&A. 

Vodafone Premium

Talking of value destruction in mergers and acquisitions, how can we fail to mention Vodafone’s £100bn+ acquisition of Mannesmann in the late 90s? In recent years Vodafone has been more cautious, but that’s not to say it has been smart in spending billions of shareholders’ funds. 

Its stock trades some 10% below its five-year high, but is more expensive than BT stock based on its relative value to operating cash flows. The premium may be justified by a higher yield, but Vodafone’s M&A strategy is one of the biggest risks for its shareholders. 

Latest quarterly figures have push up the stock to 230p from 207, proving that Vodafone may be able to deliver value by growing organically. Its stock is still down 9% this year, however, and could struggle in weeks head if M&A talk turns out to be true. 

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.