Investors who want big dividends and don't mind risk may want to consider a stake in Vodafone Group PLC now that the British wireless giant has agreed to shed its U.S. holdings in a mammoth $130-billion (U.S.) deal.
The deal to sell its 45-per-cent stake in Verizon Wireless will allow Vodafone to step out of the U.S. wireless market at a time when increased competition and rising interest rates threaten to shrink margins.
It also allows Vodafone to focus on its main European markets, which are benefiting from a slow economic recovery, and to pursue new growth in Africa, Asia and the Middle East.
To be sure, the shares aren't as cheap as they once were. They ran up 10 per cent in the days leading up to the announcement Monday of its Verizon deal, before falling by 1 per cent Tuesday to close at $32.01 on the Nasdaq.
Edward Jones analyst David Heger slapped a "hold" rating on the stock now that it's trading near its 52-week high. However, he still believes the shares are worth owning, in large part because of their generous 5-per-cent yield.
Macquarie Group analyst Guy Peddy raised his price target and cut his rating to "neutral," suggesting in a note that investors "look to take profits and revisit the investment case in six to 12 months."
Analysts say Vodafone got a good price for its stake in Verizon Wireless, which it sold to its partner Verizon Communications Inc. for 9.4 times EBITDA, or earnings before interest, taxes, depreciation and amortization. But investors are nervous because nearly half the purchase price – $60.2-billion – will be paid in Verizon Communications shares.
Vodafone fell by nearly 4 per cent in early trading on Tuesday, as investors considered the risk of being paid in shares of a stock that faces big market challenges in the U.S.
In addition, the deal includes a "collar" agreement that limits the number of shares that Verizon will have to pay if its share price falls or rises above certain limits. In effect, the collar clause provides only limited protection for Vodafone shareholders if Verizon shares continue to fall.
"I think the problem is that the deal is a paradox," Bernstein Research's London-based analyst Robin Bienenstock said in an e-mail. "It is a statement by Vodafone that the top of the U.S. wireless market has been and gone … and yet as a Vodafone shareholder the deal is structured so that you get paid with this obviously declining currency of Verizon shares that you cannot monetize until March when the deal closes."
Verizon Communication shares, like other consumer-related stocks, have been under pressure since late May when the U.S. Federal Reserve said it would begin tapering its massive bond-buying program, known as quantitative easing. While the taper is an encouraging sign the U.S. economy is recovering, there are concerns that the rise in interest rates will dampen consumer spending.
Morningstar Inc. analyst Allan Nichols said the Vodafone stock dropped on Tuesday because some investors concluded they will save money on taxes by selling now rather than waiting for the deal to close, at which point they will receive a distribution of cash and Verizon shares that could be taxed as regular income in the United States.
"For some individuals it is cheaper to sell now and pay a long-term capital gains tax rather than receive the distribution and pay tax as ordinary income," he said in a note.
While long-term Vodafone investors are still waiting for a return to the stock's peak above $57 in 2000, short-term holders are cheering its comeback, including a 25-per-cent jump since the start of the year.
"We plan to maintain our position in Vodafone … and we think the dividend will hold its value," said Richard Fogler, chief investment officer of Toronto-based Kingwest & Company.
He said the company is considerably cheaper than many of its competitors in terms of share price to EBITDA. And while about two-thirds of the company's revenues are now in Europe, it also has operations in the Middle East, Africa, and the Asia Pacific, which makes it a diversified bet.