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Wednesday, September 11, 2013 - 14:30

Is It Time To Cash Out Of This Telecom Giant?

Wednesday, September 11, 2013 2:30 PM

When America was on the doorstep of the Roaring '20s and the birth of modern American consumerism, the predecessor to SunTrust Bank (NYSE: STI) made a shrewd investment.

When Coca-Cola (NYSE: KO) went public, the bank was part of the underwriting group. The lead underwriter, J.P. Morgan (NYSE: JPM), took its $100,000 fee in cash. SunTrust took its payment in the company's newly issued shares, which came out to be around $70,000. The stock certificates and Coca-Cola's secret formula sat in the bank's vault for nearly a century growing to nearly 30 million shares worth more than $2 billion and paying around $53 million annually in dividends.

Fast-forward to 2012. After a brutal financial crisis, SunTrust decided to do what many considered sacrilege. After being battered by a soft economy, tighter government regulation and bad loans, the company decided to sell its stake in Coca-Cola, use the cash to clean up its balance sheet and focus on its future.

To SunTrust's credit, it followed the old Wall Street axiom "Sell when you can, not when you have to." The bank did wait until the crisis had subsided and the price of Coca-Cola's stock had recovered from its crash lows to fetch a more attractive premium.

Flickr/Karl Baron
After Vodafone's initial investment in Verizon 10 years ago, the company will take in around $130 billion in cash when all is said and done.

The latest example of a smart company cashing in some chips when it's time is Vodafone (NYSE: VOD). One of my main reasons for owning shares of Vodafone, which I profiled a year ago, was the company's 45% stake in U.S. wireless giant Verizon (NYSE: VZ).

Vodafone's investment has paid off. After an initial investment of $20 billion 10 years ago, the company will take in around $130 billion in cash, Verizon stock and notes when all is said and done. That comes out to an average annual return of 55%, not including dividends. That's pretty strong in anyone's book.

That same decade has treated Vodafone investors just as well. Not including dividends, shareholders have gathered annual returns of around 16%. Dividends would boost that to an annual average of well over 20%.

And thanks to the Verizon deal, investors will continue to reap rewards. Vodafone shareholders are scheduled to receive a distribution that represents about 70% of the sale in cash and Verizon stock.

In addition, the company plans to increase its common dividend by 8% in 2014. That's on top of an already generous 4.7% yield.

So now what? Do Vodafone holders take the money and run? Not on your life.

Kings Of The Wild Frontier
Currently, 70% of Vodafone's revenue comes from Western Europe. We all know the growth story there: There is no growth.

Flickr/Martin Pettitt
Vodafone has been gearing up for an ambitious and well-financed stab into emerging and frontier markets.

Herd wisdom would tell us that in selling its crown jewel, the Verizon stake, the company is condemning itself to stagnant growth mediocrity. Quite the contrary. Vodafone has been gearing up for an ambitious and well-financed stab into emerging and frontier markets. It's the frontier market thesis that excites me the most.

Africa, one of the world's most promising frontier markets, is probably Vodafone's most impressive growth stories. Profits in its African division are set to outpace those of its Southern European division in as little as three years, the company says. In fact, earnings are growing as quickly as 50% in some regions such as Ghana, the Democratic Republic of Congo, Mozambique, Tanzania and South Africa.

Other frontier and emerging markets important to Vodafone's growth strategy include the Middle East, India and the emerging Asia Pacific region. As of the quarter ended June 30, the emerging and frontier divisions generated $4.7 billion in revenue. This number grew organically (no accounting tricks!) by 7.5% from last year while the company's business in developed markets shrank by 7.2% during the same period.

Lean And Mean
Vodafone's big haul with the Verizon sale will turbocharge an already rock-solid balance sheet. Long-term debt to capital sits at only 28%, impressive for a $158 billion telecom company. Although telecoms are cash-flow monsters, they typically shoulder a lot of debt (which is why they have to be cash-flow monsters). Vodafone has managed to increase its dividend by nearly 50% over the past nine years.

So with a mountain of cash, Vodafone is ready to ramp up its adventure in sub-Saharan Africa. The cash will come in handy. In a market where there is little to no infrastructure (including electricity in some instances), network build-out is imperative. But in a region where wireless handset penetration is expected to reach 85% by 2015, the investment is worth it.

Risks to consider: While Vodafone's foray into frontier markets is bold, it's also fraught with risk. Again, the capital investment will be substantial, and in an area known for governmental corruption where the bulk of the population lives on less than $2 per day, the challenges are numerous. However, although the European business is stagnant, it is predictably so. This will provide the company with dependable, predictable cash flow that will allow it to operate comfortably and provide value to shareholders while it executes its growth strategy.

Action to take --> Vodafone currently trades near $33. The stock has climbed over 30% this year, excluding dividends. While that feels stretched out, based on the dynamics of the stock, there's still value at this level. The forward price-to-earnings ratio is a moderate 11.4. Based on the Verizon sale windfall contributing to earnings, the company's strong financial position, and its emerging-market growth strategy, a 12-month price target of $42 sounds about right. Factoring in the 4.7% dividend yield, that would be a total return of nearly 33%.

P.S. -- Great-yielding stocks like VOD that have plenty of cash for dividend growth are the foundation for StreetAuthority expert Amy Calistri's "Daily Paycheck" investing strategy. To see how she's used this strategy to earn $49,000 in dividend checks since 2010, click here. 

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.