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Verizon Communications (NYSE: VZ) made a big splash in the mergers and acquisitions arena when it recently acquired Yahoo! (NASDAQ: YHOO) in a $4.8 billion deal.
Investors and analysts questioned the motives for the Verizon deal; Verizon stock initially dipped on the news. Yahoo, after all, has been stuck in a prolonged decline. Its core internet properties, including email and search, long ago lost the battle with internet giant Alphabet (NASDAQ: GOOG).
And, Verizon won’t be getting Yahoo’s hidden gem assets, specifically its 15% stake in Chinese e-commerce behemoth Alibaba (NASDAQ: BABA) and its 35% stake in Yahoo Japan. Yahoo will also be retaining its $7.7 billion of cash.
Nevertheless, Verizon is getting a lot right in the telecommunications industry. Its core wireless business is a cash cow, and the deal for Yahoo provides a number of growth opportunities going forward.
Breakdown of Verizon Deal
Verizon will acquire Yahoo’s operating businesses, including Yahoo’s search, email and messenger assets, along with Yahoo’s advertising technology. Investors are right to question the rationale for the deal. After all, Verizon is paying $4.8 billion for Yahoo’s assets, many of which are in decline, and it isn’t acquiring what seemingly were the only assets worth buying.
But the deal presents a number of benefits to Verizon. First, the deal makes sense from a financial perspective. Verizon is paying cash for Yahoo’s assets, which is a sensible use because Verizon’s cash sits idle on the balance sheet. With interest rates at rock-bottom levels, that cash is not creating much value for shareholders.
Plus, $4.8 billion is a relative pittance for Verizon. It ended last quarter with $2.8 billion in cash, which alone covers over half the price tag. The remainder will easily be covered by Verizon’s massive cash flow. Verizon generated $21 billion of free cash flow last year.
In addition to making financial sense, the Verizon deal makes strategic sense as well. Of all the assets Verizon is acquiring, none carries more potential than Yahoo’s advertising technology business. Even though Yahoo’s core search and mail platforms are in decline, Yahoo still has more than 1 billion monthly active users, as well as 600 million monthly active mobile users.
Moreover, Yahoo has industry-leading advertising technology that leverages its data and content This is what Verizon is really after—buying Yahoo instantly increases Verizon’s scope and provides a significant boost to its media and advertising businesses. This same strategy is the reason why Verizon acquired AOL for $4.4 billion in 2015.
Verizon is making a big push into media and advertising, particularly in mobile video. These business are growing at a high rate in the U.S., due to increasing mobile activity and data consumption. According to industry research firm eMarketer, Yahoo is expected to bring in $2.32 billion of U.S. digital ad sales in 2016, while AOL is forecast to generate $1.3 billion in mobile ad revenue this year.
Long-Term Benefits for Verizon
Verizon shareholders may be unimpressed by the prospect of acquiring Yahoo, given Yahoo’s stagnation over the past several years. But there are a number of long-term benefits in the Verizon deal that should add to growth. Wireless is immensely profitable for Verizon, but growth in the telecom industry is slowing. For all intents and purposes, the wireless industry is saturated in the U.S.
For that reason, Verizon management deserves some credit for staying on top of the trends and looking out into the future. Verizon’s next growth engine will be digital advertising, which should continue to allow the company to reward shareholders with higher earnings and dividends each year.
Verizon stock trades for 15 times earnings, which is a cheaper valuation than the S&P 500. Plus, Verizon offers investors a hefty 4% dividend, which is roughly double the market average dividend yield. The company has raised its dividend for the past nine consecutive years, and growth in new business areas will help it continue that streak.
Verizon remains an attractive stock pick for value and income investors.
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