Verizon And AOL Enter $4.4 Billion M&A Deal

 

Verizon Communications Inc. announced its intent today to purchase AOL Inc. for $50 per share in cash. The deal is valued at $4.4 billion, and will be funded with cash and commercial paper.

With wireless revenue growth becoming more challenging, telecom companies have been focusing on digital growth, thus, the AOL acquisition. Verizon will benefit from AOL’s contribution to its advertising, mobile and video businesses.

In conjunction with the merger, AOL has been in talks to spin off its Huffington Post division, for a possible value of $1 billion.

The deal is expected to close this summer.

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AOL INC: SELL

(AOL, $50.61, up $8.02 midday)

I haven’t reviewed AOL Inc. recently, due to the company’s current lackluster earnings growth, and the stock’s overvalued price/earnings ratio (PE). On March 26, 2014 I said, “If somebody gave me the stock today, I’d put in a sell order at $45, then move on.” The price briefly reached $45, then collapsed.

Currently, earnings per share (EPS) are expected to fall 5.8% this year, then rise 13.3% and 15.5% in 2016 & ’17 (December year-end). The 2015 PE, prior to the buyout announcement, was 20.2. The stock remains overvalued.

Why are EPS and PE important? Because the buyout transaction could fall apart. And if it does, shareholders need to squarely face the fact that they continue to own an overvalued stock. That’s why the share price has done nothing but bounce up and down for several years. In that light, it would be wise for shareholders to make a selling decision:

• sell right now, grateful for today’s share price bonanza;

• or put in a stop-loss order, to protect yourself if the M&A deal unexpectedly falls apart.

 

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Other potential scenarios include:

• another company could make a competing buyout offer, potentially triggering a bidding war, in which case the AOL share price ratchets upward;

• or shareholders could hold their shares, and wait to accept the cash offer from Verizon. (Keep in mind that, from today through the close of the M&A deal, your invested capital will probably stagnate.)

It is not your job, as the investor, to be perfect. It is your job, as the investor, to make wise decisions, based upon the information at hand. Protecting yourself from loss of capital is a tool at your disposal: use it.

 

WHAT WOULD I DO IF I OWNED AOL SHARES?

I would be thrilled with today’s share price increase, sell my stock, and reinvest the capital into an undervalued growth stock. That way, my money would potentially keep growing immediately.

Goodfellow LLC Rating: Sell, Public.  (05/12/15)

Chart courtesy of StockCharts.com.

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 Both 2015 Goodfellow LLC model equity portfolios

are outperforming the U.S. stock market indices!

 

VERIZON COMMUNICATIONS

(VZ, $49.72, down $0.08 midday)

Last fall, when I wrote about Verizon on October 4, 2014, I said “The short-term upside is $52.” I also cited Morgan Stanley’s hint at an upcoming M&A deal, saying “Morgan Stanley analysts have made it clear that Verizon would be willing to take on an additional $6 billion in debt, depending on the type of M&A activity.” I then encouraged investors to “accumulate more shares on any pullback below $50” on November 15, 2014.

Since that time, future EPS growth expectations at Verizon have fallen to a crawl, and the long-term debt-to-capitalization ratio has increased from 68% in 2013 to 88% in 2014.  None of this is good news for Verizon’s share price.

Prior to today’s merger announcement, Wall Street expected Verizon’s EPS to grow 14.6%, 3.6%, and 0.8% in 2015 through 2017 (December year-end).

The AOL acquisition is expected to be immediately accretive to Verizon’s earnings. But don’t get too excited. You can’t look at AOL’s expected attractive ’16 & ’17 EPS growth, project those numbers onto Verizon’s sorry-looking numbers, and walk away saying, “Earnings problem solved!”

For point of reference, Verizon’s 2014 revenues totalled $127 billion, while AOL’s revenues totalled $2.5 billion. AOL is a comparatively small company. While it benefits Verizon to acquire AOL, there will likely only be minor enhancement to Verizon’s low-single-digit EPS growth in the next few years.

Verizon’s current dividend yield is hefty at 4.42%; and the 2015 PE is fair at 12.9.

The stock has been trading sideways for two years. I no longer see a catalyst to push the price through upside resistance around $50. Nevertheless, the chart has been looking a little more bullish in recent weeks. If you’re lucky enough to get a chart breakout, consider using stop-loss orders, because the fundamentals are weak.

Goodfellow LLC Rating: Public.  (05/12/15)

Verizon Communications completed the acquisition of all remaining Verizon Wireless shares from Vodafone in February 2014.

Verizon Communications was featured in the Goodfellow LLC Growth & Income 2012 model equity portfolio.

Chart courtesy of StockCharts.com.

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Happy investing!

 

Crista Huff

President

Goodfellow LLC

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