David Einhorn's Vodafone (VOD) Thesis Coming to Fruition? ~ market folly

Tuesday, March 30, 2010

David Einhorn's Vodafone (VOD) Thesis Coming to Fruition?

In the past we posted up David Einhorn and hedge fund Greenlight Capital's investor letter. In it, we learned that he was bullish on shares of Vodafone (VOD) as it represented one of the larger positions in their portfolio. Greenlight Capital of course has an impressive track record, returning 22% annualized. Einhorn's thesis on Vodafone argues that VOD's most valuable asset is its 45% ownership stake in Verizon Wireless. (Verizon Communications (VZ) owns the other 55%).

Previously, Vodafone had received a dividend from Verizon Wireless. However, they haven't received one in quite some time as Verizon Wireless' cashflow was being used to pay back debt to Verizon Communications. Verizon Wireless is expected to be debt-free by the end of next year and this is where the catalyst component of this investment comes in. Einhorn believes the restoration of this Verizon Wireless dividend or some other transaction is highly likely. And as you'll find out below, this may very well be the case.

Greenlight's average cost of their position was £138 per share. At the time of their purchase, they estimated that VOD was trading at "less than 3x estimated 2010 EBITDA, versus in excess of 5x for the peer group average in Europe." And while they wait for the catalyst to come to fruition, they still capture a nice 6% dividend. Einhorn purchased the regular VOD shares traded on the London Stock Exchange, but US investors can still purchase the ADR shares traded on the Nasdaq (ticker VOD as well).

Vitaliy Katsenelson of Investment Management Associates and ContrarianEdge also previously elaborated on reasons to own Vodafone. In the past he has labeled it a 5.5% inflation protected bond with a free non-expiring call option because of its solid dividend and large potential catalyst. If you pull out VOD's Verizon Wireless stake, he points out that the company is trading at an enterprise value to EBITDA (EV/EBITDA) of 5.5 and a price to free cashflow of 8.2, deeming it cheap on valuation.

Katsenelson also highlights some of Vodafone's other valuable ownership stakes. It owns 3.2% of China Mobile (CHL) and 44% of Societe Francaise du Radiotelephone (SFR), both of which it receives dividends on. Lastly, he points out that VOD's debt is not a problem as it can be paid off with cashflows. Below is Katsenelson's slide outlining the bullish case for Vodafone:

(click to enlarge)

Turning to the catalyst portion of the thesis, let's now focus on the recent article from the FT where we learned that Vodafone will be pressuring Verizon Communications to pay up. The article highlights that there's really three scenarios here that would please Vodafone (VOD) shareholders:

- Verizon Wireless resumes its dividend payments to Vodafone
- Vodafone and Verizon merge
- Vodafone sells its stake in Verizon Wireless

Many will argue that the resumption of dividend payments is the most likely, but event-driven stakeholders wouldn't mind any of the above. After all, we've heard that many hedgies have a long VOD, short VZ trade on.

A potential merger or sale though could prove problematic. As the FT article notes, "The UK group's willingness to countenance an all-share merger with Verizon Communications is partly based on legal advice that any sale of Vodafone's Verizon Wireless stake would attract a large tax liability. However, one person familiar with Vodafone said a merger was not attractive, partly because of a lack of synergies between the US and UK groups."

What's interesting though is that Verizon Communications' finance director John Killian did note that, "we are a long way away from when I really need to seriously think about that particular issue," referring to a potential scenario where they would restore Verizon Wireless' dividend in 2012. So, perhaps this catalyst is further off than people thought.

For now, nothing is decided. While these on and off discussions have seemingly been going on forever, it does appear as if VOD has gained some leverage at the negotiating table as Verizon Communications struggles to compensate for their declining fixed-line phone business. We'll have to see if the ball starts rolling now and if Einhorn's VOD thesis could eventually come to fruition. After all, the article's informant claims that VOD has the upper hand in negotiations. In the mean time, many investors seem content to wait and pocket the dividend.

For more on Greenlight Capital, head to our coverage of the rest of David Einhorn's portfolio as well as their prior investor letter.

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