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This week, the British telecom giant Vodafone (NASDAQ:VOD) reported results for the third quarter ended December 31, 2013. The results were disappointing. Vodafone's performance in Europe was worse than expected. The results confirm my doubts regarding Vodafone's ability to grow revenue in Europe (see this article). Earlier, AT&T (NYSE:T) announced that the company will not make an offer for Vodafone in the near future. AT&T is looking for a large acquisition in Europe because the company experiences limited growth prospects in the United States (see this article). However, AT&T ruled out an offer for Vodafone in the next six months. Vodafone's poor performance in Europe may be the reason why AT&T is more careful in acquiring Vodafone in the near future.

Third quarter earnings

Vodafone's third quarter earnings show an alarming negative image in Europe (see table below). I compared Vodafone's organic service revenue in Germany, Italy, United Kingdom and Spain. These four markets accounted for almost 48% of Vodafone's total revenue in the third quarter of this fiscal year. Vodafone's service revenue decreased in all four markets compared to the third quarter of 2013. The decline of the service revenue in Germany is alarming, because this is Vodafone's largest market. The service revenue in Germany accounted for almost 19% of Vodafone's total revenue in the third quarter of this fiscal year.

Q3 2014Q3 2013Trend
Germany-7.9%-0.2%-7.7%
Italy-16.6%-13.8%-2.8%
UK-5.1%-5.2%+0.1%
Spain-14.1%-11.3%-2.8%

Source: Vodafone's Q3 2014 and Q3 2013 earnings report

Another alarming factor is the acceleration of the decrease in service revenue (see "Trend" column in the table above). I compared the decline in revenue in the third quarter of this fiscal year and the third quarter of fiscal year 2013. The revenue decline accelerated in three of Vodafone's four major markets, except for the United Kingdom. Again, the negative performance in Germany (-7.7% trend) is a major development to watch in the coming months. Vodafone faces though competition, according to Vodafone's third quarter earnings report. In reaction to the declining revenue in Germany, Vodafone stated:

Service revenue decreased by 7.9%, driven by intense price competition in both consumer and enterprise segments and an MTR cut effective from December 2012.

A positive note from Vodafone's earnings report was the service revenue growth in emerging markets. The organic growth in India was 13.2% and subsidiary Vodacom grew service revenue by 3.5%. However, the revenue growth in Asia and Africa was by far not enough to cover for the lost revenue in Europe. Overall, Vodafone's organic revenue decreased by 4.3% in the third quarter of this fiscal year.

Acquisition target

AT&T is looking for an acquisition target in Europe. Vodafone is one of the three possible targets, together with Orange (NYSE:ORAN) and some of Telefonica's (NYSE:TEF) European assets. However, AT&T's board first needs to convince shareholders to enter the highly competitive market in Europe. The shareholders question the value when AT&T decides to enter the European market. In fact, these doubts are confirmed by analysts at Societe General. The analysts conclude that an acquisition of Vodafone does not provide value for shareholders and that the company should repurchase stock instead (see this article).

AT&T ruled out the possibility to bid for Vodafone in the next six months on January 27, 2014. In my opinion, AT&T will not make an offer for Vodafone unless Vodafone shows that the company can turn around the negative trend in Europe. AT&T is only interested in Vodafone's European assets and the company will have a hard time to convince shareholders to acquire a company that loses more than 10% of its revenue in Europe annually and does not provide any value for AT&T's shareholders.

Conclusion

In my opinion, Vodafone's problems in Europe increased during the third quarter this fiscal year. Next to the problems in Southern Europe, Vodafone experienced problems in its major market:
Germany. Vodafone's service revenue in Germany decreased by 7.9% (organic). Furthermore, a potential takeover by AT&T is less likely after AT&T waived the right to make an offer for Vodafone in the next six months. I do not expect AT&T to make an offer as long as Vodafone struggles in Europe.

Source: Vodafone's Struggles In Europe Turned AT&T Away