Timing of AOL (AOL) Deal for Verizon (VZ) Not Perfect, But Also Not the Worst Idea - Cowen

Cowen and Company is out with commentary on Verizon (NYSE: VZ) following reports that it approached AOL, Inc. (NYSE: AOL).

Analyst Colby Synesael comments, Even before the increasing competitive environment in 2014, we have published on numerous occasions that Verizon and AT&T will continue to develop their respective mobile platforms as a way to differentiate from Sprint and T-Mobile in an effort to maintain/justify their superior pricing. However, AT&T and Verizon have taken somewhat different roads to building “the platform”. For example, AT&T’s mobile platform development and differentiation has primarily been around Digital Life (LTEenabled home security/monitoring), the Connected Car, and most notably its pending DirecTV acquisition. We believe the DirecTV acquisition will be used to leverage a larger video (U-Verse) base to scale content cost and in turn leverage such content relationships via licenses onto a mobile platform.

Meanwhile, Verizon’s strategy has been around building the video technology first with only minor deals around content (NFL, Redbox which has since been dissolved). While AOL boasts ~200MM unique visitors/month and ~2MM paying members, we believe Verizon is continuing its “technology first” platform development, as building its multicast video platform has content needs that we believe go well beyond the AOL assets. Management has stressed in the past that being a multicast operator does not drive the need for exclusive content but rather the need for licensing and session rights, and it is particularly important to get the mobile rights. Verizon has been especially interested in recent CBS and HBO OTT offerings that open up discussions around new business models (as an augmentation, not a disruption, to FiOS). Further, the only legitimate bidders for OTT wireless rights would be the carriers themselves as the sole keepers of viable mobile access solutions to customers. Consumers will quickly reach data caps (and consume less) if content distributors do not forge a partnership with carriers. Thus while Verizon’s potential procurement of content is a nice add-on, we believe rich content would be available in some sustainable model with or without this acquisition. We believe the compelling asset in the deal would be AOL’s programmatic advertising technology which automates the buying and selling of ads online that we think could eventually be leveraged both in FiOS and Mobile platforms, leveraged on additional content (in future unannounced partnerships), and with ads/content eventually delivered with EdgeCast.

The timing of an AOL acquisition is not ideal, especially considering the recent AWS-3 auction (which could see Verizon shelling out >$20B) and the need for flexibility in the 2016 broadcaster auction. However, assuming an AOL deal of $4B would increase Verizon’s leverage by just 0.1x (assuming a $4B debt raise and an all cash deal). Meanwhile our model assumes that the company can reduce its leverage to 1.4x by 2019 simply by growing into EBITDA. Thus an additional commitment to delever could mean an upgrade from the credit agencies sooner with negligible negative impact from this deal.

Cowen has Verizon at Market Perform with a price target of $51.

For an analyst ratings summary and ratings history on Verizon Communications click here. For more ratings news on Verizon Communications click here.

Verizon Communications closed at $46.57 yesterday.

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