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The Value of Vodafone

Here's an idea for the June contest: Vodafone (VOD).

Vodafone is listed on the London Stock Exchange. The share price is about 163 pence for a market cap of roughly £85B. In the US, Nasdaq-traded ADRs representing ten ordinary shares can be bought for $27.

Vodafone stock is owned by gurus Francis Chou, Mason Hawkins and Charles Brandes.

Most of the numbers used in this analysis are from recent sec filings:

The Business



In 1980, Racal Electronics Plc, agreed with General Electric Company Plc to allow Racal to access GE's tactical battlefield radio technology.

In 1982, Racal's newly formed Racal Strategic Radio Ltd. subsidiary won one of two UK cellular telephone network licenses, with the other going to British Telecom. Vodafone was launched in 1985.

A 50 bagger in 15 years — 1988, Racal Electronics floats 20% of Racal Telecom, valuing Vodafone at £1.7 B.

1991, Racal Telecom (now Vodafone group) is demerged from Racal.

Today, Vodafone is the world's largest mobile communications company with approximately 350 million subscribers through its operations in Germany, Italy, Spain, the UK, Turkey, India, the republic of South Africa and dozens of other countries worldwide. Vodafone is based in Newbury, UK.

Looking for the Buffett connection? Newbury is in Berkshire.

Competitive advantages



Vodafone's global footprint and excellent network quality attract high-end customers (travelers, business). In an industry that depends on coverage and quality of the network, Vodafone leads.

Management generates savings from technology standardization, off-shoring, outsourcing, platform sharing and group purchasing. As a percent of EBITDA, Vodafone historically has the lowest capex of its peer group. That's impressive for a company that has been spending on rapid growth.

Risks & fears



Currency Vodafone's operating income is mainly euros and USD. The company is based in the UK so reported financials can be volatile due to fluctuating exchange rates.

New technology Companies like Vodafone depend on control of the access point to competing technologies. Wi-fi/wi-max could become a threat if someone uses this technology to create national/global networks at a lower cost. In my opinion, as the cost of such national or global networks does not hinge on the hardware/technology used, this is not a major threat. Nevertheless, this key risk merits continued observation.

Capex expansion There is some fear of an explosion of capex due to the adoption of data. According to Vodafone, in 2010, data use has gone from 4 petabytes/quarter to almost 15. Cisco (CSCO) estimates a 66x increase in mobile Internet traffic from 2008 to 2013. Current networks will be obsolete… and the wireless carrier is in trouble.

I believe the economics involved are misunderstood. Increasing capacity is cheaper than increasing coverage. Upgrading an existing network with 100x capacity is much cheaper than building new towers & cell sites, running new backhaul lines, etc. Historic capex has been about increasing coverage. Going forward, it's about increasing capacity.

Technically speaking, there are "natural "capacity gains in packet switched networks (data) versus circuit switched networks (voice). Voice networks are overbuilt to avoid dropped calls. This requires a lot of excess capacity in the system. IP Data doesn't need continuous access and unlike voice, can withstand more than ~100ms "circuit" break before dropping a connection.

Purchasing frequencies for 4G in Europe is a cost that is important to consider. Vodafone estimates the purchase of frequencies would cost roughly $2 billion for its European markets. In any case, the market price for such frequencies are lower now than they were historically; there are fewer bidders.

Operators in Europe are now sharing their infrastructure, which should practically eliminate the need for new towers in an already well-covered area.

In short, I believe Capex won't go up. It's likely to stay flat in markets with adequate coverage. Indeed, carriers on both sides of the Atlantic have guided towards flat capex as 4G is rolled out.

Competition



Vodafone competes with the incumbent telco in every market it operates in and it does so successfully. In each country, Vodafone is able to grow under the umbrella of the "lazy" incumbent. On a global scale, there is no other. Big incumbents are too busy fending off Vodafone on their home turf to think about competing globally. Arguably, BT is the exception.

