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:
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.
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.
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.
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:
- Focus on key areas of growth potential (India and South Africa);
- Deliver value and efficiency from scale (lowest capex/EBITDA).
- Generate liquidity or free cash flow from non-controlled interests.
- 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."
- 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%.
- 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.
- 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: [www.dailymail.co.uk]
Owner earningsWe 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.
BreakupForty-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
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
- The market does not understand the magnitude of owned cash flow hidden within Vodafone due primarily to non-consolidated subsidiaries.
- Market participants fear the coming mobile data revolution will be value destructive for wireless providers.
- 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.
- Historically Vodafone has been highly acquisitive.
Vodafone has unique and durable competitive advantages, is well managed, highly profitable and demonstrably cheap.
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.