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Vodafone - Taking Liberty with EUR18.4bn deal

George Salmon | 9 May 2018 | A A A
Vodafone - Taking Liberty with EUR18.4bn deal

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Vodafone Group plc USD0.20 20/21

Sell: 130.26 | Buy: 130.28 | Change 0.80 (0.62%)
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Vodafone has announced a deal to buy Liberty Global's operations in Germany, the Czech Republic, Hungary and Romania.

Vodafone says the deal will enable it to become the leading next generation network owner in Europe. The combined group would have 54 million cable/fibre homes connected to its own network, with a further 56m homes and businesses on wholesale arrangements.

The deal, which still requires regulatory approval, would see Vodafone pay EUR10.8bn in cash, and take on EUR7.6bn of Liberty Global debt. The group plans to finance the acquisition through existing cash, new debt facilities and around EUR3bn of convertible bonds.

A break fee of EUR250m will likely be payable by Vodafone if the Transaction does not complete.

The shares rose 1.3% on the news.

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Our View

It wasn't so long ago that the investment case at Vodafone was more about capitalising on the growth potential of India and emerging markets than the core European operation.

The Liberty deal, which comes hot on the heels of the decision to deconsolidate the Indian business, changes all that. Should the deal go through, it'll be Vodafone's biggest for 18 years. It'll also mean 77% of group profits will likely be generated in Europe.

While also shifting geographic focus, the deal has potential to assist Vodafone in dealing with a couple of long-standing issues.

The first is the significant fixed costs running a telecoms business comes with. The cost of infrastructure and mobile spectrum is huge. For Vodafone, the result has been that free cash flow hasn't always covered the dividend.

The Liberty deal will bring greater scale, which has clear benefits. Vodafone reckons it can generate EUR535m per year in operating and capital expenditures synergies within 5 years of the deal going through, at a cost of EUR1.2bn.

The second problem is that despite all the investment in the upkeep of the network, there's not much differentiating providers other than the price they charge, and so little to stop customers going with the cheapest deal. This problem was most recently illustrated in India, where a new rival undercut the group, leading to billions in write-downs.

To try counter the lack of pricing power, Vodafone's been rolling out broadband, fixed line and TV services across its European markets to sit alongside its existing mobile offer. Early indications are that the tactic is working, and customer retention is significantly better among customers taking up multiple products. Adding millions of extra broadband customers opens the door to even more cross-selling opportunities.

This is Vodafone's biggest acquisition since 2000, and the group expects it'll cost about EUR1.2bn to integrate the two businesses. That means the risks can't be ignored, especially since net debt will tick up towards the top end of the group's target range.

Nonetheless, the dividend policy remains unchanged. Vodafone plans to increase the payout each year and a prospective yield of 6.2% will look attractive.. But in the long run, it's only useful if the group can generate the cash to back up the promises.

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Trading details - 1 February 2018 (at constant exchange rates)

European third quarter revenues were EUR8.6bn, a decline of 2.8% on the prior year. On an organic basis, which means excluding the deconsolidation of Vodafone Netherlands, and changes in currency movements and handset financing, service revenue rose 0.3%. Nonetheless, this was behind Q2's 0.8% growth, as an improving performance in Germany and the UK was offset by weaker trends in Spain and Italy.

Average revenue per user is stabilising in mobile, despite a shift in sales mix towards SIM-only contracts in many European markets. In fixed line, a record net 496,000 customers were added to the high speed next generation network.

In the AMAP division, revenues were EUR2.3bn. While this represents a year-on-year decline of 5.6%, the drop was driven by unfavourable exchange movements. Strong customer growth and demand for data across all markets helped organic service revenue rise 6.8%, up from the 6.2% increase in Q2.

The Vodacom business (which serves countries in Southern Africa) delivered revenue of EUR1.1bn, with organic service revenue rising 5.3%. Continued growth in Turkey and Egypt contributed to growth of 8.3% in the rest of the AMAP division, where revenues totalled EUR1.2bn. India, which has been deconsolidated for reporting purposes ahead of the proposed tie-up with Idea Cellular, saw organic service revenue decline 23.1% as competition remains intense.

The group reiterated its full year guidance for organic adjusted EBITDA growth of around 10%, with pre-spectrum free cash flow to exceed EUR5bn.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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