On June 9, Vodafone (VOD) agreed to merge its New Zealand operation with Sky Network Television, the leading pay-TV provider in the country. While Sky is technically acquiring Vodafone New Zealand, as it is acquiring all of Vodafone New Zealand's stock for £1.7 billion, Vodafone will end up owning 51% of the combined company.
This price is also about a 20% premium to our fair value estimate for Sky. While we think the price is a bit high, valuing Sky at eight times 2017 estimated EBITDA at a time of declining revenue, we like the combination from a strategic viewpoint, and for now we retain our fair value estimate and narrow moat rating for Vodafone. Approval will require a positive vote from 75% of Sky's shareholders.
This transaction continues Vodafone's movement into converged services. While New Zealand is a small market, the combined company will be able to offer the best video content over all kinds of devices. In addition, the weakness of satellite delivery for TV is mitigated by the New Zealand government building and owning a fibre broadband network, which allows content to be sent both directions at a fair price, as it is not an incumbent telecom operator setting a wholesale price favourable to incumbents.
We have previously discussed the importance of convergence in Europe and, increasingly, in Latin America; now we see it moving into other geographies. We like Vodafone's strategy of transitioning from a wireless-only provider to offering a fully converged product. That said, we are also aware of Vodafone's history of overpaying for acquisitions.
Vodafone’s Past Acquisitions
The purchase of Kabel Deutschland and Ono, the largest cable television providers in Germany and Spain, respectively, were designed to help the firm grow again. As convergence among fixed-line telecom, broadband, television, and to a lesser extent wireless telephony increases, Vodafone is heightening its exposure outside wireless.
While we think the firm overpaid for both acquisitions, the deals make a lot of strategic sense, as they will allow Vodafone to carry its own backhaul traffic, avoiding Deutsche Telekom's and Telefonica's fees. It also continues Vodafone's expansion into adding fixed-line, broadband, and pay television capabilities to its wireless service. Such acquisitions picked up in 2012 with the purchase of Cable & Wireless Worldwide in the United Kingdom, TelstraClear in New Zealand, and also pending Neotel by its Vodacom subsidiary. However, the first two transactions, in particular, were made at low multiples, unlike Kabel Deutschland and Ono.
We are somewhat concerned that the firm is going on another buying spree where its record of such purchases is poor. That said, we think its existing assets and announced rollout of fibre in some countries should provide it with the networks it needs to compete in an increasingly converged telecom world. With Vodafone's Project Spring nearing completion, we anticipate long-term improvements to the firm's moat and margins and believe the worst of the short-term hit is nearing its end.
