Vodafone: Smaller, Better and More Valuable

Just got an interesting review from Bernstein Research of the last quarter results of Vodafone. It seems that the Company has gone from having the worst price perception, no devices, internally focused country managers and cost rather than network focused consumers to best in class price perception, competitive devices, country managers now compensated on a more commercial, externally focused basis, and consumers increasingly focused on network quality where Vodafone can excel.

With a wave of data usage supporting revenue growth and not yet pressing up capex, Vodafone’s core operations should have a good 2-3 years. Top line revival should go a long way to undo many of the bearish arguments for which constant top line decline is the core symptom of a terminal diagnosis.

Please find the main highlights ater the jump.

Main Highlights:

• In the next 2-3 years operational, and in particular European operational momentum, is on Vodafone’s side. The Company has gone from having the worst price perception, no devices, internally focused country managers and cost rather than network focused consumers to best in class price perception, competitive devices, country managers now compensated on a more commercial, externally focused basis, and consumers increasingly focused on network where Vodafone can excel. With a wave of data usage supporting revenue growth, favoring full service operators and not yet forcing capex up, Vodafone’s core operations should have a good 2-3 years. Top line revival should undo the bearish argument for which constant top line decline is the core symptom of a terminal diagnosis.

• We believe that several of our concerns regarding execution (laid out in our open letter in November last year) are now being addressed, and hope to see evidence of that this year. A number of senior managers have left the business, and there has probably been more turnover than we have given the Company credit for in the past. Management recently told us that compensation of country managers has changed to be more outward and commercial looking than inward looking. We remain optimistic that there will be more important changes in 2010.

• To move the share price beyond GBp150 Vodafone needs to lay out a clearer portfolio strategy and slim down. We think there are four categories of assets within Vodafone’s portfolio: core Europe (where they can be #1 or #2), peripheral Europe (where they will likely be consigned to a role as a weak 3rd or 4th), emerging markets and miscellany. Vodafone should change capital allocation to the different categories of assets, focusing on the core; squeezing and/or disposing of the periphery; selectively investing in emerging markets, and monetizing the miscellany. All this will improve their leverage in negotiations with VZ.

• Slimming the portfolio would increase shareholder remuneration and take the focus off the minority assets – the timeline of which is largely out of Vodafone’s control. Better portfolio management should convince shareholders to wait for that value realization by proving that they are willing and interested in being smaller, better and more valuable to its owners. We think that management is more focused on satisfying shareholders and restoring investor confidence. Sale of non- core assets excluding SFR and VZW would result in flat FCF per share after share buybacks, and an increase in the dividend of ~20% in FY2011 and ~40% in FY2012 on top of the 10% YoY growth we are forecasting. It could well also lead to a re-rating and should allow for more focused management of the core assets.

Investment Conclusion

BR guys think that Vodafone should be buoyed throughout 2010 by consolidating mobile markets, fading price headwinds and improving volume trends driven by some enterprise volume recovery and the end of iPhone exclusivity. In addition to this they will likely also see continued cost cutting, and stable capex while other companies scramble to catch up on their under-spend during the lean years. In spite of a recent recovery we think that the stock is still trading at an unreasonable discount to peers in Europe and the US.

On top, theye are increasingly confident that some change to the current unsatisfactory relationship with Verizon could be in the offing in the next 1-2 years and that this is not yet priced into the stock. We rate VOD Outperform with a target price of 180 GBp.

Net, net, good investment proposition. Enjoy the reading. Best, CVA. Flying to Madrid from Santo Domingo.

Disclaimer: the author has no position on any of the referred companies.