Management



Vodafone's former CEO, Arun Sarin, spent excess cash acquiring minority stakes in foreign wireless "challengers" to the Incumbent telcos. Verizon Wireless (VZ)(US), SFR (France), Polkomtel (Poland) and Bharti (India) to name some. To be fair, in each case, Vodafone paid a high price for stakes that eventually turned out to be worth multiples. Nevertheless, investors punished the stock, accusing management of "building an empire."

Arun Sarin left in 2008, handing over to Vittorio Colao. Vittorio Colao, aged 49, joined Omnitel Pronto Italia in 1996, which subsequently became Vodafone Italy of which he became chief executive in 1999. In 2004 he left Vodafone to join RCS MediaGroup (Corriere della Sera, La Gazzetta dello Sport, City and Urban) where he was chief executive until he rejoined Vodafone as CEO, Europe. Colao's strategy is simple and certain to close the gap between price and value. He sells minority stakes Wall Street ignores and frees up energy and cash to concentrate on organic growth in India and South Africa. Under Colao Vodafone is to:

  1. Focus on key areas of growth potential (India and South Africa);
  2. Deliver value and efficiency from scale (lowest capex/EBITDA).
  3. Generate liquidity or free cash flow from non-controlled interests.
  4. Apply rigorous capital discipline to investment decisions.


One can easily check 1, 2 and 3 against management's actions since 2008. No. 4 is not easily "checked."

  1. On March 31, 2011, Vodafone Group Plc announced that it would buy an additional 33% stake in its Indian joint venture for $5 billion after partner Essar Group exercised an option to sell the holding in the mobile-phone operator. The deal will raise Vodafone's stake to 75%.
  2. Vodafone sold its 3.2% stake in China Mobile (CHL) for $6.5 billion. Vodafone has also sold its 44% stake in SFR for $11 billion.
  3. While Vodafone did not agree with Verizon on a fair price for Verizon wireless, Verizon communications has agreed to let Verizon wireless start paying dividends. In order to maintain its own dividend, Verizon communications has no choice.


Gerard Kleisterlee, aged 64, will succeed Sir John Bond as chairman in July. He retired as CEO of Philips Electronics (a former Mason Hawkins holding) recently. Kleisterlee is a member of the Daimler AG Supervisory Board, a member of the Audit Committee of Shell and a member of the board of directors of Dell (DELL), yet another Hawkins stock.

Most of the cash from the China Mobile sale, roughly £2.7 billion, will be returned to shareholders through share buybacks. The gradual buyback gives the company flexibility to turn off the cash taps quickly if circumstances change.

Colao's strategy of unlocking the hidden value of Vodafone's minority stakes is hard to fault.

Read more: http://www.dailymail.co.uk/money/article-1310931/INVESTMENT-EXTRA-IAN-LYALL-Vodafone-sheds-assets-fund-share-buyback.html

Value



Owner earnings

We use FCF as a starting point to estimate the magnitude and sustainability of the cash income available to stockholders.

In the last five years FCF as reported (GuruFocus) has averaged $13 billion per annum. This does NOT include FCF from Verizon wireless as this is not consolidated in Vodafone's numbers. Verizon Wireless's cashflow is a not so carefully hidden secret that can be found in their sec filings; they file under their formal name Cellco. Forty-five percent of Verizon wireless's FCF of $ 15B is roughly $6 B. We add only the FCF of Verizon Wireless to the FCF of Vodafone for a total of $19B per annum and ignore all other (non-consolidated) minority stakes.

We check to see if FCF doesn't overstate true cash earnings due to unsustainably low Capex.... Capex since 2006 has been around $15 billion, which is about 50% of net PP&E ! Without getting into much detail, we conclude Vodafone has not been underspending on capex. In fact, we can safely assume a large fraction of that $15B Capital expenditure is spent on growth. In this case, FCF understates true owner earnings. We'll stick with $19B though.

So, we have an estimate of $19 billion of owner earnings (cash available to shareholders). This is pessimistic, as we disregard all minority stakes except Verizon Wireless and assume capex is just maintenance while clearly it's not.

$19 billion => £12 billion of owner earnings on a £85 billion market cap — a 14% yield.

