Vodafone Plc – 04 February 2014

The Road Ahead for One of Europe’s Largest Mobile Operators

Company Overview:

Reuters: Vodafone Group Plc (Vodafone) is a mobile communications company. The company provides its services to mobile voice, messaging, data and fixed line. Vodafone has equity interests in telecommunications operations in nearly 30 countries and around 50 partner networks worldwide.

Vodafone Red offers consumers and businesses a package with mobile data allowances, unlimited calls and texts, plus cloud and back-up services to secure personal data.

Vodafone Cloud allows customers to store their personal digital content, such as contacts, photos and videos in the Vodafone network and to access it on the move from any connected device. Vodafone OneNet integrates landlines and mobiles providing a communication solution. Vodafone Secure Device Manager gives customer a way to manage many of their smart devices

Index FTSE 100 Ticker Code VOD.L Latest Close 220.00 52 Week Low  159.71 52 Week High 241.72
CEO Vittorio Colao CFO  Andy Halford P/E  6.4 Dividend Yield %  4.5 Dividend Cover  1.68

 

Is it Time to Hang up on Vodafone?

Vodafone was front and centre of an M&A revival during 2013. This saw the company agree to the sale of its stake in US business Verizon Wireless for $130 billion and change. In addition to the cash and equity payment, Vodafone will also receive full control of its Italian business. With the transaction approved by shareholders on the January 28 this year, the company officially has the all clear to proceed with the sale and to then go ahead with its proposed “return of value” program.

Under the terms of the ROV program, Vodafone will return $84.0 billion (£51.4 billion) to shareholders by way of a special dividend to be paid on 04 March 2014. This amount equates to a payment of approximately 105.00 pence per share which would, based upon an entry at current prices (222.00), provide investors with a return of 47% on each share held.

Those with an interest in receiving the dividend have until 18:00 pm on the 20 February 2014 to purchase their shares; any purchases after that time will not be eligible to receive the Return Of Value payment. All shares must be held until at least 08:00 am on the 24 February 2014 (Ex Div) in order for investors to remain eligible for the payment.

It is worth noting that following the ex dividend date, there is a legitimate possibility that Vodafone shares could decline significantly due to investors exiting their positions. Early estimates suggest a retracement back toward the 160.00 pence level is possible. As a result, it is important to be familiar and comfortable with the case for investing in Vodafone after the dividend payment before making any purchases.

Vodafone – After the Dividend

Vodafone’s decision to exit the US telecoms business has proved to be a popular one with both income and capital gains-focused investors. However, despite any near term advantages, it does present risks to both investors as well as the group. Before discussing these risks, it is helpful if we acknowledge first the reasons why Vodafone has become a popular portfolio constituent for so many investors over the years.

Vodafone has enjoyed a good standing among income investors, having paid one of the more generous dividends available from blue chip FTSE 100 companies since embarking on an aggressive return of capital and growth strategy in 2003. This was when the company increased its dividend by nearly 15% in a single year which helped to initiate a steady recovery in the share price since its collapse in tandem with the dot.com bubble.

Due to this dynamic, Vodafone’s dividend strategy from here is likely to be just as much a driver of price action as the company’s actual business growth strategy going forward. This large position of income investors in the shares is a particular cause of concern over the near term. This is because the disposal of Verizon Wireless is likely to reduce Vodafone’s free cash flow on an annual basis from $4.1 billion down to just over $2 billion.

Clearly it is going to be difficult for the business to support dividend payments in line with those of the past given such a significant reduction in available cash. This could see the share price placed under significant pressure over the near term, while the outlook further from here is entirely down to Vodafone’s forward growth prospects.

Vodafone Plc Weekly Chart

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Positives and Negatives for Investors in Vodafone

Clearly the reduction in free cash flows poses a problem for Vodafone, in that the most likely outcome of this transaction is a reduced or stagnant dividend going forward, despite management pledges to continue with its dividend growth strategy.

The company has also increased its exposure to Europe, an area that the group CFO recently described as subject to a “tough trading environment” and “lower revenues”. Despite this, the continent is in the midst of an economic recovery and the gamble that Vodafone has taken is that this recovery will eventually lead to increased demand for both core and luxury services such as mobile voice minutes and wireless 4G data.

The strategy is risky as it leaves the company overly exposed to the continental recovery as well as to consumer sentiment toward the wireless data concept, given its large simultaneous gamble on the success of 4G services. Despite this, the company does have the support of a sizable cash pile which it has pledged to use for investment into core business operations, while remaining open to consider non organic growth opportunities (M&A) should they arise.

Further along the road ahead, the potential does also exist for Vodafone to become an M&A target itself.  At present, there are no current bidders. This is as AT&T, one of the leaders in the US telecoms market, announced on January 28 2014 that it had “no current intentions” to pursue an acquisition of Vodafone.

The hedge for investors in Vodafone shares over the months ahead however, is that should management fail to improve shareholder value and growth prospects for the company, the possibility of this M&A outcome will increase.

In summary;

The risks attached to an investment in Vodafone are moderate. The company is unlikely to prove a successful prospect for short term speculators; however, an opportunity does still exist for those investors with the requisite time frame. Over the medium to longer term the company will either succeed in generating increased shareholder value or face being swallowed by a more competent competitor.

This is while the special dividend payable in March provides a buffer against any near term volatility in the share price caused by investors “hanging up” on the company. However, despite the longer term merits of Vodafone as an investment, the stock is likely to undergo a revaluation once the special dividend has been paid.

This could see the shares trade back below the 200.00 pence level, potentially as low as 190.00. Once this readjustment has taken place the shares should stabilise and eventually move forward.