30 May 2008

Smooth operator

Just two years ago Vodafone was in the thick of it – unloved, beleaguered and under pressure to show that its prospects remained intact.

During 2006, the share price languished following a £30 billion goodwill write off from the previous acquisition of German phone giant Mannesmann in 2000. Its stake in US wireless company Verizon was in question and the dividend policy was unclear. Together with some general shareholder restlessness, came the inevitable calls for the head of the Chief Executive Officer, Arun Sarin.

Recognising the price competitiveness and saturation of developed European markets, Vodafone identified additional potential elsewhere. It made acquisitions in Turkey and, more recently, acquired a controlling stake in Hutchison Essar of India. It established a new unit to reflect its new aspirations, the EMAPA division (Eastern Europe, Middle East and Africa, Asia, Pacific and Affiliates) – and, in the recent full-year results, this unit showed organic growth of some 15%. Earlier this month, the company also reiterated its desire to raise its 50% stake in Vodacom, South Africa’s largest wireless provider.

In addition, the company's previous decision to stick with its US stake in Verizon confounded the doubters, as the value of the stake appreciated and furthermore is continuing to provide Vodafone with some substantial income.

The growth of diverging technologies means that mobile and wireless internet is an area in which it is keen to develop, alongside its fixed line internet interest. It announced earlier in May that it would be selling Apple’s iPhones in countries ranging from Australia, through to India, Greece and Portugal.

Thus, having surmounted the former problems one by one, whilst continuing to lay the foundations for the future growth of the company, the CEO has now decided to quit while the company remains in good shape. Furthermore, the succession planning which was clearly in place – Sarin’s deputy Chief Executive Vittorio Colao will take up the reins in August – did not unsettle the share price.

The results themselves fell bang in line with expectations, whilst the company continued its progressive dividend policy, which will be seen as a sign of management faith going forward. The 11% hike in the dividend adds to what is already a healthy dividend yield.

 The company's ability to generate cash from its massive customer base (which exceeds 250 million), may well be helped along by the fact that over 40% of these customers were in the stronger growth markets of Asia, the Middle East , Africa and eastern Europe.

This increasing exposure to emerging markets and the upbeat management comments which accompanied the results, combined to push the shares ahead on the day, adding to the 9% rise they had already seen over the last year, compared to the wider FTSE100 which had retracted 7% over the same period.

Without question, the company remains in a fiercely competitive environment, especially in the more mature markets in which it operates. Caution also continues to overhang the shares with regard to future regulatory rulings (where there is continuing pressure for mobile phone companies to reduce tariffs) and the uncertainty of the global economic outlook, which could be seen potentially to undermine Vodafone’s medium term strategy.

Nonetheless, the economies of scale which the company enjoys have enabled it to weather the competition to date, by being able to work on thinner profit margins due to the volume of business it generates. On top of this, of course, Vodafone has already shown the ability to engineer a strategic recovery in a relatively short period of time, and with this in mind, the results are not likely to dent the currently positive market opinion of the company.

Richard J Hunter
Head of UK Equities
Hargreaves Lansdown Stockbrokers

30 May 2008

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