Look-through cash earnings of £12 billion easily cover £30B of debt bearing an interest of less than £ 2.5 billion per annum.

Breakup

Forty-four percent of SFR (with 20m subscribers) was sold for $ 11 billion implying SFR is worth $25 billion. That's over $ 1000 per subscriber. We use this data point to value Vodafone's operations in Germany, Italy, Spain and the UK at $75 billion.

Verizon Wireless doesn't have significant debt and spits out $15 billion of cash per annum. That's $ 150 per subscriber each year. Let's say Verizon Wireless is worth $ 1500 per subscriber; $150 B — 45% of $150 B is $65 B.

Ok, we're there. We get paid to own the Indian, South African, Dutch, Romanian, Egyptian and Turkish operations.

Vodafone recently bought the remaining 33% of Vodafone Essar for $5 billion to become the sole owner. This values the Indian subsidiary, with 130m subscribers at $15 billion. The market says a Vodafone subscriber in India today is worth less than 10% of a US subscriber. By 2021, this value may well have converged somewhat. By then, the number of subscribers in India may have risen a bit too. Just speculation, not for the gurufocus crowd. It's not the subscribers we are paying for, it's the infrastructure.

Anyway, 75 + 65 + 15 = $ 155B => £ 100 billion

Catalysts



Cashflow no longer hidden Verizon Wireless generates roughly $15 billion of FCF. The cash, until recently, was used to repay debt owed to Verizon communications. Verizon communications used this cash to fund the dividend it paid its shareholders.

Now that the debt has been repaid, the cash is piling up. Verizon communications generates negative cash flow from its non-wireless assets. In order for Verizon communications to maintain its dividend, Verizon Wireless will need to start paying a dividend to its shareholders. In short, 45% of that $15 billion annual cash starts showing up in the Vodafone numbers.

Realization of Verizon Wireless Vodafone gets a decent bid for its stake in Verizon wireless from Verizon or someone else.

The opportunity exists because

  1. The market does not understand the magnitude of owned cash flow hidden within Vodafone due primarily to non-consolidated subsidiaries.
  2. Market participants fear the coming mobile data revolution will be value destructive for wireless providers.
  3. Building the network in India to cater for the huge demand potential there, is currently not profitable and probably won't be for a long time to come. It creates an overhang for profits.
  4. Historically Vodafone has been highly acquisitive.


Conclusion

Vodafone has unique and durable competitive advantages, is well managed, highly profitable and demonstrably cheap.

Disclosure

This is not a recommendation to buy or sell any security. I had no position in any of the stocks mentioned at the time of writing.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

Visit batbeer2's Website


Rating: 3.7/5 (35 votes)

Comments

hschacht
Hschacht - 2 years ago
So what is your intrinsic value estimate? I follow the logic (which is why I own VOD), but it would help to have a conclusion.
Adib Motiwala
Adib Motiwala - 2 years ago
batbeer,

Good idea. It would be great if you helped the readers understand :

1) How you arrived at the Cash Flows / FCF for Verizon Wireless. I think VZ consolidates the Cash Flow from Operations for both land line and wireless. It does provide separately the revenues for both and also the capex for each division. I believe wireless is 60% of sales but 90%-95% of operating profit. So, did you take the Cash Flow as proportionate to Sales or Operating Profits.

2) I think the VOD Capex seems incorrect. I have it as $8 billion. So, you meant $13 billion of FCF (currently) + $5 billion from VZ Wireless = $18 billion (11 billion pounds).

(3) How did you estimate VOD's operations in Europe as $75 billion.

Thanks!

batbeer2
Batbeer2 premium member - 2 years ago
Thanks for the comments and questions.

@ Henry

So what is your intrinsic value estimate?

Two ways to get a "precise" number.

- Assuming the market demands a 9% return for the average stock; over time..... VOD's look-through earnings are £12B implying a value of 12B * 100/9 = £ 133B. That's roughly 250p per share.

I prefer thinking in terms of yield and not discuss the "right multiple". Still, for those who like multiples..... I'm slapping a p/e of 11 on the look-through earnings of VOD to get fair value of 250p.

