Dominic White explains how Vodafone’s results would have looked a lot worse had it not been for the performance of its stake in the US operator
Vodafone shareholders must be praising the day that CEO Vittorio Colao refused to do as some of them were begging and sell its 45 per cent stake in US network Verizon Wireless.
Were it not for the strong performance of that operation, and the sizeable dividend it paid to Vodafone, this week’s results would have looked very dark indeed.
For several years, Vodafone’s investment in the US was viewed by shareholders as a drag on the group’s performance because the majority shareholder, Verizon Communications, blocked payment of any dividends from the joint venture.
But that changed two years ago, meaning that Vodafone now gets access to the business’s impressive cash flows, as well as basking in the increased equity value of the operation.
Now that Vodafone Europe, including Vodafone UK, is struggling, the decision to hold on to the asset looks smarter than ever.
Vodafone announced this week that it received a £2.4 billion cash dividend from Verizon Wireless at the half year mark and would return more than 60 per cent of the payment back to shareholders through a £1.5 billion share buy-back.
Of course, Vodafone still lacks control of its destiny in the US because it is the minority shareholder, something which goes against its stated policy of aiming to have majority control of its assets.
But in response to suggestions by analysts that now would be a good time to sell the Verizon Wireless stake Colao said he was “very comfortable” with keeping it.
Indeed, why would he want to sell right now when many of Vodafone’s other operations are doing it so rough?
As Espirito Santo analyst Will Draper told Reuters: “If you stripped out the impact from the United States then these results would look pretty poor, and that’s a problem.”
The biggest problems are in southern Europe where Vodafone was forced to slash almost £6 billion from the carrying value of its operations.
That basically means that the company no longer thinks the businesses will generate the same cash over time as they used to.
It couldn’t really come to any other conclusion when it saw that revenues in southern Europe fell a whopping 10 per cent over the half.
Italy fared worst, with underlying profits down 16.6 per cent, and Spain was not far behind, with underlying profits down 12.7 per cent.
Unsurprisingly, Vodafone put it down to pricing pressures and the “macroeconomic environment”.
The fact is that most people in these recession-ravaged countries don’t have money to spend on new handsets and expensive tariffs right now.
The writedowns also reflected changes to the discount rates it used to calculate carrying value, said Vodafone.
Its operations in the UK fared better, but underlying profits were weaker than analysts had forecasted, falling by 7.5 per cent to £589 million on service revenues down 2.1 per cent to £2.41 billion.
Vodafone said: “Macroeconomic pressures continue to impact consumer confidence adversely and, in turn, reduce out-of-bundle revenue.
“In addition, there has been significant pressure resulting from competitors introducing a number of new unlimited tariffs during the fourth quarter of the 2012 financial year.”
In response to this pressure, the company launched its ‘Vodafone Red’ integrated tariffs during the period.
On the plus side, data revenue grew by five per cent due to higher smartphone penetration and growth in smartphones sold with a data bundle.
But margins slipped 1.4 percentage points as the company had to spend more to retain customers.
The southern European write downs pushed the Vodafone group into a pre-tax loss of £492 million compared with an £8 billion profit last year.
But analysts were more concerned that it missed forecasts on its earnings before interest, tax, depreciation and amortisation, which were down 2.9 per cent at £6.6 billion.
Colao admitted the operating performance in the fi rst half had been “slightly below our expectations” and that business conditions will be similar in the second half.
The good news was that Vodafone expects its profits for the full year to be in the upper half of its forecast range.
And the emerging markets businesses continue to show strong growth, with underlying profits up 10.6 per cent to £2 billion on service revenues up 5.2 per cent to £6 billion.
But the Vodafone share price, which fell three per cent on the day of the results, is now well below the level it stood at two years ago when Colao (pictured) unveiled his big strategy plans.
Having been something of a stock market darling until August of this year, the question now is, can Colao get the share price back on track?
He admitted the company needed to keep trimming its cost base in Europe – news that will doubtless prick up the ears of Vodafone UK employees.
The management seems to want to do whatever it takes to maintain the level of dividends, having raised the interim payout by 7.2 per cent to 3.27p.
But Colao also believes he has spied a “number of positive developments” in the company’s European homeland despite “significant short-term challenges” posed by tough economics and increased regulation.
Smartphone penetration, currently at just 30.7 per cent in Europe, will only increase, he pointed out.
“With the broad deployment of high-speed data networks, we expect customers’ appetite for data to increase signifi cantly,” he said.
“As a result, we believe that the long-term prospects for the mobile market are highly attractive for those that make scale, standardisation and the customer data experience fundamental to how they operate.”
The key, of course, will be turning that into greater revenues and profits.
Then there’s a new “strategic” approach to consumer pricing and bundling in Europe, which is designed to o er customers “worry-free usage” and, at the same time, stabilise Vodafone’s average revenues per customer.
So the group is launching new tariffs including unlimited voice and SMS, and much larger data allowances than before and claiming to be “radically simplifying” its pricing.
In an industry that has long relied on mutual confusion of customers to secure bigger profits, it’s an honourable ambition, if Vodafone can actually achieve it while protecting its margins.
As Vodafone enters the next phase of his turnaround strategy, investors seem happy to give Colao the benefi t of the doubt, for now at least.