BT(LSE: BT-A) (NYSE: BT.US) has entered exclusive talks to acquire EE for 12.5bn, it emerged earlier this week. Dear me
I appreciate BT is churning out cash, but such an expensive deal heightens the risk associated toBT stock into 2015.
BT stock has outperformed the FTSE 100 index by almost 10 percentage points since it confirmed, on 24 November, that it was considering a takeover ofTelefonicas O2 mobile operations in the UK. A couple of days later, EEs owners Deutsche TelekomandOrange announcedtheywere in exploratory discussions with BT.
Short-term movements in stock prices do not dictate investment strategies, but they should not be overlooked, either.
Since 5 December, when BT stock rose to420p, the shares have lost5.4% of value. The FTSE 100, by comparison, has lost 5% of value over the period. It could be argued that BT shares should have fared much better than the index in the wake of M&A talks.
Furthermore, since BT announced earlier this week that it was in exclusive talks to buy EE, its stock has underperformed the market by about three percentage point.
An Expensive Call
The purchase price of 12.5bn for EE on a debt/cash free basis isnt good news for shareholders.
In short, BT is valuing the targets equity at 2x sales and 8x earnings before interest, taxes, depreciation and amortisation (Ebitda). That is premium of about 20% to BTs own valuation. BT should have asked for a 20% discount against its own valuation, in my opinion, or should have opted to go for O2, which is smaller but has a decent network.
The implied valuation of EE is demanding even assuming BT can achieve synergies of between 5% and 7% of the EEs revenues (between $320m and 450m annually). While BT says that in considering the financing of the cash element, BT has a range of options and is mindful of the importance of maintaining a conservative financial profile, it looks like the British behemoth is paying too much for assets that may promise significant synergies, but whose Ebitda and revenue growth prospects are not particularly appealing.
Vodafone Is Still Expensive
Does BTs strategy suggest it may be time to bet on Vodafone? Well, maybe although Vodafone stock is not exactly in bargain territory right now.
Vodafone shares, which trade at 223p, have been resilient in the wake of upbeat quarterly results, which showed an improvement in its operations. M&A talks also contributed to value creation in recent weeks.
I may add Vodafone to my diversified portfolio but only if it drops to 170p/180p. And even then, I would not feel very comfortable retaining a meaningful exposure. I think Vodafones dividend, its main attraction, is jeopardised by its capital structure, which is stretched.
Just like BT, Vodafone may decide tobecome a fully fledged quad-play services provider, but itll have to engineer a multi-billion takeover ofLiberty Global.An alternative would be to acquireFastweb, which is another takeover target, according to the rumour mill.
For now, Id look elsewhere for value.
Initially, I thought BT would maintain financial discipline in M&A, but it looks increasingly likely I will be proved wrong.
I am not bothered, though, because I think I may opt to invest in a company identified inthis FREE wealth report— its shares have risen by more than 200% since 2012 and its prospects look really good. Incidentally, it’s not too big andcould also be taken over!
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