Early morning on Tuesday I wrote an article titled "Sell Vodafone, Buy AT&T." Before I go on with this article let me clear up a few housekeeping things about the last.
At the time I wrote, details of the plan to sell Verizon Wireless were only a brief outline. In comparing Vodafone (NASDAQ:VOD) to AT&T (NYSE:T) I was speaking generally and trying to assume a "midpoint" in what was outlined. For example, analysts expected the deal to be between $116-132 billion and perhaps $30-40 billion of that would be returned to shareholders.
My article's biggest concern, and I hope that I expressed this well, was that Vodafone seemed to want to scramble for additional huge acquisitions. In looking to "bag" the next "elephant," I feared much of the funds would be squandered and I didn't like this uncertainty.
Unfortunately the news moved faster than what I could keep up with. By Monday the deal was announced to be $130 billion, the very high end of the spectrum. "OK," I thought, "that's a few points for Vodafone," but I still felt the thesis of my article was intact. Then, late on Monday night this CNBC interview with Vodafone CEO Vittorio Colao came out. Colao said Vodafone would return most of the proceeds to shareholders, a whopping $84 billion. In other words, management exceeded expectations of shareholder returns by some $44 billion, or 28% of the company's ADR market cap. That is hugely material and turns my thesis on its head.
At that time I was away from the computer, and by the time I had woken up and read the news my article had already been published. So the news cycle had made a fool out of me and my article was basically wrong. I have no qualms taking responsibility for that.
This article is an attempt to make it right. In it I will look at what the new Vodafone may look like. This company will be leaner. It will still be global but also much more Eurocentric. Vodafone must go from a "pure play" mobile provider into cable and broadband lest it face obsolescence in Europe. In its new plan, management revealed how it can do that while remaining the most shareholder friendly big telecom in Europe. Because of its massive return of capital to shareholders, and a limited but focused plan to shore up the European business, I now believe Vodafone should not be sold.
Global But Eurocentric
Chart by Author, Financial Information From Interim Management Statement.
This pie chart shows how Vodafone will become a majority-Europe company after the big sale. Per last quarter's results Europe revenue will go from 46% to 70%. In coming years, however, emerging markets will continue gain share.
As a eurocentric company, Vodafone has two big issues. First is double-digit declines in southern Europe. This region is suffering from severe recession or possibly even worse. As I pointed out in my last article, southern Europe has dragged down the rest of the company: Group revenues were last reported declining 1.9%.
Vodafone's second issue is revenue decline in its most important core markets, Britain and Germany. This is an issue management has more control over. Much of the latest decline has been from competition, which is able to offer not just mobile communications but also high speed internet, cable TV and in some cases land line service. Vodafone has traditionally been a no-nonsense prepaid voice and SMS company. But consumers are increasingly favoring a convergence of services out of desire for ease and simplicity. This is a transition Vodafone must make. If it does, the company will truly benefit from the tailwind of increasing mobile data use in Europe and should return to solid mid-single digit revenue growth for the entire group.
Rifle Shots, Project Spring
Vodafone has thus far done "rifle shot" acquisitions of cable providers in Britain and Germany. This year it acquired Kabel Deutschland for $10.2 billion and Cable & Wireless Worldwide for $1.7 billion in Britain. There is talk of them buying Spanish and Swiss cable providers, too. CEO Vittorio Colao also announced Vodafone would build out its fiber optic network in Europe as well as launch 3G and 4G service in smaller countries as part of its $9 billion investment called Project Spring.
If Vodafone wants to truly leverage mobile data growth in Europe, it needs to be competitive with "bundling" and raise Average Revenue Per User numbers. By making these smaller strategic acquisitions, Vodafone is planting the seeds to grow and remain relevance in Europe without breaking the bank. This will not be an easy fight for Vodafone in Germany and the UK. However, I believe it will succeed because historically Vodafone is one of the best operators in Europe and it now has the war chest to accomplish this task.
In limiting itself to only the most meaningful acquisitions and investments, Vodafone is proving itself to be an excellent capital allocator. Despite the call of some large shareholders to make dynamite acquisitions, management has kept its capital discipline. Many of these same shareholders apparently now believe that Vodafone must acquire or become a target itself. I say let Vodafone be a target. Better to do that than blow money on "empire building." And if Vodafone does get bought, you can bet that transaction will be for another premium.
Green Data Shoots
In a world where smartphones dominate, consumers increasingly want the assurance of unlimited data plans. The company is now trying to transition from prepaid voice to contract-based unlimited voice and data.
"Vodafone Red," the company's new contract plan, is management's answer. Red has resulted in improved in Average Revenue Per User (ARPU) numbers. Over half of European mobile service revenue now comes from the Red bundle, up a proportional 9 percentage points year on year. In addition to Red, management is seeing customers use more data. Average usage per smartphone continues to increase and more customers are turning to 4G, which is now 15% of European data traffic. When Vodafone finally adds all its cable and broadband capabilities through acquisition and investment, it will merely have to expand their existing "Red" program to include it.
Shares of Vodafone are up approximately 30% on the year, but with a dividend yield hovering around 5% and trading at 11 times forward earnings, Vodafone is still very reasonable. Granted, I still think there are more sure-fire big telecom deals out there: AT&T trades at 12.4 times forward earnings, a dividend of 5.4%, and has already established success with bundling mobile communication, cable and broadband internet.
However, Vodafone has massive cash to return to shareholders , which AT&T does not. In the long run Vodafone is also a play on Europe and any possible recovery there. Thanks to the cash returned to shareholders, the planned dividend increase of 8% in 2014 will now be possible despite latest revenue difficulty.
Colao and company really deserve some admiration, here. Not only did they secure the third biggest M&A transaction of all time, but they have resisted the urge to "empire build" with that money. Instead, they are keying in on the most meaningful projects while returning most of the proceeds to shareholders. In other words, management has struck a balance.
Vodafone's biggest drag continues to be southern Europe, where revenues are declining in the double digits. However, the company has a number of things going for it. It's unique emerging-market exposure mitigates some of southern Europe's decline. If Vodafone is able to boost revenue per user and gain market share through bundling in Europe, in the long run the company will be a good "recovery" play. In the meantime, this deal's capital returned to shareholders will be a huge gust of wind in the sails, and that 5% dividend yield puts support under the price. All things considered you should stick with Vodafone.