Should you buy shares in Vodafone?

Businesses often change what they do as they mature. Indeed, between takeovers, mergers and disposals, some companies change shape almost completely within quite a short timeframe.

UK giant Vodafone (LSE: VOD) is a classic case. It’s been involved in plenty of M&A – merger and acquisition – activity over the years. It’s now a totally different operation to the one that was de-merged from the old Racal Electronics (remember them?) almost 20 years ago.

Vodafone is now the world’s leading mobile telecommunications company, with units around the globe.

Yet shareholders haven’t got much out of all this wheeling and dealing. Vodafone’s share price is no higher than it was in July 1998. The stock market overall has hardly done brilliantly over that time, but Vodafone has still underperformed it by around 5%.

But now they might finally be seeing some payback. Vodafone has just landed a £2.8bn bonus. What’s more, it’s paying most of this cash out to shareholders.

That’s great news for existing investors. But what if you’re not already in the stock? Is it still a buy? Let’s have a look…

Vodafone’s American windfall

So, where is this windfall for Vodafone shareholders coming from? Vodafone holds 45% of an American business called Verizon Wireless (VW). The other 55% is held by the US telecoms major Verizon Communications.

VW is a very serious telecoms player. It owns and runs the largest mobile phone network in America. Indeed, with more than 106m subscribers, it has a third of the country’s mobile market, according to Informa WCIS. In 2010 it generated revenues of over $63bn.

That sounds like a great investment for Vodafone. And until 2005, it was. Vodafone was getting a healthy cash dividend. But then this came to a shuddering halt. VW decided it had higher priorities than keeping Vodafone happy, such as paying down its debts.

As a result, Vodafone has since been one big unhappy part-owner. And in turn, the firm’s own shareholders have given the management flak for holding an investment that wasn’t paying any return.

No wonder Vodafone’s board has been angling for dividend payments from VW to be restarted again. There had been hints from Verizon Communications that this might happen next year, but nothing concrete – until the end of last week.

VW has just said that it will pay out $10bn to its shareholders in January next year. That will mean a £2.8bn windfall for Vodafone, which will boost its free cash flow by almost 40%.

The UK firm is going to use £800m to pay down some debt. And the good news for anyone who holds Vodafone shares is that they’ll get a slice of the remaining £2bn, in the form of a special dividend of 4p per share (we don’t yet have the full payment details as yet).

Is Vodafone still worth buying now?

It’s hardly a surprise that Vodafone shares went up by 5p on Friday, even though the rest of the market was dropping fast.

Sure, some sort of payment had been forecast at some stage – we wrote about this last year – but it turned out to be bigger than expected. In fact, you might have expected a much bigger rise in the stock but for one thing – officially the VW payment is a one-off. In other words, it’s not guaranteed to be repeated next year.

So does this seriously temper the good news? Not really, says Vodafone’s management. It hopes that with Verizon Communications changing bosses, more pressure will be put on VW to make the cash distribution an annual event. And management also pointed out last week that the company has been right to keep hold of the VW stake, despite pressure from shareholders – analysts reckon the holding has risen from in value about $20bn in 2001 to $65bn-$70bn this year.

Indeed, there should be “more dividends still to come, and bigger”, agrees Espirito Santo Investment Bank: “It would be amazing if there wasn’t a regular payment from now onwards, as VW can certainly afford to pay much more than $10bn per annum.”

Further, and maybe most important of all, a fundamental change is now taking place at Vodafone. In contrast to much of its history, the firm is flogging off several of its smaller assets, and making good use of the money.

Last month, for example, it raked in £7bn in cash by selling its 44% shareholding in French mobile operator SFR to media conglomerate Vivendi. And Vodafone will use £4bn of this windfall to buy back 5% of its shares. This will boost future earnings – to see how this works, why not take a look my colleague Tim Bennett’s recent article on the subject: Can you trust reported earnings figures? As Tim notes, we’d rather see this paid back as dividends, but it’s better than nothing.

Meanwhile, Vodafone already looked cheap, even before last week’s announcement. Last year we noted that the firm’s net asset value (NAV) was somewhere between 185p and 210p. That can only be higher now after the latest news.

What does this all add up to for Vodafone shares? At 172p, on a current year forecast p/e of just 10.7, which analysts see dropping to under ten next year, and a very tasty prospective yield of 5.6%, this is a stock to lock away.

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  • kenneth archer

    There is no case for buying back shares as time and again it does not improve the price of the share only good dividends do that. All shareholders should vote no to buy backs.

  • SW

    > Vodafone’s share price is no higher than it was in July 1998

    I’m curious why you use 1998?

    BTW MoneyWeek tipped VOD around Aug 2009 … thanks for that tip, the shares are now up 30%. Mucho appreciated!