High-yield/macroeconomics (fka YIELD)

[Democritus_of_Abdera]

IWA & Reverse Morris Trust...

Abreis, if you continue to hold IWA, you may want to think through what you will do if Verizon (VZ) spins off its rural lines in the north central US (Illinois, Indiana, Ohio, and Michigan) to IWA as a reverse Morris Trust, a recurring speculation these days.

The reverse Morris Trust is a tax strategy whereby VZ would avoid substantial taxes on its depreciated rural copper telephone lines they got from GTE. IWA would become a much larger regional telephone company that might benefit from economies of scale. Because of the tax advantage one would expect that VZ would sell (divest) the property to IWA at a substantial discount. They might also pay IWA for its wireless spectrum.

In short, to execute a reverse Morris trust, VZ must create a subsidiary that is bigger than IWA. This subsidiary then merges with IWA. The VZ shareholders get IWA stock prorated to their VZ holding. IWA management takes over the merged company.

VZ just completed a similar reverse Morris Trust divestiture of its New England rural telephone land lines to Fairpoint Communications (FRP). It took about 1.5 yrs after the announced intent before the deal was actually completed. This deal with FRP can be used to predict what will happen if a similar merger is made with IWA. The details can be found in FRP’s Form 434B3 filed on February 29, 2008.

The most important lesson relevant to IWA’s dividend policy was that the New England states required that Fairpoint reduce its dividend and paydown debt as a precondition for regulatory approval of the deal. I suspect that similar concessions would be likely if IWA were to take over the VZ north central GTE lines.

A second lesson was that the merger itself created selling pressure. This is because VZ is in both the S&P 500 and the Dow Jones Industrial Average. Index funds that received Fairpoint shares as a result of the deal were forced to sell them. The number of shares that they receive in a reverse Morris Trust deal is large (i.e. Verizon shareholders must control at least 50% of the resultant entity for the deal to be tax advantaged). Additional selling pressure may have resulted from those original VZ shareholders invested in VZ for the wireless story, not the rural telephone franchise.

Personally, I think that IWA would be greatly strengthened by addition of VZ’s north central GTE lines. But there would be some integration turbulence and the dividend will probably be reduced. If such a deal is announced, I don’t expect any big swings in stock price. However, I will probably liquidate my position because I am in it for the current yield, not long term growth.

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Some useful websites:

http://telephonyonline.com/mag/telecom_rlec_ma_next/ - Early speculation about IWA involvement in reverse Morris Trust for VZ properties (5/22/06).

http://www.raymondjames.com/pdfs/industry/itell013007b_0843.pdf - Discussion of the financial rationale for a union (1/30/07).

http://biz.yahoo.com/ap/080409/fairpoint_analyst_note.html?.v=1 – Discussion of why Fairpoint share price dropped after reverse Morris Trust deal was announced (4/9/08).

http://www.sec.gov/Archives/edgar/data/1062613/000095012308002306/y40915bxe424b3.htm
SEC form 434B3 filed by FRP on 2/29/08.