- Breakup gets us at least £ 100B => 200p.

Again, I believe these estimates are pretty pessimistic for reasons given in the article.


@ Adib

I think the VOD Capex seems incorrect. I have it as $8 billion.

I'm looking at VOD's Capex on gurufocus's 10 year financials. Roughly $ 15B => £ 9B. You may be using a different source. Frankly, I did not add it up and divide by 5 to get the five-year average. I just squint my eyes at the screen ;-). In any case, Vodafone's Capex is high in relation to its fixed assets which is the important bit. Just checking to see if FCF isn't overstating owner earnings due to an unsustainable Capex dip..... it isn't.

I could have pointed out that the company has increased the total number of subscribers substantially.... especially in India and South africa. Just another way to check they're not underspending on Capex but I like to write short articles with long threads ;-)

I just editted my FCF & owner earnings numbers a bit; I fudged some pounds and dollars in the original article.


How you arrived at the Cash Flows / FCF for Verizon Wireless.

Verizon Wireless files with the sec as Cellco.

In recent filings, you will find they have been reducing debt outstanding by about $ 15B per annum. I consider cash you can use to repay debt without taking on new debt a good proxy for owner earnings.

Alas, there's a limit to the amount of debt you can repay. Verizon Wireless will now start accumulating cash and/or pay dividends. You'll notice they recently stopped filing with the sec precisely because they've now retired all the debt.

So, did you take the Cash Flow as proportionate to Sales or Operating Profits ?

I just counted the cash based on information available with the sec. ;-)

- EDIT- I've now included the answers to these questions into the original article.
batbeer2
Batbeer2 premium member - 2 years ago
How did you estimate VOD's operations in Europe as $75 billion.

The short answer:

A subscriber in a mature market is worth $ 750 - $ 1500. I use the lower number.

The long answer:

In each of the following markets, Vodafone is the established #2 player; the most successful challenger to the incumbent telco. With the exception of the UK (25%), market share is more than 30%; as is the case with SFR.

Germany, 36m subscribers

Italy, 23m subscribers

Spain, 17m subscribers

UK, 19m subscribers

That's a total of roughly 100m subscribers. SFR has about 20m (some are IP TV customers). So, if SFR is worth $ 25B, I think it's safe to say the other operations, together, are worth $ 75B. For good measure, I just ignore Italy because most of the subs there are prepay.... margin of safety.

For comparison, my estimate of Verizon wireless's value, based on FCF, is $ 150B, also on 100m subscribers. Then again, Verizon is the #1 player in its market, beating the old incumbent. Verizon produced $ 150 of owner earnings per subscriber last year... this makes sense.

Alternatively, we can break down EBITDA, operating income etc.... but I have not found a way to get a value for Vodafone's operations in these four European countries of less than $ 75B.
DocMoney
DocMoney - 2 years ago
Bought on the strength of your analysis. 3% of portfolio... Happy camper now:)
batbeer2
Batbeer2 premium member - 2 years ago
Hi DocMoney, nice gain, congratulations !

I beat you though. I invested $ 0 and gained $ 500 ;-)
batbeer2
Batbeer2 premium member - 2 years ago
BTW..... Shares are up because Verizon Wireless announced it would start paying a $ 10B dividend to its parents.

http://online.wsj.com/article/SB10001424053111903635604576474662914183744.html#ixzz1TgJovAEm

http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/telecoms/8671322/Vodafone-shares-rise-after-special-dividend-boost.html

Verizon Wireless, with no debt, paying a $ 10B dividend should fetch at least $ 175 B in the market if it were pulicly traded. Vodafone could choose to spin out its stake to current Vodafone shareholders. That stake would be worth $ 75 B or roughly $1.50 (90p) per Vodafone share.... I use round numbers.

An ADR represents 10 Vodafone shares so that's $15 per ADR.

