A recent post on the FT Alphaville blog describes Vodafone (LSE: VOD) as being one of the UK’s most “persistently irritating” companies. It’s hard to argue with that statement.
The group has flip-flopped from strategy to strategy over the past two decades, and shareholders have been left holding the bag. Over the past 15 years, the Vodafone share price has produced a total return of 94% compared to 114% for the FTSE All-Share Index.
That might not seem too bad on the face of it, but if you exclude dividends, the shares have returned -59%.
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This performance reflects the fact that Vodafone’s shareholder equity has slumped from €92bn to €57bn over the past ten years as the company has struggled to expand in a competitive environment.
Vodfone’s challenges are twofold.
Telecoms companies require vast amounts of capital to grow and maintain their assets. For example, over the past 11 years Vodafone has spent just under €9bn (£7.6bn) a year on new equipment and technology. To put that into perspective, a business with a market capitalisation of £7.6bn would be the 48th-largest company in the FTSE 100.
And Vodafone cannot meaningfully cut this spending as it might lose market share. This is the other great challenge the firm has to manage, and it is one of the reasons why CEO Nick Reed has been calling for greater consolidation in the European market.
Vodafone has been trying to consolidate the market to improve returns
To give the company credit, it has been trying to consolidate the market. In 2019, Vodafone completed the €19bn purchase of Liberty Global assets in Europe, expanding its footprint in Czechia, Germany, Hungary and Romania.
Under pressure from Cevian Capital, Europe’s largest activist investor, Vodafone has also tried to ink deals in Spain and Italy, and is rumoured to be looking at a deal with Three in the UK.
Three UK is owned by Hong Kong infrastructure conglomerate CK Hutchison and is the UK’s fourth-largest mobile operator. Any deal is likely to come with substantial synergies, but it’s also likely to attract significant scrutiny from regulators. What’s more, considering Vodafone’s recent record, there is no guarantee it will happen.
Despite these headwinds, Vodafone’s results for the year to the end of March show it is making progress growing revenues and profits. Revenues rose 4% to €45.6bn and operating profit increased by 11.1% to €5.7bn. In Germany (a market analysts keep a close eye on as it accounts for 30% of Vodafone’s service revenue) revenue grew by 1.1%.
That said, while any growth is positive, in the face of high-single-digit inflation, the numbers are not all that impressive.
I think Vodafone’s cash flow figures are a much more accurate reflection of the company’s financial position. Free cash flow for the year totalled €3.3bn, all of which was swallowed up by dividends (€2.5bn) and share buybacks to offset “dilution linked to mandatory convertible bonds.” With more cash flowing out than coming in, group net debt increased by €1.1bn to €41.6bn.
In other words, Vodfone is paying out more than it can afford. And not for the first time: in the 2021 financial year it paid out €2.4bn to shareholders on free cash flow of €3.1bn, and spent €1.5bn buying out remaining minority shareholders in Kabel Deutschland Holding to resolve a long-running legal dispute.
The firm was able to reduce overall debt by packing up some of its infrastructure assets into a new business, Vantage Towers, which unlocked €2bn in an IPO.
The Vodafone share price looks attractive but investors should steer clear
Despite Vodafone’s global footprint, huge capital spending, revenue growth and acquisitions, the business is still relying on asset sales to keep debt under control and fund dividends.
This is only sustainable for so long. And management is now warning that life is going to get harder for the business as the “macroeconomic climate presents specific challenges”. Vodafone will be able to raise prices in line with inflation for subscribers on some of its contracts, but this could increase churn if consumers start to shop around.
While the Vodafone share price currently supports one of the highest dividend yields in the FTSE 100, investors need to look past the stock’s 6.4% dividend yield and focus on its long-term record of creating value.
On this front, Vodafone’s record is terrible. It has been selling the family silver to fund shareholder returns while borrowing money to fill any gaps. Net debt stood at €24.4bn at the end of 2012. At the end of March the figure was €41.6bn. With interest rates on the rise, the cost of this borrowing is only going to grow.
It does not appear as if Vodafone’s prospects are going to improve any time soon. Investors may be better off looking elsewhere for income.
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