Shrunken Vodafone has narrow path to growth

Liberty Global

02/05/2024 12:30

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are his own.)
    By Pierre Briancon
       LONDON, May 2 (Reuters Breakingviews) - Margherita Della
Valle has trimmed Vodafone  VOD.L  to her liking. The CEO of the
British telecom operator has agreed to sell the group’s
stuttering Spanish and Italian divisions for a total of 13
billion euros. It will use part of the proceeds to bolster
returns to shareholders. For future growth, Della Valle is
counting on selling more services to corporate clients, a
recovery in Germany and fast growth at the group’s African
operations. That may not be quite enough to close a stubborn
valuation gap.
    Vodafone is a shadow of its former self. Who remembers that
it was the architect in 2000 of the largest corporate merger in
history – the $190 billion acquisition of Germany’s Mannesmann,
which created the then world’s largest telecom operator? It has
now become the showcase for a troubled European telecom industry
caught between the fierce competition favoured by the region’s
regulators, the need for massive investment in new technologies,
and low profitability. And in spite of a strategy shift
implemented by Della Valle, the telecom operator remains
undervalued.
    The former group CFO, Della Valle was elevated to the top
seat in January 2023 to improve sagging valuations by
accelerating a disposal plan that her predecessor Nick Read
seemed reluctant to carry out. The stock had already sunk by
nearly 50% under Read’s four-year tenure. Yet so far, Vodafone
investors aren’t impressed by the new direction taken by the
group. Shares have lost nearly 10% since Della Valle agreed to
sell the Spanish unit to investment vehicle Zegona
Communications  ZEG.L  six months ago and even though she
accepted Swisscom’s  SCMN.S  8 billion euro offer for Vodafone
Italy on March 15. That’s in spite of a pledge to double a share
buyback programme to 4 billion euros.
    Vodafone’s discount to its peers remains significant even
when stripping out the two soon-to-be-shed divisions. Della
Valle hopes to conclude the Spanish sale in the first half of
this year, pending government approval. The Italian deal could
be closed in the first quarter of 2025. Vodafone will then
shrink to an ensemble made of a German operator listed in London
that makes twice as much revenue as the UK division, a 65% stake
in listed African telco Vodacom  VODJ.J  and other scattered
assets. Pending regulatory and government approval, it also
plans to merge its UK business with local rival Three, owned by
CK Hutchison  0001.HK .
    A comparison of each of Vodafone’s entities with their peers
in different markets illustrates the current valuation gap,
before the eventual merger with Three. Assuming revenue and
operating profit grow, or shrink, in line with the first half of
the fiscal year, the German division’s EBITDA after leases – an
industry yardstick – could come in at a little over 5 billion
euros for the 12 months to March 2024. If valued on the same
enterprise value to operating income multiple of 6.1 as larger
and more profitable local rival Deutsche Telekom  DTEGn.DE , the
German unit would be then worth around 30.5 billion euros
including debt, Breakingviews calculations show.
    In a similar vein, applying British incumbent operator BT’s
 BT.L  forward multiple of 3.8 would value the UK division at
just over 4.7 billion euros. Valued like France’s Orange
 ORAN.PA , Vodafone’s other European assets would be worth 8
billion euros. Applying the same method of comparing with local
peers, Vodafone’s remaining markets would be worth around 3.8
billion euros. And the group’s 50% stake in a Dutch joint
venture with Liberty Global  LBTYA.O , VodafoneZiggo, would be
worth some 7 billion euros if trading on the same multiple as
KPN  KPN.AS .
    These assumptions lead to a Vodafone total enterprise value
of around 54 billion euros. The company hopes to use up to 6
billion euros of its Spanish and Italian proceeds to cut down
debt, which would then shrink to around 30 billion euros,
leaving 24 billion euros’ worth of equity. Throw in the around 6
billion euros of the group’s stake in listed South African unit
Vodacom. Add the company’s indirect stake in Vantage Towers,
delisted in May last year, which could be worth a bit more than
7 billion euros, if its share price had declined in sync with
Spanish competitor Cellnex  CLNX.MC . Vodafone’s equity would
then amount to 37 billion euros, or about 32 billion pounds. The
group’s market capitalisation of 18.3 billion pounds suggests it
is trading at a 42% discount to its potential value.
    Della Valle seems confident that after two years of flat
growth, she can turn the group’s fortunes around in Germany,
which will account for more than 30% of the group’s total sales
after the recently agreed disposals in Italy and Spain. With an
ageing population, the EU’s biggest nation hardly looks like a
booming consumer market for data and internet usage. Vodafone
however sees room to improve its operating performance in the
country. And contrary to other European markets, Germany hasn’t
been disrupted by new competitors eager to wage a price war, as
Xavier Niel’s French startup Iliad did for example in Italy.
    African subsidiary Vodacom’s revenue has meanwhile been
growing a healthy 9%. Della Valle’s other growth hope lies in
offering services such as information technology outsourcing or
cybersecurity to corporate clients. That activity is seen
expanding by 5% a year. The hope is to grow the segment from 30%
to 50% of the group’s services revenue, in spite of the
competition from industry incumbents who have been servicing
corporates big and small for years. Based on today’s numbers,
“mission accomplished” in that division would translate into
over 7 billion euros of added sales, and a hypothetical 2
billion euros in extra EBITDA after leases based on the group’s
current operating margin. That could add 10 billion euros in
enterprise value, based on Vodafone’s 2025 multiple, helping to
close the gap and offering comfort to investors such as Gulf
technology company e&  EAND.AD , which hiked its stake to about
15% since the Italian top executive took over.
    Putting Vodafone back on the growth path will however take
time. Della Valle’s shrinking job is mostly over. She has to
switch to a sharper focus on improving operational performance,
which may not yield immediate results, requiring investor
patience. It took Della Valle just over a year to prune the
decaying Vodafone tree. It will take longer before she can take
pride in its fruits.
    Follow @pierrebri on X
    
    CONTEXT NEWS
    Vodafone said on March 26 that it would aim to save around
400 million euros ($434 million) over the next two years at its
German operations as part of a restructuring that will hit some
2,000 jobs.
    The move is part of a cost-cutting drive announced nearly a
year ago which will result in the loss of some 11,000 jobs
worldwide.
    Vodafone agreed in October 2023 to sell its Spanish division
to investment vehicle Zegona Communications for 5 billion euros.
It also announced on March 15 a plan to sell its Italian unit to
Switzerland’s Swisscom for 8 billion euros in cash.

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Graphic: Vodafone is trading at a discount to its intrinsic
value    https://reut.rs/4aYRf1B
Graphic: Vodafone has underperformed peers under CEO Della Valle
   https://reut.rs/3WpksOQ
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Editing by Lisa Jucca and Oliver Taslic)
 ((For previous columns by the author, Reuters customers can
click on  BRIANCON/ 
pierre.briancon@thomsonreuters.com; Reuters Messaging:
pierre.briancon.thomsonreuters.com@reuters.net))