How Vodafone Has Grown by Shrinking

by Tony D'Altorio

How Vodafone Has Grown by Shrinking

by Tony D'Altorio, Investment U Research

Wednesday, January 19, 2011

2010 was not a good year for UK mobile telecom giant Vodafone Group (Nasdaq: VOD).

Back then, disgruntled stockholders were up in arms over its poor performance. And last July, activist shareholder Ontario Teachers' Pension Plan tried to oust Vodafone's chairman and even break up the company.

It also didn't like CEO Vittorio Colao's plan to fix Vodafone. But despite repeated attempts against him, he began implementing it anyway.

Discarding his predecessors' grandiose plans, Colao began to slim the company down. He began selling many of the company's minority stakes in overseas mobile operators to focus instead on business in Europe, India and sub-Saharan Africa.

And his efforts paid off... The company's stock recorded a 2011 total return of 22%, outperforming the European telecoms sector by 16%.

Vodafone's Turnaround Plan

Downsizing generated a lot of cash for Vodafone.

In September, it sold its 3% stake in Chinese mobile operator China Mobile ADR (NYSE: CHL) for about $6.65 billion. Then in November, it announced the sale of its securities in Softbank (PINK: SFTBF), the Japanese mobile phone and internet company, for about $4.8 billion.

Now, in the next few weeks, investors expect Vodafone to finish selling its second most valuable minority stake in an overseas operator. The company's 44% stake in French mobile operator SFR could be sold to French conglomerate Vivendi ADR (PINK: VIVDY) - which owns the other 56% - for $11 billion.

Meanwhile, Mr. Colao is edging Vodafone's core European operations back to growth. In the three months to September 30, 2010, their underlying revenues fell only 0.8%, compared to a 4.4% loss in the same period last year.

Continuing that comeback depends largely on another part of the CEO's strategy. Last year, Vodafone began ditching its all-you-can-eat plans, which allowed smartphone customers to download as much data as they wanted for a fixed monthly fee.

Instead, the company has a new model to introduce, where customers pay according to how much data they consume. That pricing will then hopefully increase Vodafone's revenue from smartphone customers each month.

Rivals such as Spain's Telefonica ADR (NYSE: TEF) are creating similar plans. And while other smaller companies may opt to keep the all-you-can-eat models, they don't have the infrastructure to be much of a threat.

Vodafone, on the other hand, has the latest groundwork because it continued building even during the global recession. The company believes customers will be willing to pay a premium to have access to its reliable, high-speed networks.

Vodafone To Receive Dividends from Verizon Wireless

Vodafone could finalize an agreement with Verizon Wireless this year to once again obtain dividends. It owns a 45% stake in the leading U.S. mobile provider, while Verizon Communications (NYSE: VZ) owns the rest.

Created in 2000, the joint venture hasn't brightened the two company's relations. And in 2005, when Verizon insisted that Verizon Wireless stop paying dividends to its parent companies, things really got tense.

Verizon said that cash should instead go towards reducing debt. But its real reason was to push Vodafone to sell its stake - at a bargain price - to Verizon.

Yet Vodafone hung on, partly over the fear of a huge capital gains tax bill. Still, much of its fate lies in the U.S. with Verizon Wireless, despite its successes elsewhere.

Verizon Wireless contributed 36% of Vodafone's earnings in 2009-10, though none of the company's free cash flow, since there were no dividends.

2011 Is Looking Up For Vodafone

Fortunately, the balance of power seems to have swung in the UK company's favor now. In September, Verizon CEO Ivan Seidenberg began hinting at resuming Verizon Wireless' dividends in 2012.

Rumors indicate that if Verizon wants to maintain the dividend to its stockholders next year, it needs more cash. And to do that, it has to tap Verizon Wireless' cash by resuming dividend payments to its two parents.

That could drive Vodafone's cash flow up 70% in the next three years. In turn, that could lead to big hikes in its dividend, which already sits at 4.7%.

And despite its outperformance in 2010, Vodafone is still fairly cheap, trading at a single-digit price/earnings ratio. That's low for a company with smart management, operational advantages and valuable mobile telecoms assets around the globe.

Good investing,

Tony D'Altorio

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