Should Vodafone take the money and run?

Citation

Curwen, P. (2013), "Should Vodafone take the money and run?", info, Vol. 15 No. 6. https://doi.org/10.1108/info-04-2013-0016

Should Vodafone take the money and run?

Article Type: Rearview From: info, Volume 15, Issue 6

A regular column on the information industries

As of 31 December 2012, the structure of Vodafone’s mobile operations was as seen in Table I. This contains data on Vodafone’s subscribers adjusted to take account of its equity stake, and includes both directly held and indirectly held operations. Most of the individual numbers are provided by Vodafone itself, but those for Kenya and Bharti Airtel, for example, have had to be estimated. However, the overall picture is reasonably accurate.

France Télécom, Telefónica and Telenor have stakes in more networks than Vodafone, but no other operator comes near its worldwide total of controlled subscribers. Furthermore, Vodafone has nearly 70 Partnership Network Agreements in place that do not involve equity stakes, so it is clearly the operator with much the largest worldwide reach of one kind or another.

On the face of it, therefore, this is a company concerned with expansion, not contraction, but that is a gross simplification in practice. For example, it sold out of China in 2010 and out of France and Poland in 2011, having previously given up on the superficially attractive market of Japan. According to recent reports it is willing to sell its stakes in Australia, Egypt and New Zealand. Naturally, it is also on the lookout for attractive purchases, and has expressed an interest in acquiring a stake in, for example, Yoigo in Spain and TIM Brazil, but overall, it is undergoing what might be termed a housekeeping exercise, tidying up its holdings into a more sensibly structured portfolio.

It that context, its long-standing negotiations with Verizon Communications with a view to selling Vodafone’s 45 per cent stake in Verizon Wireless come as no great surprise. In the first place, the operator uses a different 2G/3G technology to Vodafone’s European operations, although that is being addressed in part by the worldwide switch to LTE (albeit using a sub-set of the 700 MHz band in the USA and a completely different set of bands in Europe and mostly elsewhere in the world). Secondly, and crucially, Vodafone is the minority partner and can be outvoted on all major decisions such as the payment of dividends. Vodafone has no minority stakes in Europe – virtually all subsidiaries are wholly owned – and the residual tiny stake in Bharti Airtel is the only significant exception elsewhere, so it is unsurprising that Vodafone has struggled to come to terms with its subservient role at Verizon Wireless.

The problem is that not merely does the USA network generate more paying subscribers than any other market bar India – which is much more competitive, not to mention less affluent – but it is hugely cash generative. Over a six-year period, Verizon Communications refused to pay out this cash in the form of dividends, partly because it needed to invest heavily in rolling-out LTE, buying up spectrum and paying down loans, but also partly, no doubt, to irritate Vodafone to the point at which it would sell out of Verizon Wireless at a knock-down price – at $100bn or more the number of alternative (necessarily non-US) bidders is short on the ground. Vodafone chose to grit its teeth in the face of considerable pressure from some shareholders who wanted, understandably, to cash in, but the situation has now eased to the degree that Vodafone has so far received $8.3bn in dividend payments.

On the other hand, there are currently at least two factors favourable to a sale. In the first place, Vodafone will be paid in dollars and the dollar has fallen from roughly $2/£1 to roughly $1.5/£1, a significant improvement. Secondly, the recent disturbances in the financial markets have not been conducive to a move to raise a huge sum in the bond market to finance the deal, but conditions are looking far more stable in 2013 and it can be assumed that the money would be forthcoming at a fairly modest interest rate.

There is also the significant matter of the tax position since Vodafone would be hit with a huge tax bill in the USA if it was to be bought out in cash. Vodafone structures its international operations through a series of holding companies, several of which are based in low-tax jurisdictions such as The Netherlands and Luxembourg. As Vodafone Investments Luxembourg has accumulated sizeable potential tax losses through writing down the value of its investments, one possible way to structure any sale would be to involve this company. That said, Vodafone would need to structure the deal with care to avoid any allegation by politicians and consumers that it was aggressively seeking to reduce its tax bill.

Alternatively, Vodafone could swap all or part of its shareholding in Verizon Wireless for shares in Verizon Communications. A partial swap could arguably be quite attractive to Vodafone. The cash component of such a deal would create the possibility for Vodafone to engage in one or more of the following:

pay a special dividend to shareholders;

acquire fixed-wire assets in Europe; and

reduce its debt or buy-back its own shares.

