Vodafone And The Verizon Anomaly

2nd Jan '14 by Maddox

3 comments 21880 reads

“The remarkable story of colossal hidden value discovered in one of the most in-depth analyst covered FT100 stocks!”

Spotting a pricing anomaly in the market is essentially what all stock market investors are hoping to find. However, when that anomaly is circa £80bn in magnitude and found hidden in one of the most widely covered FT100 stocks it is truly astonishing. Well, that’s what happened in 2013 with Vodafone, and its lucky shareholders will be receiving over £50bn of this value early in 2014.

That a mis-pricing of this enormity could have occurred is both surprizing and difficult to comprehend. I first spotted that there may be hidden in Vodafone in July 2011 when its long held investment in Verizon Wireless (VZW) paid a ‘one-off’ dividend of which Vodafone received a cool $4.5bn.

At this time Mr Market looked to be valuing Vodafone (LON:VOD) solely on its attractive dividend yield of 5.45% with a share price of circa 155p and market capitalisation of £75bn. This was clearly anomalous; Mr Market appeared not to be putting any value on Vodafone’s 45% ownership of VZW – and yet it had just promised a huge windfall dividend. Vodafone’s market value was completely justified by its already generous dividend yield.

One’s first reaction is that this couldn’t be true, there must be a mistake or something missed, but it was very intriguing and certainly worth a closer look.

How could Mr Market miss Vodafone’s hidden £84bn stake?

Well it’s still difficult to fathom, but the reason appeared to be twofold:
? Firstly Vodafone’s VZW investment was not consolidated into its P&L accounts – it was simply not reported. Thus, anyone scanning Vodafone’s figures in late 2011 would see that its dividend yield was circa 5% - ignoring the additional special dividend of 4p giving a true yield of 8.34% for 2012.
? Secondly, VZW was also a non-performing asset in that it hadn’t paid a dividend for many years (2005 – 2011).

For these two reasons Mr Market had completely discounted Vodafone’s investment in VZW to being essentially worthless.

So what was Verizon Wireless worth to Vodafone?

This again was not easy to assess in 2011, VZW as 55% owned by Verizon Communications (VZ), was fully consolidated into its Balance Sheet and P&L. This meant that VZW figures were not visible in the combined balance sheet. However, the…

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MrContrarian

2nd Jan '14

I hold VOD, having bought when the Verizon offer was made. I am close to selling. Here's an antidote to your enthusiasm by Oz fund manager & blogger John Hempton http://brontecapital.blogspot.co.uk/2013/06/vodafone-kabel-deutschland-meet.html
His extremely poor view of Vittotio Colao as a value destoyer is credible given the poor performance of the VOD businesses ex-VZW.
I have found VOD UK's customer service to be very poor last year, repeatedly failing to resolve a problem with mobile broadband billing. Three or four people in CS screwed up or didn't care about my problem. One was downright insulting in his arrogant and mistaken dismissal of my complaint. Such serial failings come from the top IMO.
That's only a sample of one of course, and EE seem to be rated the worst for CS in the UK.

Asagi

I'd guess that there will be over 40 professional analysts being paid to produce research on Vodafone.

The trouble is, their research is effectively broadcast i.e. to their client base of thousands. I would imagine that within the top banks, there could be hundreds of thousands of authorised subscribers to research notes on Vodafone. That's a big audience to disappoint.

You have encapsulated the anomaly thus:
Thus, anyone scanning Vodafone’s figures in late 2011 would see that its dividend yield was circa 5% - ignoring the additional special dividend of 4p giving a true yield of 8.34% for 2012

and gone on to give reasons for the special dividend being sustainable.

I'd take Vodafone's side here: the VZW dividend was not within their gift so they were justified in not making it part of the normal payout (for awhile at least).

However, once anyone became convinced that the payout would continue (either as dividend or buyback), the massive undervaluation was clear as day. Vodafone was already a blue-chip company with a high quality earnings stream and large dividend: buying Vodafone in early 2013 was probably the best risk:reward payoff I have EVER seen in the FTSE 100.

For analysts to call this required them to put their reputation on the line. Better to be just as wrong as everyone else than proffer a scenario that does not come to pass for more than 12 months. It probably reveals the short-term biases within investment bank research.

I think they might call it groupthink.

There is also the old adage "if something looks too good to be true, then it probably is". Some analysts would have done the sums and come up with a valuation for VOD significantly higher than 200p. The trouble is that the shares had not traded as high as that in more than ten years..... so a lack of confidence also applies.

Blue chip prices are set by institutional trade flows. We should not be surprised that Mr Market missed it, given how great an influence sell-side analysts have on professional money managers.

Asagi (no position)

Maddox

3rd Jan '14

Hi Asagi,

Thanks. I agree with everthing you've mentioned. But the role of the analyst is surely to challenge assumptions and the accepted view otherwise what value are they adding (or at least spotting)? We need more iconoclasts in those roles.

I also thought Vodafone wise in paying specials rather than increasing the normal dividend - as otherwise it would have played into Verizon's hands.

Vodafone and the Verizon anomaly

How could Mr Market miss Vodafone’s hidden £84bn stake?

So what was Verizon Wireless worth to Vodafone?

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Maddox

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