Spinning out that stake would have NO IMPACT on current Vodafone revenue, dividends or earnings.
tonyg34
Tonyg34 - 2 years ago
Enjoyed the article and wanted to pick your brain about developments in M2M services and cloudNAPs. Have you given any thought to the market dynamics of these new product offerings and how would you assess the potential value? The link is a follow-up article I wrote about your article.

http://www.gurufocus.com/news/140654/vodafones-hidden-catalyst-its-green
Adib Motiwala
Adib Motiwala - 2 years ago
So, what do you think the ADR is worth ? In my calculation, FCF is about $15 billion USD with the payout from VZ.
hschacht
Hschacht - 2 years ago
VOD is probably the most obvious undervaluation in my portfolio with the clearest catalyst. My fair value is at least $35 per ADR.
batbeer2
Batbeer2 premium member - 2 years ago
@ Adib

I put in a fair value vote for the ADR.... same as Henry.

@ Tony

I'll get back to you later.
batbeer2
Batbeer2 premium member - 2 years ago
>> Vodafone stock is owned by gurus Francis Chou, Mason Hawkins and Charles Brandes.

We can now add Bruce Berkowitz to the list.

@ Tony Re: M2M & Smartgrids, I've given the matter some thought.

This development requires coverage (as opposed to bandwidth). Mature markets have >> 90% coverage by at least 2 players. That would typically be the incumbent + Vodafone.

The new business would mostly be national. In Germany VOD would face heavy competition from Deutsche Telecom and in the UK BT, In the US AT&T etc. etc.

Vodafone could and probably will get some business by selling national coverage, especially to smaller companies that simply aren't able or willing to build their own. Having said that, in this space, Vodafone doesn't have a specific advantage over the incumbent.

In short, IMHO it's a plus but it isn't a home-run.

Just random thoughts; thanks for the question.
tonyg34
Tonyg34 - 2 years ago
@Batbeer2

Thanks for the reply.

I agree that nationalism may play a heavy hand in who wins the most coveted smartgrid contracts, but M2M services appear to be open to the low cost provider.

LightSquared's 15 yr. pact with Sprint and Dish Networks planned purchase of spectrum from TerreStar lead me to believe that there is more competition in the telecom, and thus M2M, space than I had originally realized. Despite high costs of entry and regulatory limits on spectrum availability and infrastructure investment, new technologies (LTE, satellite, microwave, and higher-frequency communications) and new competitors continue to enter the market all the time.
batbeer2
Batbeer2 premium member - 1 year ago
After almost two years Bloomberg says:

Verizon Communications Inc. ( VZ ) is looking to resolve the status of its joint venture with Vodafone Group PLC ( VOD ) this year with a range of options having been considered, although talks haven't reached a substantial stage, Bloomberg News reported Tuesday on its website, citing people familiar with the situation.

The two companies as recently as December discussed a full combination, with that option stumbling over leadership and headquarter location issues, making a buyout or partial sale of Vodafone's stake in Verizon Communications more likely. Talks between the two companies on both options are likely to resume this year, the report said.

Verizon and Vodafone representatives declined comment to Bloomberg.

Read more: http://www.nasdaq.com/article/verizon-looking-to-resolve-vodafone-jv-status-this-year--bloomberg-20130305-01084#ixzz2MhXkzXEa


VZ really needs the cash while Vodafone does not. Vodafone is likely to come out on top. I guess a merger is best for tax reasons. VOD simply buys VZ. Current VZ owners get some cash and maybe some stock in the new company. They will call it a merger to satisfy a few egos.

Alternatively, VZ simply IPOs its 55% stake of wireless. They use the proceeds to tender for the current VZ shares (a reverse merger). VOD could just hang on to its 45% stake. Of course, VOD could subsequently buy a small stake to get control of the board.... and we're back to scenario #1.

Management of VZ is simply running out of options. It is time to pay the piper.
batbeer2
Batbeer2 premium member - 7 months ago
BINGO!

Verizon communications buys Vodafon's 45% stake in Verizon wireless and pays Vodafone:

$60B in cash ($12 per ADR)

$60B in VZ stock (that's almost 45% of the current market cap Verizon communications!)

After the deal, Vodafone shareholders will own 30% of Verizon communications which would then include all of Verizon Wireless.

WOW!

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