Consolidation in the Wireless Communications Industry:
Vodafone Acquires AirTouch
.
Deregulation of the telecommunications industry has resulted in increased consolidation. In Europe, rising competition is the catalyst driving mergers. In the United States, the break up of AT&T in the mid-1980s and the subsequent deregulation of the industry has led to key alliances, JVs, and mergers, which have created cellular powerhouses capable of providing nationwide coverage. Such coverage is being achieved by roaming agreements between carriers and acquisitions by other carriers. Although competition has been heightened as a result of deregulation, the telecommunications industry continues to be characterized by substantial barriers to entry. These include the requirement to obtain licenses and the need for an extensive network infrastructure. Wireless communications continue to grow largely at the expense of traditional landline services as cellular service pricing continues to decrease. Although the market is likely to continue to grow rapidly, success is expected to go to those with the financial muscle to satisfy increasingly sophisticated customer demands. What follows is a brief discussion of the motivations for the merger between Vodafone and AirTouch Communications. This discussion includes a description of the key elements of the deal structure that made the Vodafone offer more attractive than a competing offer from Bell Atlantic.
Vodafone
Company History
Vodafone is a wireless communications company based in the United Kingdom. The company is located in 13 countries in Europe, Africa, and Australia/New Zealand. Vodafone reaches more than 9.5 million subscribers. It has been the market leader in the United Kingdom since 1986 and as of 1998 had more than 5 million subscribers in the United Kingdom alone. The company has been very successful at marketing and selling prepaid services in Europe. Vodafone also is involved in a venture called Globalstar, LP, a limited partnership with Loral Space and Communications and Qualcomm, a phone manufacturer. "Globalstar will construct and operate a worldwide, satellite-based communications system offering global mobile voice, fax, and data communications in over 115 countries, covering over 85% of the world's population".
Strategic Intent
Vodafone's focus is on global expansion. They are expanding through partnerships and by purchasing licenses. Notably, Vodafone lacked a significant presence in the United States, the largest mobile phone market in the world. For Vodafone to be considered a truly global company, the firm needed a presence in the Unites States. Vodafone's strategy is focused on maintaining high growth levels in its markets and increasing profitability; maintaining their current customer base; accelerating innovation; and increasing their global presence through acquisitions, partnerships, or purchases of new licenses. Vodafone's current strategy calls for it to merge with a company with substantial market share in the United States and Asia, which would fill several holes in Vodafone's current geographic coverage.
Company Structure
The company is very decentralized. The responsibilities of the corporate headquarters in the United Kingdom lie in developing corporate strategic direction, compiling financial information, reporting and developing relationships with the various stock markets, and evaluating new expansion opportunities. The management of operations is left to the countries' management, assuming business plans and financial measures are being met. They have a relatively flat management structure. All of their employees are shareowners in the company. They have very low levels of employee turnover, and the workforce averages 33 years of age.
AirTouch
Company History
AirTouch Communications launched it first cellular service network in 1984 in Los Angeles during the opening ceremonies at the 1984 Olympics. The original company was run under the name PacTel Cellular, a subsidiary of Pacific Telesis. In 1994, PacTel Cellular spun off from Pacific Telesis and became AirTouch Communications, under the direction of Chair and Chief Executive Officer Sam Ginn. Ginn believed that the most exciting growth potential in telecommunications is in the wireless and not the landline services segment of the industry. In 1998, AirTouch operated in 13 countries on three continents, serving more than 12 million customers, as a worldwide carrier of cellular services, personal communication services (PCS), and paging services. AirTouch has chosen to compete on a global front through various partnerships and JVs. Recognizing the massive growth potential outside the United States, AirTouch began their global strategy immediately after the spin-off.
Strategic Intent
