Vodafone shares set for deeper fall but Liberty will call again

Vodafone and Liberty Global have called ‘it’ off.

For many investors, ‘it’—the deal—was as much a source of concern as whether it would go through or not.

This added to the uncertainty over the four months or so since a potential deal between the world’s No.2 mobile company and world’s biggest cable company was mooted.

The pair confirmed they were considering an ‘asset swap’ in June.

The eventual outcome of this would be a de facto partnership that could have enabled ‘cross selling’ of cable, fixed-line, mobile, broadband and other ‘quad-play’ services, and beyond.

In short, it could have been a quicker way for Vodafone to catch-up with the capabilities of ‘quad’ or ‘triple-play’ rivals, like TalkTalk, BT, Liberty-owned Virgin Media, Sky and others.

The increasing threat implied by these has probably been instrumental in keeping Vodafone stock under pressure in the year-to-date with a 9% drop (by last Friday) compared with the FTSE’s 6%, despite VOD’s 14% run-up between 19th May and early June.

In fact Vodafone stock setting fresh 2015 lows on Monday with a fall as deep as 4.5% is quite consistent with investors re-evaluating the equity story which had taken the shares 44% up from October 2014’s trough to June 2015’s peak.

Similarly, Liberty-Vodafone talks reportedly stumbling on the parties’ inability to agree the relative value of assets on both sides is something we spotted as a potential risk in the summer.

As noted then, a pro forma figure for the European VOD assets coveted by Liberty might have been based on c. 7.05 times 2017 Enterprise Value/Ebitda.

That implied a take-out figure for VOD’s German businesses alone of £7.7bn.

It was questionable whether Vodafone could discount its entire European operations for less.

On the other hand, the implied value may have made the eyes of even inveterate leveraged acquirer John Malone, Liberty’s chairman, water.

In the end though, I expect Vodafone investors to find some solace in the fact that valuation (AKA ‘price’ in an asset-swap deal) was the main area of concern.

The same logic that drove Vodafone and Liberty together in the first place still holds sway.

Synergies estimated between $30bn of combined net asset value will be one important factor.

Plus, Vodafone still needs to tackle the issue of European service diversification head-on, and there are still no other viable sellers in the region right now.

On LBTYA’s side, it wants material European expansion.

But high leverage (total debt/equity: 313.70%) is (finally) starting to make LBTYA’s preferred direct leveraged finance model inefficient—something rating agencies have been warning would happen for years.

In short, it makes sense, even so soon after the ‘break-up’, to expect some sort of a ‘make-up’; though timing is of course the most important unknown.

At the very least we would need to see a signs of a more measured approach to valuation on both companies’ parts first.

Additionally, Liberty would be remiss to engage in further separate debt-fuelled corporate action before the resumption of talks.

A depletion of Vodafone equity value might encourage management to take Liberty’s call when it comes.