May 29, 2007 7:38 pm

Vodafone’s investors seem unconcerned

Arun Sarin on Tuesday shrugged off questions about Vodafone’s falling core profit margin as “not new news”.

Vodafone’s chief executive said: “All of our competitors have been lowering their margins prior to our saying we will start lowering our margins.”

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It was Vodafone’s warning in November 2005 that its core margin was falling that prompted strong criticism from investors about the group’s performance and direction.

Tuesday’s 2006-07 results were accompanied by confirmation that the margin was expected to decline further in 2007-08 at the level of earnings before interest, tax, depreciation and amortisation (ebitda).

Yet investors seemed insouciant. What has changed?

Mr Sarin agreed with suggestions that investors had effectively been re-educated over the past 18 months about the group’s prospects. To some extent, investors’ expectations have been lowered to fit a new era of maturity in Vodafone’s core European markets.

But perhaps more importantly, they have bought into the story that Vodafone is essentially a tale of two companies.

In Europe, where Vodafone generates 80 per cent of its revenue and ebitda, the group is fighting ferocious competition and relentless pressure from regulators for reductions in prices. So Vodafone has seized on emerging markets to be its growth engine.

This strategy should deliver solid but unspectacular results in 2007-08, based on Vodafone’s outlook.

Revenue is expected to be £33.3bn to £34.1bn, up 8.4 per cent at the mid range, with adjusted operating profit at £9.3bn to £9.8bn, up 0.2 per cent.

Free cash flow is due to be £4bn to £4.5bn, down 30.6 per cent. On an underlying basis it should be £5.9bn-£6.4bn but is expected to be cut to no more than £4.5bn partly because of spending on Hutchison Essar, India’s fourth largest mobile operator, which Vodafone took control of for $10.9bn (£5.5bn) earlier this month.

The fierce competition and regulatory pressure in Vodafone’s European markets was laid bare in the 2006-07 results. Organic revenue growth was up 1.4 per cent, with ebitda down 3.4 per cent.

In Germany, its largest market by revenue, the ebitda margin deteriorated by 2.4 percentage points as Vodafone slashed prices to keep abreast of its competitors.

In Italy, the so-called Bersani decree, named after the country’s industry minister, has prohibited all operators from charging top up fees on customers’ pay-as-you-go mobiles.

That has prompted Vodafone to take an impairment charge of £3.5bn. Vodafone has written down its goodwill by £11.6bn in 2006-07 because of competition in Germany and Italy and rising interest rates.

The sober picture in Europe is offset by sparkling growth in emerging markets during 2006-07. Organic revenue growth was 21.1 per cent, with ebitda up 20.9 per cent.

Revenue growth in Egypt and Turkey was up 40 per cent and Mr Sarin expressed confidence that Hutchison Essar would be a “very positive development”.

He also signalled Vodafone would stick with its minority stakes in Verizon Wireless and SFR, the US and French mobile businesses.

Vodafone reported some progress with expanding beyond being a purely mobile-centric group by selling fixed-line broadband.

But Mr Sarin’s most notable comment was a willingness for Vodafone to invest in more fixed-line networks than when the mobile-plus strategy was unveiled last year.

Previously, he had suggested Vodafone would deliver broadband almost entirely by reselling wholesale products provided by fixed-line telecommunication companies. Vodafone also highlighted how a long hoped for explosion in customers using their mobiles for data functions such as web surfing was finally showing some signs of happening.

Underlying European data revenue was £1.4bn in 2006-07, up 40.3 per cent.

Investors welcomed the results. They are more confident in Vodafone’s board since Sir John Bond became chairman last July and have been heartened by the improving share price. It has increased almost 40 per cent since a sector rally last September. Investors also liked the full year dividend of 6.76p, up 11.4 per cent.

Jim Stride, investment director at Axa Investment Management, said: “We thought the results were good, given the market background and the regulatory issues.

“And we were pleased with the dividend increase. The group is investing in the future with Hutchison Essar, although we want to see how that pads out.”

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