Mallinson: Would Vodafone put Verizon Wireless' free cash flow to better use?

The question of whether or not and when Verizon Wireless will resume regular dividend payments is a long-running strain between the company's parents Verizon Communications and Vodafone, and it frustrates Vodafone shareholders. Mindful of the hunger for cash by Vodafone and its shareholders, blocking dividends was widely perceived as the means for Verizon's unsuccessful attempt to get Vodafone to sell out.

It seems, however, Verizon has probably done everyone a favour by making its subsidiary hang onto the cash for use stateside.

Be careful what you wish for

Shareholder value is not enhanced by dividend payouts if management can find sufficiently good uses for cash generated. Nevertheless, Vodafone and many of its shareholders have been unhappy the company did not receive regular dividends since 2005 for its 45 per cent stake in Verizon Wireless. Hopes were only temporarily lifted this summer with the announcement of a $10 billion one-off payment scheduled for early 2012. Where is the best place for future cash to go; back into Verizon Wireless, to Vodafone or in the pockets of the latter's shareholders?

Being denied access to what one owns is annoying. However, it is a highly questionable presumption that the majority of any Verizon Wireless dividends would have simply been passed through Vodafone to its shareholders. Instead, Vodafone is generating significant cash from operations and some disposals for various purposes. Meanwhile, Verizon has generated rather better returns than Vodafone in recent years.

Focused overachiever

Verizon Wireless has performed very well in many ways, and it remains a top performer domestically in the US and in international comparisons. For example, in the second quarter of 2011 it registered 2.2 million total net subscriber additions and delivered a very good 45.4 percent margin of Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA). This is one of the most commonly-used metrics in assessing the operating performance of telecommunications network operating businesses worldwide. Its closest US rival, AT&T, added 1.1 million net subscribers following loss of iPhone exclusivity. In neck-to-neck competition with AT&T, and while head and shoulders above all other competitors, Verizon Wireless is in the middle of a strategic infrastructure upgrade with migration to LTE. It wishes to cling on to its free cash flow so it can buy more radio spectrum and in case of acquisitions. 

Verizon has been highly disciplined with focus on organic growth and selective in its acquisitions such as CDMA operator Alltel in 2009. In contrast, US CDMA operator Sprint Nextel has given itself all manner of problems with the "opportunistic" acquisition of iDEN technology-based Nextel and by diversifying into WiMAX with Clearwire, in which Sprint holds a 54 per cent ownership stake.

Mixed bag, varied performer

The Vodafone Group has not performed as well as Verizon Wireless. Whereas financial results are strong where Vodafone leads and market share is most concentrated, such as in Italy with an EBITDA margin around 46 per cent, it is rather weaker in other markets, including the UK, with EBITDA languishing below 30 per cent. According to Morgan Stanley, the Group's EBITDA margin was 32 per cent in its financial year ending March 2011.  Vodafone operating companies face many challenges including saturated subscriber markets, regulated prices for call termination rates and international roaming, and governments' aversion to market consolidation with full-blown mergers.

In contrast to Verizon Wireless, the Vodafone Group sprawls much of the globe with positions that vary significantly from market to market. It is a mixed bag of assets including large market share and small operators, with majority-owned companies and minorities.  Vodafone CEO Vittorio Colao, who has been at the helm since 2008, is rationalising the company's portfolio of holdings somewhat including significant disposals in face of shareholder pressure for more cash. Vodafone sold its 3.2 per cent shareholding in China Mobile for £4.3 billion ($6.6 billion) in 2010. Typical press reaction to the April 2011 sale of its minority shareholding in France reflects popular sentiment towards the company at home in the UK:

"Vodafone's recent announcement that it had sold its stake in French mobile group SFR to Vivendi for €7.75 billion (£6.8 billion) is good news for the telecoms group's long-suffering shareholders who have grown weary of empire building under former chief executive Sir Chris Gent."

It is not clear whether the reporter was aware Chris Gent was actually the last but one CEO who gave up that position in 2003. It does, however, indicate discontent stems from actions long ago.

There are virtually limitless "opportunities" to spend money on acquisitions and expansion when the geographic target is global. For example, under the leadership of Vodafone's previous CEO, Arun Sarin, the company paid $11.1 billion in 2007 to buy its way into what became Vodafone Essar in India. It agreed to pay a further $5.5 billion in 2011 to buy out its partner and raise its shareholding to 74 per cent, with the remaining shares in the hands of local owners in compliance with legal requirements.

Some of Vodafone's various investments have been quite troublesome and costly.  For example, Vodafone Essar is one among many operators in one of the most intensively competitive market. It is embroiled in litigation to resist an unexpected $2.5 billion tax demand resulting from the purchase. The acquisition of its Turkish operation resulted in significant disappointments. Shareholder disputes have plagued its indirect shareholding in the Democratic Republic of Congo through its majority-owned subsidiary Vodakom.

Cash burns a hole in the pocket

Verizon Wireless and its controlling parent has done Vodafone shareholders a favour by keeping the cash generated and investing it wisely in the US. The US has been favourable to the leading operators with market growth and regulatory stability including tolerance for consolidation.  Elsewhere in the world, market conditions are much tougher in many places and with challenges such as tightening price regulation. Whereas opportunities abound worldwide, Vodafone has found it difficult to remain sufficiently focused to ensure good overall performance.

Keith Mallinson is a leading industry expert, analyst and consultant. Solving business problems in wireless and mobile communications, he founded consulting firm WiseHarbor in 2007. WiseHarbor is publishing an annual update to its Extended Mobile Broadband Forecast in May 2011. The new forecast will include network equipment, devices and carrier services to 2025. Further details are available at: http://www.wiseharbor.com/forecast.html. Find WiseHarbor on Twitter @WiseWarbor.

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