LONDON/NEW YORK, March 22 Almost five years after taking the helm at the world's second-largest mobile phone company, Vittorio Colao doesn't want to be the third Vodafone boss to be stumped by its seemingly intractable U.S. 'problem'.
The urbane Italian, who has streamlined a company built on the foundations of aggressive expansion, is exploring what to do with the one remaining asset he does not control - the stake in U.S. operator Verizon Wireless, which makes up about 75 percent of the firm's value.
On paper Colao has several options, each with pros and cons: sell all or part of the stake to majority owner Verizon Communications, maintain the status quo in the face of Verizon's desire for a deal, or sell Vodafone in its entirety to Verizon.
But with an asking price for Vodafone's 45 percent stake in Verizon Wireless around $115 billion and a potential $20 billion tax bill on the capital gain, Vodafone investors worry that Verizon may not be willing to pay enough for a business it already controls. And some say that without exposure to the booming U.S. market, Vodafone would be just a collection of shrinking European assets paired with India and African units.
Yet with sterling weak and Verizon's valuation multiples higher than Vodafone's, conditions are favourable for a deal. Verizon has long said it would like to acquire the stake, and relations between Colao and his U.S. counterpart Lowell McAdam are stronger than in the past when the two sides engaged in long-running power struggles.
Vodafone has lawyers from Linklaters, bankers from UBS and consultants from McKinsey looking at deal options and structure, and for ways to reduce the tax bill, according to three people familiar with the situation.
"Is (a Verizon stake sale) good for Vodafone shareholders? Short term, undoubtedly yes," a fund manager at one of Vodafone's 10 largest investors told Reuters, on condition of anonymity.
"Long term it remains unclear. Verizon Wireless is their best asset, and without it Vodafone is essentially operating in an industry with structural decline, a falling free cash flow and an uncovered dividend. Therefore the overarching question is, what does Vodafone do with $115 billion?"
Chris Gent, the cricket-loving boss who built Vodafone into one of the world's biggest companies, formed the joint venture in 1999 in one of his legendary mega-deals, which he famously used to conduct while watching his favourite sport.
Gent merged Vodafone's U.S. assets with Bell Atlantic to form Verizon Wireless, but from the outset Vodafone was the junior partner and it soon started to grate. Gent's successor Arun Sarin at one point tried to buy rival AT&T instead and was even linked with a deal for all of Verizon.
Finally, Sarin settled for the status quo, which paid off handsomely as the value of Verizon Wireless rose along with its dominance of the U.S. market. Profit margins and quarterly subscriber growth have consistently surpassed its smaller rivals and in recent years it has had a headstart in offering the latest high-speed wireless technology.
But it was not always a happy marriage. From 2005 to 2011, Verizon refused to sanction a dividend from the unit to either parent in what was seen as a bid to force Vodafone out. It only relented when it needed cash to fund its own annual payout.
Now Colao is mulling his U.S. options after cleaning up the rest of the portfolio. He says the board reviews the stake at least twice a year and has an open mind on whether to keep it.
He describes it as a nice problem to have, but analysts suspect he will not want to move on from Vodafone with the issue still unresolved.
"Vittorio Colao is not the kind of person to shy away from a challenge. And conditions have never been better," one former Vodafone insider said. "But this would be huge."
Deal hopes have risen this year along with Verizon's valuation, now at 17.5 times price to earnings, compared with Vodafone's 12 times, making an offer that includes Verizon shares more attractive.
A sale would enable Vodafone to return cash to shareholders and to purchase fixed-line assets in Europe, though Colao has said he does not need money from the U.S. to fund acquisitions.
And it would give Verizon, which is reliant on the Wireless operations for growth, a lot more flexibility with its cash.
One of the main obstacles is the issue of the tax bill if Vodafone sells.
Some tax experts in the United States have said Vodafone could structure the deal to reduce the tax obligations, but analysts in Britain doubt they would want to be aggressive on an issue that can cause a backlash among politicians and consumers.
"There are lots of smart people working on the tax issue," one sector banking source told Reuters. "There are ways to minimise the leak, but it won't be a zero leak."
Deutsche Bank says a cash-and-share deal would require the U.S. group to issue between 31 and 62 percent of existing capital if it increased its leverage, leaving Vodafone with 24 and 38 percent of Verizon, giving it a regular dividend.
Erich Patten, portfolio manager at Cutler Investment Group, a holder of Verizon shares, is open but cautious about a deal. Being able to access all the cash would be a benefit but "if the dividend was put at risk that would be a negative for us".
"If it's an expensive deal I'd expect the stock would be hurt."
Verizon has always said it would like to acquire the stake but declined to comment for the story.
A lack of clarity about which holding companies within Vodafone own which assets - for instance Vodafone America holds assets in a number of other jurisdictions - means outsiders cannot tell whether Vodafone could reduce the bill, a situation that suited the company when it did not want to sell.
Vodafone could also lose the benefit it now derives from its holding company structure, including a low-tax Luxembourg unit.
With a stake sale posing so many issues, sector bankers are again looking at scenarios where the two parent companies merge.
While the problems associated with creating a firm with a combined market value of $278 billion cannot be underestimated, the chances of it happening have increased under Colao and McAdam.
McAdam, who previously ran the Wireless business, and Colao meet for dinner or coffee when in the same city, a person familiar with the situation told Reuters, and the two firms now work together on projects such as procurement and services to corporate customers.
However, for Verizon to consider a merger or acquisition of Vodafone, McAdam would have to accept that the subsequent exposure to Europe, India and Africa is a price worth paying to access all of the Verizon Wireless cash.
There are also deal structure issues, such as whether to keep market listings on both sides of the Atlantic so as not to lose major shareholders from funds that are limited to U.S. or European equities, and where it should be tax domiciled.
One of Vodafone's biggest 20 shareholders told Reuters that while he could not rule out a merger this year, he wouldn't be surprised if price and structure stymied a deal.
"Without (a merger or solution to the tax) you're probably looking at the status quo, because I can't really see on the net basis they could put up a big enough price to make it stack up for Vodafone shareholders," he said.
"It's a problem people have been trying to unravel for a long time."