The share component of the deal would enable Vodafone to continue to benefit from the success of Verizon Wireless, although if its performance subsequently deteriorated due, for example, to increased competition in the USA in the wake of a T-Mobile USA/MetroPCS merger, the value of its holding would also fall. An alternative would be for Verizon Communications to acquire Vodafone. However, while this would solve the problem of Verizon Wireless it would reverse the withdrawal of Verizon Communications from almost all its international markets and would expose the resulting company to many European markets that are, at least for now, in decline. In other words, acquiring Vodafone would solve one problem for Verizon Communications but create many more in the process.

As Vodafone’s current financial year ends on 31 March 2013, the most recent detailed financial information on the company is for the six months ending 30 September 2012. As a group, Vodafone made a loss of £1,886m during this period. However, this loss is somewhat misleading as it hides the underlying performance of Vodafone’s operations and the dividends paid by Verizon Wireless and other associated companies. EBITDA – earnings before interest, tax, depreciation and amortization – for the six months ended 30 September 2012 was £6,647m. Charges relating to the depreciation and amortization of intangible assets, purchased licences etc. amounted to £3,698m, a figure almost offset by Vodafone’s share of the profits of its associated investments. When these are combined together, Vodafone made an adjusted operating profit for the period of £6,170m. Almost all of this operating profit was wiped out by the impairment charge of £5,900m taken by Vodafone against its Italian and Spanish operations. Taxes and financing costs then pushed Vodafone into a loss for the six months.

While Vodafone has several associated investments, the largest one is Verizon Wireless. Vodafone’s share of the profits made by Verizon Wireless amounted to £3,197m, with Vodafone subsequently receiving $3.8bn (£2.4bn) of the $8.5bn (£5.3bn) dividend declared in November 2012. These figures clearly illustrate the significant financial contribution made by Verizon Wireless to Vodafone. In the first place, if Vodafone’s share of the profits made by Verizon Wireless had not been included in its results, the loss made by the group would have been substantially larger. Secondly, the contribution made by Verizon Wireless is increasing. Vodafone’s share of the profits made by Verizon Wireless increased by 27 per cent between the six months ending 30 September 2011 and the six months ending 30 September 2012. This stands in stark contrast with the fortunes of many of Vodafone’s other operations.

Table II presents the financial results of Vodafone for these two periods. Only those operations that Vodafone explicitly identifies in its half-yearly results have been included. The adjusted operating profit increased in only four cases and in two of these the increase was relatively marginal. In contrast, a large increase occurred at Vodacom, reflecting the booming nature of the African markets that it services, even though its revenues declined over the period. Revenues declined in all of the European markets listed, sometimes quite heavily, while the decrease in India was due to adverse exchange rates. Only the Egyptian and Turkish operations saw an increase in their revenues, with profits also rising in both of these countries.

While all of the operations identified in Table II were profitable during the six months ending 30 September 2012, the scale of the profits compares unfavourably with both the dividend declared by Verizon Wireless as well as the share of its profits claimed by Vodafone. The adjusted profits of the best-performing five entries in Table II equate to a combined total of £2,378m; in contrast, the share of the profits of Verizon Wireless claimed by Vodafone was £3,197m and the dividend it received was £2.4bn. In other words, Verizon Wireless plays an increasing key role in the profitability of Vodafone.

As can be seen from the above discussion, Vodafone has been presented with an interesting dilemma that could be resolved in a number of ways. For example, Vodafone could sell all or part of its stake in Verizon Wireless or, most radical of all, merge the two companies. However, the relationship between Vodafone and Verizon Communications has been prickly and the latter has withdrawn from virtually all of its non-USA connected operations, so its shareholders are unlikely to take kindly to finding themselves saddled with lots of unprofitable networks – hence litigation would surely follow. Conversely, while Vodafone’s board would be able to bask temporarily in the admiration of shareholders pocketing vast dividends, where would the company go from there apart from downhill? The operations in recession-hit EU countries are not about to turn themselves around, and it would be costly to buy into new countries even if suitable networks were to become available.

A final option, currently doing the rounds, is for AT&T to buy Vodafone, sell its stake in Verizon Wireless to its majority owner and keep most of the rest of its operations. AT&T is currently a US-based operator with an international presence largely via a below-10 per cent stake in América Móvil. Under the circumstances, it lacks the expertise to control Vodafone but there has never been any lack of hubris among aspiring mobile companies.

Peter Curwen

Visiting Professor of Telecommunications, based at the Department of Management Science, Strathclyde University, Glasgow, UK. He can be contacted at: pjcurwen@hotmail.com

Jason Whalley

Reader in Telecommunications, based at the Department of Management Science, Strathclyde University, Glasgow, UK