Now that the massive Verizon debt offering has been priced and sent out to Wall Street’s infamous sales force (the big banks bought it so they could sell it to their customers), the recriminations can begin. It’s not just that the size of the offering was so disproportionate as to be consistent with market top-like exuberance, there is the financing element that touches on funding markets and expectations for the immediate future.

First, the history of these megadeals is not favorable. Every single CEO that has ever been in this position has made the same statement, almost exact in its wording, that it was done for “strategic” reasons. That there are many more strategic reasons not to engage in such overwrought debt translation is never mentioned. Vodaphone itself has a dubious history with mega-mergers financed with massive debt, having bought Mannesmann AG in 2000.

That is what this really comes down to, the translation of debt into goodwill. Without the cheap and available debt financing run through the Wall Street sales force, these deals would never get done. The purchase price for the 45% share of Verizon Wireless that Verizon is buying from Vodaphone is about $130 billion. That prices Verizon Wireless at nearly $290 billion, putting it fourth on the list of largest American companies by market cap. It would rank Verizon Wireless at about the current market cap of Google, and slightly above Berkshire Hathaway.

That is beyond ridiculous, since the $130 billion price tag is the current market cap of Verizon itself. Just roughly approximating here, but that would mean Verizon’s current asset base and business outside of its existing 55% stake in Verizon Wireless is worth less than zero.

That actually might be the case since the company currently (even before this latest purchase) has more goodwill and intangible assets on its books ($105 billion) than tangible assets ($102.3 billion) or debt/obligations ($109.3 billion, including $26 billion in deferred taxes and an astounding $34 billion in pension obligations that currently assume a 7.5% return on plan assets). That will not change as a massive amount of goodwill is about to be added, along with a huge increase in debt load. If debt markets were priced at anything other than ZIRP artificialities, this never would have occurred.

And, in fact, it looks as if that was a possibility. The original bid for the 45% stake was only about $100 billion (itself an insane valuation). That changed after the bond market selloff, as Reuters reported,

“Talks between the two sides picked up in earnest over the summer as Verizon grew concerned that its window of opportunity was closing, with interest rates due to rise and its own stock price declining. That prompted Verizon to raise the offer from the $100 billion it had initially floated to close to Vodafone’s asking price of $130-$135 billion, sources told Reuters.”

Monetary policy and artificial interest rates are spurring businesses to engage in behavior they would not otherwise, as Verizon aptly demonstrates here. According to orthodox doctrine, that is how it is supposed to work, but there is no account for this kind of distortion on corporate behavior. Would the Fed rather Verizon buyout the minority stake in Verizon Wireless at a huge premium, or borrow some money to build out networks and increase productive capacity? The monetary textbooks say it is always the latter, and never account for the unproductive possibility of the former (including share repurchases).

The company would counter that it is part of the strategic plan of the buyout, to gain full control over Verizon Wireless to be able to “harvest” the full cash flow without considering payments to Vodaphone or other minority interests. But that is hugely convoluted thinking, considering the price tag here. Is the $130 billion worth it just to gain control over the cash flow, when the company could have avoided the financial trouble and just borrowed directly for capex at a far lower figure?

The history of these mega-deals is far more cautionary then optimistic. The biggest buyouts have largely been absolute failures (Time Warner wrote down $99.7 billion of AOL goodwill in 2002; Vodaphone itself wrote off Mannesmann goodwill every year until 2007, including a $49 billion impairment in 2006 alone; TXU and Clear Channel would be beyond bankrupt if they fully wrote off all the goodwill). The common theme running through all of them is the asset price/artificial suppression cycle that entices companies to go where they would not otherwise. Verizon’s purchase does nothing for the macro economy, except create a burden of overvaluation where it did not previously exist.

Verizon Wireless will have to suddenly become a new leader in revolutionary innovation to justify its Google-level value, otherwise it’s just another counterproductive paper chase (for the third time in fifteen years).

 

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