Vodafone divestitures, including Verizon Wireless, should be pursued at sensible prices

Keith MallinsonActivist shareholders threaten making a bad situation worse at Vodafone. Under CEO Vittorio Colao's leadership since July 2008, Vodafone is pursuing a radically different strategy to the empire-building of his flamboyant predecessor, Arun Sarin. Colao's rather humdrum focus on costs, growth in data services and with a desire to consolidate shareholdings among its existing properties rather than expand further geographically should be welcome relief for shareholders who suffered from the company's excessively priced geographic expansion last decade. Shareholder discontent with a stock price that has moved sideways for a decade following the 2000-2001 stock market bust is understandable, but there is no quick fix and impatience could be costly. Vodafone has limited room for manoeuvre. Things are actually picking up for Vodafone following the stock market and economic collapse in 2008, including a return to financial growth and with significant shareholder returns this year.

Operational improvements and woes

Improving financial performance at Vodafone is good news, but this is very modest success given previous growth expectations. Ongoing challenges are numerous. With recent earnings announcements, Colao stated that "[t]hese are the first quarterly results to show service revenue growth since the global recession impacted. We have achieved these results through our continuing commercial approach in key European markets, focusing especially on data, and from strong growth in emerging markets, with India now cash positive at an operating level and our highest ever quarterly revenue in Turkey. The financial outlook for the current year is confirmed." However, Vodafone is still significantly exposed to weak economies with almost 40 per cent of its Earnings Before Interest Tax Depreciation and Amortization derived from the most economically challenged European countries, collectively referred to as the PIIGS (Portugal, Ireland, Italy, Greece, and Spain, respectively). Vodafone faces saturated markets in Europe, declining mobile termination rates in several nations and a bleak outlook for dividends from its 45 per cent shareholding in Verizon Wireless (VZW). Competition is blistering in developed and developing nations alike and immediate prospects for market consolidation are limited to infrastructure sharing in most cases.  Spectrum auctions and network upgrades for mobile broadband will demand additional capital and competition is, in fact, intensifying with new licensees in some nations including India. Vodafone is suffering from a weakening Euro versus financial reporting and dividend payments in sterling (UK pounds).

Vodafone's CEO has confirmed he will reorganize the company following an ongoing corporate review, to "accelerate our strategy to drive shareholder value and take advantage of the widespread adoption of data."

Flogging a dead horse

The bone of contention is with Vodafone's costly acquisitions. Major investments in emerging markets will most likely never be recouped.  For example, in May 2010, Vodafone took a £2.3 billion ($3.5 billion) impairment charge on its 2007 acquisition of Essar in India for $10.9 billion. One year ago it took impairment charges of £5.9 billion chiefly relating to its performance in Spain and with its 2006 acquisition of Telsim in Turkey. In 2002, Vodafone took a goodwill charge of £13.4 billion relating to its acquisitions of Japan Telecom and J-Phone, and its £113 billion takeover of German industrial group Mannesmann. At that time it also took a £6 billion impairment charge relating to the value of businesses such as Arcor, Cegetel, Iusacell and Japan Telecom.

Matters are made worse by nasty surprises from tax authorities associated with its acquisitions. Vodafone has recently agreed to pay the UK government £1.25 billion over the next five years to settle a long running tax dispute over the 2000 acquisition of Mannesmann. Vodafone is still in dispute with Indian authorities on a potential tax charge of $2 billion relating to its 2007 purchase of Essar.

Shareholder Ontario Teachers' Pension Plan is incensed with Vodafone's "history of poor capital allocation and disastrous M&A." Its target for attack was Chairman John Bond. It was under the watch of this chairman, since 2006, and former CEO, from 2003 to 2008, Arun Sarin, that major value-destroying acquisitions in Turkey in 2005 and India in 2007 were made. Attempting to take the chairman's scalp highlighted activist discontent, but this initiative was overwhelmingly defeated. The OTPP's disappointments are understandable, but Vodafone's acquisition strategy was decisively reversed two years ago when Colao replaced Sarin.  

Where from here?

The danger is that continuing shareholder pressure takes things too far in the opposite direction to those spendthrift acquisitions and makes a bad job worse by destroying even more shareholder value through fire sale disposals. It makes no sense for shareholders to make Vodafone a forced seller of its VZW shareholding or 44 per cent shareholding in France's SFR. There's only one buyer in each case: such action would undermine Vodafone's negotiating power on price. VZW is a jewel with excellent operational performance, but a shareholder agreement incompetently forged and managed by Vodafone since a decade ago means that Vodafone is currently deriving virtually nothing from its 45 per cent ownership. Apparent desperation for resumption of dividends is working against the alternative objective of maximizing the price from a possible sale of Vodafone's stake to Verizon. Bond said at the annual shareholders' meeting that "our goal is to negotiate from a position of strength with Verizon," and he also appropriately pointed out that "[the stake] has been rising in value over the years so the decision not to sell yet has been the right decision." Prospects for dividends from VZW are uncertain at best with reducing cash demands at Verizon following its FiOS build-out for fixed broadband and TV, plenty of things to spend money on at VZW with mobile broadband and further possible acquisitions. Verizon has clear and strong incentives to frustrate its junior partner in VZW to its own benefit with a low purchase price. Vodafone would be better off generating cash by selling-off minorities such as its 3.2 per cent stake in China Mobile.

Vodafone is not your run-of-the-mill conglomerate: dismantling it would present some special challenges. Some-of-the-parts valuations by equity analysts indicate that Vodafone is trading at a deep discount of 40 per cent to underlying asset value with its many national operators. These theoretical assessments do not recognize the inability a break-up seller would have to obtain full value from co-owners such as Verizon or in selling to national competitors in face if regulatory resistance to consolidation. Other kinds of purchasers might be possible in some cases, as was with Softbank in its 2006 acquisition of Vodafone's struggling Japanese operations, but a narrowed field is not conducive with the highest prices. Furthermore, a large capital gains tax charge would be incurred with, for example, a disposal of Vodafone's VZW stake.

Vodafone's empire-building days are over. Divestitures make sense, but should only be pursued at sensible prices. With or without the current management, strategies seem sound. Management, including the CEO in particular, is making the best of the predicament it has inherited from its reckless predecessors.

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 has recently published its Extended Mobile Broadband Device Forecast to 2020. Further details are available at: http://www.wiseharbor.com/forecast.html

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