AirTouch has chosen to differentiate itself in its domestic regions based on the concept of "Superior Service Delivery." The company's focus is on being available to its customers 24 hours a day, 7 days a week and on delivering pricing options that meet the customer's needs. AirTouch allows customers to change pricing plans without penalty. The company also emphasizes call clarity and quality and extensive geographic coverage. The key challenges AirTouch faces on a global front is in reducing churn (i.e., the percentage of customers leaving), implementing improved digital technology, managing pressure on service pricing, and maintaining profit margins by focusing on cost reduction. Other challenges include creating a domestic national presence.
Company Structure
AirTouch is decentralized. Regions have been developed in the U.S. market and are run autonomously with respect to pricing decisions, marketing campaigns, and customer care operations. Each region is run as a profit center. Its European operations also are run independently from each other to be able to respond to the competitive issues unique to the specific countries. All employees are shareowners in the company, and the average age of the workforce is in the low to mid-30s. Both companies are comparable in terms of size and exhibit operating profit margins in the mid-to-high teens. AirTouch has substantially less leverage than Vodafone.
Merger Highlights
Vodafone began exploratory talks with AirTouch as early as 1996 on a variety of options ranging from partnerships to a merger. Merger talks continued informally until late 1998 when they were formally broken off. Bell Atlantic, interested in expanding its own mobile phone business's geographic coverage, immediately jumped into the void by proposing to AirTouch that together they form a new wireless company. In early 1999, Vodafone once again entered the fray, sparking a sharp takeover battle for AirTouch. Vodafone emerged victorious by mid-1999.
Motivation for the Merger
Shared Vision
The merger would create a more competitive, global wireless telecommunications company than either company could achieve separately. Moreover, both firms shared the same vision of the telecommunications industry. Mobile telecommunications is believed to be the among the fastest-growing segment of the telecommunications industry, and over time mobile voice will replace large amounts of telecommunications traffic carried by fixed-line networks and will serve as a major platform for voice and data communication. Both companies believe that mobile penetration will reach 50% in developed countries by 2003 and 55% and 65% in the United States and developed European countries, respectively, by 2005.
Complementary Assets
Scale, operating strength, and complementary assets were given as compelling reasons for the merger. The combination of AirTouch and Vodafone would create the largest mobile telecommunication company at the time, with significant presence in the United Kingdom, United States, continental Europe, and Asian Pacific region. The scale and scope of the operations is expected to make the combined firms the vendor of choice for business travelers and international corporations. Interests in operations in many countries will make Vodafone AirTouch more attractive as a partner for other international fixed and mobile telecommunications providers. The combined scale of the companies also is expected to enhance its ability to develop existing networks and to be in the forefront of providing technologically advanced products and services.
Synergy
Anticipated synergies include after-tax cost savings of $340 million annually by the fiscal year ending March 31, 2002. The estimated net present value of these synergies is $3.6 billion discounted at 9%. The cost savings arise from global purchasing and operating efficiencies, including volume discounts, lower leased line costs, more efficient voice and data networks, savings in development and purchase of third-generation mobile handsets, infrastructure, and software. Revenues should be enhanced through the provision of more international coverage and through the bundling of services for corporate customers that operate as multinational businesses and business travelers.
AirTouch's Board Analyzes Options
Morgan Stanley, AirTouch's investment banker, provided analyses of the current prices of the Vodafone and Bell Atlantic stocks, their historical trading ranges, and the anticipated trading prices of both companies' stock on completion of the merger and on redistribution of the stock to the general public. Both offers were structured so as to constitute essentially tax-free reorganizations. The Vodafone proposal would qualify as a Type A reorganization under the Internal Revenue Service Code; hence, it would be tax-free, except for the cash portion of the offer, for U.S. holders of AirTouch common and holders of preferred who converted their shares before the merger. The Bell Atlantic offer would qualify as a Type B tax-free reorganization. Table 1 highlights the primary characteristics of the form of payment (total consideration) of the two competing offers.

