Vodafone shares suffered their sharpest one-day fall for more than seven years on Tuesday, after the UK mobile phone operator warned that margins would drop next year, hit by continued heavy investment in its troubled Japanese arm and intensifying competition in core European markets.

Investor confidence was further undermined by the group's disclosure that it expected to see £5bn ($8.7bn) in tax liabilities crystallise in the next three years.

The shares fell 15¾p to close at 129¼p in London. One analyst identified the disclosure of the tax liabilities as the “thing that put the skids under the share price”, saying it could cut £4bn from the valuation of the business.

The extra investment in Japan also surprised investors. Arun Sarin, Vodafone's chief executive, said the extra funding was to prepare the business a distant number three in the market for more intense competition next year.

There has been speculation that Vodafone could pull out of Japan, but Mr Sarin insisted on Tuesday that the group was there “for the long term”.

The new management team was “on course” to turn the business around, he said, promising that margins would start to grow again in the 2007-08 financial year.

Vodafone's guidance on its European outlook was in line with expectations, following warnings from other large mobile operators that competition was increasing. The group said it would need to spend more to win customers in the more mature markets as it looked to expand its subscriber base beyond 171m.

Like others in the industry, Vodafone is also being hit by regulatory intervention in Europe. Spain, Germany and Italy are following the UK in cutting so-called termination rates where one operator pays a fee to another for a call that “terminates” on the latter's network.

Vodafone is trying to offset slowing growth in its mature core businesses by pushing more users on to 3G services. The group currently has 5m 3G subscribers following the launch of the service late last year.

Mr Sarin is also targeting acquisitions in emerging markets, focusing on eastern Europe, Africa and south-east Asia.

He ruled out a move into the fast-growing Russian market, blaming a lack of opportunities and the political climate. “If you look at the things that are going on there in government terms, it is not the most welcoming place at this point in time,” he said.

The sharp drop in the share price came as the group reported strong interim profits. Earnings before interest, tax, depreciation and amortisation rose to £6.7bn in the first six months to the end of September, from £6.3bn. Revenue rose 9 per cent to £18.3bn.

Pre-tax profits fell to £4.1bn from £4.5bn, hit by a £515m write-down on a Swedish business it agreed to sell earlier this month.

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