Late Monday morning, Vodafone confirmed it's in discussions with Hong Kong's CK Hutchison Holdings in relation to a possible combination of Vodafone UK and Three UK.
Vodafone argued this was in response to Ofcom's observations that both operators lack the scale to earn an acceptable return on future investment in the 5G roll out. It's envisaged that Vodafone would own 51% of the combined business. No guidance was given on the timeframe, nor assurance that a deal will be proposed.
The shares finished Monday up 2.6% and were up another 2.6% by late morning today.
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Our view
The market reaction to press speculation and later confirmation of the discussions on a potential merger with Three UK was muted. Not surprising given the lack of any real detail. For now, it's best to remain focused on the underlying business.
Being a telecoms giant means some amount of revenue is all but guaranteed. The enormous, expensive and complex infrastructure that comes with setting up and maintaining networks means there are only a few companies in the field.
That essential-service status is a definite benefit of Vodafone, and telecoms generally, have some exciting opportunities ahead with the roll out of 5G. However, competition amongst peers remains intense, capital expenditure eye watering, and governments continue to raise prices more than expected when companies bid to use chunks of the electromagnetic spectrum for mobile data, putting pressure on cash flows.
Vodafone's net debt pile stood at €41.6bn at the last count, after the acquisition of Liberty Global assets in Europe and the sale of some European tower assets in the Vantage Towers IPO. That leaves the group at the upper end of its net debt to cash profits target.
Keeping debt under control is all the more crucial given Vodafone's bull case has long been based on an attractive dividend. The question now is whether the sharper focus on the European consumer markets can help the group grow shareholder returns over time.
The Liberty deal, although firmly in the rear-view mirror, did create more cross-selling opportunities. Vodafone's long been focused on rolling out broadband, fixed line and TV services across its European markets, since customer retention is significantly better among those taking multiple products. Vodafone also reckons Liberty can deliver €535m a year in operating and capital expenditure savings within 5 years of completion. European business more generally has been a little lacklustre. Nothing of concern, but it would be fair to call growth across mobile contract and broadband customers as a little stagnant. That's both the joy and the curse of a telecoms giant, growth will rarely shoot the lights out, but demand is unlikely to totally fall off a cliff either.
Outside Europe the Vodacom subsidiary has some exciting growth opportunities in Africa, including M-Pesa which offers mobile financial services. Africa could become increasingly important as the region develops, and Vodafone's leading position in several markets means it's well positioned to benefit.
Unfortunately, these initiatives don't really address the industry's biggest challenge. Despite the multi-billion investments in mobile spectrum, there's not much differentiating mobile providers other than the price they charge. Customers often just go with the cheapest deal.
Speed-tiered unlimited data plans seem to be making some progress, allowing the group to price discriminate between customers based on how willing they are to pay for extra speed. But ultimately, we don't think there's much preventing competitors from copying it if it proves to be a winner.
All-in-all then, while we think the portfolio changes and strategy make sense, the fundamental challenges that go with being a telecom remain. With balance sheet pressure mounting and spectrum costs not going away Vodafone still has work to do before it can be said to be in rude health.
Vodafone key facts
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
First Quarter Trading Statement (25 July 2022, figures exclude the impact of acquisitions and exchange rate changes)
Organic revenue rose 2.7% to €11.3bn in the first quarter, reflecting growth in service revenue in Europe and Africa.
Vodafone's on-track to meet full year expectations, including underlying free cash flow of around €5.3bn.
Group service revenue growth was partially offset by a 0.5% decline in Germany, with a stronger UK performance outweighing this. There was overall growth across Business and Consumer segments.
In Germany there was a 0.5% decline in service revenue to €2.9bn, reflecting broadband and TV customer losses in the second half of last year. This lower customer base also fed into a 1.6% fall in Fixed service revenue, although Mobile service revenue rose 0.8% as 6,000 contact customers were added in the quarter. Total revenue was €3.3bn compared to €3.2bn last year.
Italy, UK, Spain and Other Europe saw a mixed picture, with service revenue falling 2.3% and 3.0% in Italy and Spain, while the UK and Other Europe rose 6.5% and 2.5%. Weakness in Italy and Spain was driven by increased pricing competition, and the stronger UK performance reflected annual price increases across contracts.
Vodacom's service revenue grew by 2.9% to €1.2bn with growth in both South Africa and Vodacom's international markets. The increase was the result of contractual price increases in South Africa and data revenue growth elsewhere. Inflation-related price increases in Turkey helped service revenue rise 24.7% to €814m in Other Markets. Other revenue of €98m was €7m higher than the same time last year.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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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