The latest issue of our European Value Report, published on January 28th, highlights Vodafone (VOD) as a top monthly investment idea. Key excerpts are included below, but first let's look at David Einhorn's thesis on Vodafone, as laid out in Greenlight Capiital's Q4 2009 letter to investors:
"VOD is a U.K. based wireless operator with over 300 million subscribers worldwide and a market capitalization of £73 billion. The Partnerships established their position in VOD at an average cost of £1.38 per share. VOD's core consolidated operations in Europe, Asia, the Middle East and Africa already generate in excess of an 8% equity free cash flow yield and support a near 6% dividend yield for shareholders. This does not count any value of VOD's most significant asset, a 45% ownership in Verizon Wireless, the #1 US cellular operator. Vodafone does not consolidate Verizon Wireless and, as a result, sell-side analysts seem to ignore its significant value. VOD currently does not receive a dividend from Verizon Wireless which we believe has led to the market implicitly ignoring its value, despite significant growth in revenue, EBITDA, and cash flow. We believe that Verizon Communications (VZ), which owns the other 55%, will need continued access to the cash flow from Verizon Wireless, and will therefore restore the dividend to VOD or work on an extraordinary transaction. Currently Verizon Wireless's cash flow is being used to repay inter-company debt to VZ. However, this debt will be fully repaid by mid-2010, at which point we expect VZ will need to act. We believe that any changes that reveal the value of VOD's Verizon Wireless stake will force the market to re-rate VOD shares. In the meantime, we collect a nice dividend. Ascribing a reasonable valuation to Verizon Wireless and VOD's other unconsolidated assets, we estimate that VOD trades at less than 3x estimated 2010 EBITDA, versus in excess of 5x for the peer group average in Europe."
The following is an overview of Vodafone, excerpted from European Value Report:
Vodafone provides wireless communications services worldwide. The company had 303 million consolidated subscribers and 323 million proportionate subscribers at September 30, 2009. Non-consolidated operations include a 45% stake in Verizon Wireless and stakes in China Mobile, Bharti Airtel and SFR. Minority interests are mainly attributable to Vodafone Essar and Vodacom. (Click to enlarge)
Selected Operating Data
We start our approach to valuing Vodafone by recognizing the significant value inherent in its Verizon Wireless stake. The first table below shows estimated values of Vodafone’s 45% equity stake in Verizon Wireless based on a range of EBITDA multiples applied to Verizon Wireless’ calendar 2009 EBITDA.
Our next step is to value the rest of Vodafone’s operations. We are guided by a simple observation: the current Vodafone dividend yield of 5.8% is supported by a 6%+ FCF yield based on cash flows excluding Verizon Wireless (to be conservative, we include purchases of network licenses in the calculation of free cash flow and do not reduce cash taxes paid by Vodafone for amounts attributable to Verizon Wireless pass-through tax payments). As these cash flows are diversified geographically and likely to grow over time (>60% of consolidated subscribers are in emerging markets), an investor can make a fair return from these “non-Verizon Wireless” cash flows when buying Vodafone shares at the current price.
In summary we add the estimated value of Vodafone's 45% stake in Verizon Wireless and the estimated equity value of the rest of Vodafone, i.e. the current stock price, to arrive at a fair value for all of Vodafone operations of £1.85 to £2.11.
Disclosure: No positions