Will Vodafone ring the right US number?

Sarin ponders whether $30bn bid for AT&T Wireless would create shareholder value

Arun Sarin, the chief executive of Vodafone, must be going cross-eyed squinting through his "lens of shareholder value creation".

This is the instrument Mr Sarin promised he would use to evaluate a bid for AT&T Wireless, America's number three mobile phone company, up for sale for about $30bn.

The trouble for Mr Sarin is that a clear view of this simple sounding, if potentially expensive, transaction is being clouded by the shadow of Ivan Seidenberg, the former cable splicer's assistant who runs Verizon Communications and who is Mr Sarin's chosen partner in the US mobile market.

Between them Vodafone and Verizon Communications own a joint venture called Verizon Wireless, America's biggest mobile operator. Vodafone, however, owns only a 45 per cent stake in the joint venture. The chance to extricate Vodafone from its minority stake in the number one player for full control of the number three player has presented Mr Sarin with what may prove the most intractable strategic problem he will ever face.

Should he call up John Zeglis, his opposite number at AT&T Wireless, or maybe even send a text, and make an offer in time for this Friday's deadline that would knock out Cingular, his main rival for the AT&T business? Or, should he heed the warnings of his shareholders, and City analysts alike, who dislike the sound of the deal and want him to consider other options instead, including sticking with Verizon Wireless.

Mr Sarin is trying to square his strategic belief that the AT&T deal makes sense, with shareholders' concerns that it will destroy value for several years to come. Weekend press articles included quotes from an anonymous Vodafone director suggesting the risk of diluted earnings from an AT&T deal was the wrong way to look at the conundrum.

Simon Weeden, telecoms analyst at Goldman Sachs, said: "If correct, this suggests that the company is looking at AT&T Wireless as a strategic opportunity, an approach that is unlikely to be well received by investors concerned about the possible value destruction of a potential transaction."

The flow chart constructed by analysts at ING Financial Markets shows various paths that Vodafone could choose to lead it through the US mobile maze. But it is not exhaustive. There are other options being discussed in the City.

One is the Big Bang theory of Vodafone mounting a $150bn bid for the whole of Verizon Communications, gaining full control of the mobile joint venture in the process. Another is simply engaging Verizon Communications in merger talks, avoiding the need for any sort of bloody hostile bid. A third is to sell out of the Verizon Wireless joint venture altogether and await developments before making another US move, while a fourth is simply to maintain the status quo.

Either way, the sale of AT&T Wireless and Vodafone's interest in bidding, confirmed to the stock exchange on Monday, are concentrating the biggest brains in the mobile industry over what should happen next.

The advantages to Mr Sarin of scooping AT&T Wireless are fourfold. First, Vodafone would gain control of its US operations, enhancing Vodafone as a global brand with common services across the world. Second, AT&T Wireless operates on compatible technology to Vodafone's European operations while Vodafone's US Verizon Wireless business, ironically, operates on a different technology platform. Third, AT&T Wireless has a strong corporate customer base which Vodafone could exploit, and fourth, missing out on AT&T Wireless now could leave Vodafone facing yet more expensive acquisitions in the future.

However, it is hard to find a single Vodafone shareholder offering their wholehearted support for the deal.

Morley Fund Managers in the UK has already voiced its concern, as has David Cummings, the head of UK equities at Standard Life which owns more than 2 per cent of Vodafone. He said: "Any deal with AT&T Wireless from Vodafone's perspective makes me nervous, particularly the bid price, which looks expensive."

The likes of Mr Cummings want Mr Sarin to stick with what he has already, at least for the moment. Bidding for AT&T Wireless would mean selling Vodafone's 45 per cent stake in the Verizon joint venture, possibly worth $20bn, but it would come with a $4bn tax bill as well. Beating off a rival bid from Cingular, which has greater cost savings and synergies to exploit from a deal, would prove expensive.

Damien Chew, telecoms analyst at ING, said: "Buying AT&T would incur high transaction costs and destroy value [for Vodafone]. We estimate value destruction could be around $11.2bn from the forced sale of its Verizon stake."

He said a strong US presence would not be guaranteed as further consolidation could still occur. A partnership strategy, such as Verizon Wireless, would be less risky and allow Vodafone to focus on deploying higher-margin third-generation mobile services and consolidating its holdings in markets such as France and Japan.

Vodafone shareholders are also worried that turning AT&T around and upgrading its technology could be a huge distraction. Regulatory approval could take at least six months, all the time allowing competitors to take advantage of AT&T's state of flux.

Mr Chew's flow chart shows that under all the scenarios envisaged, Mr Seidenberg's Verizon would still end up beating Vodafone into number two or three spot in the US, largely by virtue of taking control of Verizon Wireless and then buying smaller mobile players as well, such as Sprint.

But the City is already looking beyond the AT&T deal, which so many in the Square Mile think makes no financial sense for Vodafone. The most dramatic option is buying the whole of Verizon Communications, selling off its legacy fixed line business and keeping the mobile arm.

However, this would require a massive issue of Vodafone shares of more than $100bn, and while Vodafone is a much admired business there is unlikely to be such an appetite in the market for such a lot of paper.

Alternatively Vodafone could use this opportunity to engage Verizon Communications in merger talks, persuading Verizon shareholders that their long term interests would be best served by connecting with Vodafone's global mobile might. Vodafone, being roughly two thirds the size of Verizon Communications, would presumably want management control but would still be left with the need to sell off Verizon Communications' fixed line operations.

There is an alternative option and one that would appeal to logicians familiar with Occum's Razor, the medieval principle which says that to any complex question, the simplest answer will prove the most likely explanation.

In this case, Mr Sarin would wait. Verizon Communications' fixed-line operations are expected to recede in value as mobile becomes more prevalent in the US. Come 2005, Vodafone could be in a stronger position to negotiate a merger with Verizon Communications or extract a higher price for its 45 per cent stake in Verizon Wireless. Perhaps then will be the time for Mr Sarin to try to simplify the US mobile maze.