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Why it may not be a win-win deal for Vodafone and Verizon

Lex is a premium daily commentary service from the Financial Times. It helps readers make better investment decisions by highlighting key emerging risks and opportunities.

Win-win scenarios rightly invite skepticism, at least where investors are concerned. So what to make of share price rises at Vodafone and Verizon Communications this week as the odds rose on a blockbuster sale by the former to the latter of its 45-per-cent stake in Verizon Wireless?

Vodafone jumped 8 per cent on Thursday on thoughts that it would be selling out at a juicy $130-billion (U.S.) price just as the lucrative U.S. mobile sector becomes more competitive. It could then return much of the deal proceeds to shareholders and use the rest to tackle a moribund but evolving European market.

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Shares in Verizon Communications, meanwhile, added 2 per cent as number-crunchers totted up likely improvements to free cash flow and earnings per share once full ownership of the fatter-margin mobile business is secured. Happiness all around.

Hmm. Mutually beneficial deals may appear possible in the short term, but time tends to shine a crueller light. Think of a simple property transaction. A sells a second home overseas to B, just as that housing market peaks. The seller is happy to have exited at the top and deploys some of the proceeds in doing up his wreck of first home. B knows he has paid top dollar, but is cock-a-hoop with the convenience of his new house, which provides savings on bills and the like. Over the years, though, this euphoria may well fade – most obviously in B's case if the local housing market tanks, or in A's if the first home is hard to salvage.

Such parallels are not that far-fetched. Even if a Verizon Wireless deal concludes at a the tasty rumoured price, Vodafone's Vittorio Colao is gambling that the company can start to win in Europe, where fixed and mobile services are converging and consumers switching to packages covering a bundle of devices. Verizon's Lowell McAdam must hope that U.S. wireless margins do not erode too fast as smartphone usage reaches saturation, 4G networks are widely deployed and competitors, like Sprint, up their game. His risk is arguably larger since Verizon will be doubling its bet on the U.S. wireless market at a premium price.

In truth, deals struck at high prices usually take place when buyers are scouring for growth with limited options. The drug sector is a case in point – witness Amgen's pricey Onyx deal. Such bets aren't always doomed: Novartis, say, did well by buying Alcon eyecare from Nestlé on a forward multiple of 23 times. But investors should pause for thought.

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