\begin{array}{c}\text { Table 1. Camparis an of Farm of PaymentTotal Consideration }\\\begin{array}{|l|l|}\hline\text {Vodafone } &\text { Bell Atlantic } \\\hline\text { 5 shares of Vodafone common plus \$ 9 for each } &\text {1.54 shares of Bell Atlantic for each share of AirTouch common } \\\text { share of AirTouch common } &\text { subject to the transaction being treated as a pooling of interest } \\\text { } &\text {under U.S. GAAP. } \\\hline\text { } &\text {Share exchange ratio adjusted upward 9 months out to reflect the } \\\text { } &\text { payment of dividends on the Bell Atlantic stock.} \\\hline\text { } &\text {A share exchange ratio collar would be used to ensure that Air Touch } \\\text { } &\text { shareholders would receive shares valued at \$ 80.08 . If the average } \\\text { } &\text { closing price of Bell Atlantic stock were less than \$ 48 , the exchange } \\\text { } &\text { ratio would be increased to 1.6683 . If the price exceeded \$ 52 } \\\text { } &\text { the exchange rate would remain at }1.54 .{ }^{1} \\\hline\end{array}\end{array}

{ }^{1}

The collar guarantees the price of Bell Atlantic stock for the Air Touch shareholders because

\$ 48 \times 1.6683

and

\$ 52 \times 1.54

both equal

\$ 80.08

. Morgan Stanley's primary conclusions were as follows:

Morgan Stanley’s primary conclusions were as follows:

1. Bell Atlantic had a current market value of $83 per share of AirTouch stock based on the $53.81 closing price of Bell Atlantic common stock on January 14, 1999. The collar would maintain the price at $80.08 per share if the price of Bell Atlantic stock during a specified period before closing were between $48 and $52 per share.

2. The Vodafone proposal had a current market value of $97 per share of AirTouch stock based on Vodafone’s ordinary shares (i.e., common) on January 17, 1999.

3. Following the merger, the market value of the Vodafone American Depository Shares (ADSs) to be received by AirTouch shareholders under the Vodafone proposal could decrease.

4. Following the merger, the market value of Bell Atlantic’s stock also could decrease, particularly in light of the expectation that the proposed transaction would dilute Bell Atlantic’s EPS by more than 10% through 2002.

In addition to Vodafone’s higher value, the board tended to favor the Vodafone offer because it involved less regulatory uncertainty. As U.S. corporations, a merger between AirTouch and Bell Atlantic was likely to receive substantial scrutiny from the U.S. Justice Department, the Federal Trade Commission, and the FCC. Moreover, although both proposals could be completed tax-free, except for the small cash component of the Vodafone offer, the Vodafone offer was not subject to achieving any specific accounting treatment such as pooling of interests under U.S. generally accepted accounting principles (GAAP).

Recognizing their fiduciary responsibility to review all legitimate offers in a balanced manner, the AirTouch board also considered a number of factors that made the Vodafone proposal less attractive. The failure to do so would no doubt trigger shareholder lawsuits. The major factors that detracted from the Vodafone proposal were that it would not result in a national presence in the United States, the higher volatility of its stock, and the additional debt Vodafone would have to assume to pay the cash portion of the purchase price. Despite these concerns, the higher offer price from Vodafone (i.e., $97 to $83) won the day.

Acquisition Vehicle and Post Closing Organization

In the merger, AirTouch became a wholly owned subsidiary of Vodafone. Vodafone issued common shares valued at $52.4 billion based on the closing Vodafone ADS on April 20, 1999. In addition, Vodafone paid AirTouch shareholders $5.5 billion in cash. On completion of the merger, Vodafone changed its name to Vodafone AirTouch Public Limited Company. Vodafone created a wholly owned subsidiary, Appollo Merger Incorporated, as the acquisition vehicle. Using a reverse triangular merger, Appollo was merged into AirTouch. AirTouch constituted the surviving legal entity. AirTouch shareholders received Vodafone voting stock and cash for their AirTouch shares. Both the AirTouch and Appollo shares were canceled. After the merger, AirTouch shareholders owned slightly less than 50% of the equity of the new company, Vodafone AirTouch. By using the reverse merger to convey ownership of the AirTouch shares, Vodafone was able to ensure that all FCC licenses and AirTouch franchise rights were conveyed legally to Vodafone. However, Vodafone was unable to avoid seeking shareholder approval using this method. Vodafone ADS’s traded on the New York Stock Exchange (NYSE). Because the amount of new shares being issued exceeded 20% of Vodafone’s outstanding voting stock, the NYSE required that Vodafone solicit its shareholders for approval of the proposed merger.

Following this transaction, the highly aggressive Vodafone went on to consummate the largest merger in history in 2000 by combining with Germany’s telecommunications powerhouse, Mannesmann, for $180 billion. Including assumed debt, the total purchase price paid by Vodafone AirTouch for Mannesmann soared to $198 billion. Vodafone AirTouch was well on its way to establishing itself as a global cellular phone powerhouse.
-How valid are the reasons for the proposed merger?

In a Statutory Merger

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