Why Verizon Communications Holders Like it Spending $130 Billion

It’s not every day the prospects of a company spending $130 billion has its shareholders thrilled, but few scenarios in the corporate world are quite like Verizon Communications VZ +3.63% and Vodafone VOD.LN +8.66% .

Vodafone, the U.K. wireless giant, confirmed Thursday it was back in discussions with Verizon Communications over their lucrative joint-venture Verizon Wireless. WSJ is reporting that Verizon Communications may be near a deal in the next week that could see it pay Vodafone $130 billion for Vodafone’s 45% stake in the carrier.

That certainly has Vodafone shareholders excited, as its ADRs in New York are up 8.6% premarket to $31.93, which would be the highest they have traded since January 2011.

Verizon Communications shareholders are nearly as excited as well.

Its stock is up 5% to $48.90 in premarket action and there have been nearly 4 million shares of Verizon traded in premarket activity, almost half of its typical daily volumes.

The potential for these two to strike one of the biggest deals of all time has long had analysts excited.

Barclays analysts base their entire thesis on Verizon shares on the probability of a deal with Vodafone. In a recent report, the analysts laid out their case for a $59 price target by saying they expect a deal done in 50% cash and 50% debt. It would add about 31 cents to Verizon’s 2014 earnings per share, a 12.7% boost.

The analysts also presented a scenario that the deal provides a 75-cent boost to earnings, which would make shares worth $65 a piece. The downside scenario was Verizon backing away from a deal and sending shares to $49.

Wells Fargo analysts Thursday morning said they see “any step toward resolution of this ownership as a significant positive for the VZ shares.”

Analysts and investors in Verizon Communications love the chance to spend $130 billion for one reason: cash flow.

“The free cash flow power of the VZW ‘machine’ would help further strengthen VZ’s already solid cash flow position and payout ratio,” Wells Fargo wrote.

Verizon pays a divided of 51.5 cents per quarter, compared to the 78 cents it earned per share in the second quarter. For all of 2012, it paid $2.03 when it earned, on an adjusted basis, $2.24 a share.

Much as in a leveraged-buyout, Verizon would be able to take the cash-cow that is Verizon Wireless and pay down the $50 billion plus that analysts expect it to raise in debt.

RBC’s credit analysts said a deal done at $125 billion, half in debt, half in equity, would put Verizon at a debt-to-Ebitda ratio of about 2.6x. That could impact Verizon’s single-A credit ratings.

But, “the positive financial benefit of owning 100% of Verizon Wireless is all of this free cash flow will be retained within the Verizon complex, allowing for rapid debt paydown,” RBC wrote.

In 2012, Verizon Wireless generated $28.6 billion in cash flow from operations and spent only $8.9 billion in capex, according to RBC. That rate would allow Verizon to get back to a more A-rated debt ratio of below 2x in 2015, RBC said.

Nomura analysts said Verizon’s pro-forma cash flow would go from $9.9 billion in 2012 to $17.1 billion in 2015. That’s why they support the deal, even at the “lofty” multiples a $130 billion deal would imply.

“As Verizon would own 100% of arguably the best wireless asset in the country, in addition to a modestly improving wireline business, we believe the market should support this deal even at this lofty multiple,” Nomura wrote.