By William Trent, CFA of Stock Market Beat

When Verizon (VZ) announced a deal to swap some of its access lines for shares of FairPoint (FRP), we wondered if investors were getting a fair shake. At $1,800 per access line, the deal appears to be in line with recent transactions, and serves to take another slug of debt off Verizon’s balance sheet without incurring taxes for shareholders. However, small shareholders could come out of the deal with a handful of FairPoint shares worth little more than the commissions that would be incurred in selling them.

Raymond James is out with an excellent analysis of the deal and its implications for additional similar deals. According to Raymond James:

The FairPoint deal offered a few advantages for both parties. By diversifying into a larger base of customers
and lowering its FCF payout ratio, while divesting its wireless minority partnership, we believe FairPoint shed
some risk it had previously borne, while expanding its presence in one of its largest states (Maine). For
Verizon, however, it would appear to us to be the best possible offer it could have structured. Had the
company sold the property for cash (presumably at a multiple higher than the 6.3x it sold to FairPoint), then
paid taxes, we believe Verizon would have netted a multiple below 6x. We believe the assets are close to if
not fully depreciated, thus requiring a multiple higher than 7.5x which does not appear rational or likely for
these properties. Thus, a spin out to FairPoint appears to be the best option for Verizon to maximize value,
even if the multiple appears a bit low. A third option, would have been for the company to spin the properties
out to shareholders as a new company, but that would have destroyed value in the process as a
management team and company infrastructure would have to be created, leaving Verizon’s shareholders
with an asset likely worth less than 6.3x. Again, this makes the announced structure appear to be the
rational choice, in our opinion.

Why Smaller ILECs will be Advantaged in These Sales. We believe the apparent tax adverse nature of
Verizon will lend itself to doing (or at least attempting to re-produce) a FairPoint-type deal in order to unload
additional former GTE lines….

We do not believe these would be large enough for the usual access line aggregators due to equity
limitations, leaving an interesting group of suitors, such as Iowa Telecom, Consolidated, Alaska Communications Systems, and Cincinnati Bell.

The Raymond James research piece is well worth reading, as it offers a concise summary of how the deal is structured and why it limits the pool of potential acquirors.

The author may hold a position in the securities discussed. The author’s current holdings are as follows: Long: Union Pacific (UNP) put options; Air Products (APD) put options; Nasdaq 100 (QQQQ) put options; Bookham (BKHM; Ballard Power (BLDP); Syntax Brillian (BRLC); CMGI (CMGI); Genentech (DNA); Ion Media Networks (ION); Three Five Systems (TFS); IShares Japan (EWJ); StreetTracks Gold (GLD); Starbucks (SBUX); U.S. Oil Fund (USO); Plantronics (PLT) call options; Short: Starbucks (SBUX) call options; Landstar (LSTR) put options; Plantronics (PLT) put options;

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