Goldman Sachs has rethink on Vodafone

It's been a rollercoaster few years for Vodafone. Shares in the mobile phone colossus have been below 180p and above 250p on more than one occasion and over a year apart (see chart below). But after upgrading its view to 'buy' in December, Goldman Sachs has had a change of heart.

This mood swing is brought about by recent outperformance following the announcement that it is in talks with Liberty Global about a potential asset swap - the shares are up 5.8% since December. "We believe risk-reward appears more binary," says Goldman, which cuts its rating to 'neutral' and trims the price target from 275p to a more modest 250p.

Cash profit forecasts fall by about 3% for 2016-2019 due to foreign exchange headwinds across almost all markets since Goldman last refreshed assumptions in May. The hefty €2.1 billion spent on the German spectrum auction was also over four times more than the broker had pencilled in. Combined, these issues reduce mid-term free cash flow estimates by 5-7%.

Earnings per share (EPS) are now expected to fall by a third in the year ending March 2016 to 3.67p. Previously, Goldman had pencilled in 4.39p. EPS rises the year after to 3.99p, although that's still less than the old forecast for 5.02p.

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Revised illustrative scenario analysis on possible tie-ups with Liberty Global also now imply "slightly less" upside than originally envisaged. There is also rising near-term risks to European Commission support for consolidation ahead of the Demark mobile merger ruling by the new Danish EC Competition Commissioner, Margrethe Vestager.

"Excluding potential M&A, our 220p/share base-case valuation implies target multiples broadly in line with peers on EV/NOPAT/equity FCF yield," explains Goldman. "We add 30p/share to reflect the potential for Vodafone to capture a share of large available cost and possible tax synergies in an M&A scenario."

There could, however, be upside to that 250p target if Liberty and Vodafone strike a deal. One of the potential scenarios examined by Goldman involves Liberty buying Vodafone's businesses in Germany, UK and Netherlands. They're the markets that Liberty chairman John Malone has said are of strategic interest.

The implied sum of the parts range for Vodafone is 220p-280p per share. The upper end of the range implies that Liberty stock trades at $80 post the merger closing, a big premium to Goldman's current target of $70. A deal which was "materially accretive to its long-term free cash flow/share outlook" would clearly reflect well on Vodafone's valuation.

Not all bad news

Goldman's downgrade follows this week's decision by Barclays to cut estimates and lower its target to 260p. Weakness both in Germany and European currencies was blamed.

However, Goldman does still see Vodafone as a leading beneficiary of ongoing "double" consolidation of both mobile and fixed-mobile operators. "We see attractive operational gearing to this growth recovery given its low margins," it says. "We also believe VOD enjoys substantial M&A optionality - recent acquisitions of mobile operators by BT/Liberty Global suggest that the strategic value of mobile network ownership in a converging market is material, balancing the structural risk Vodafone currently faces as a mobile-centric fixed-line wholesaler.

"Additionally, if management is willing to reconsider the structure of the group, we believe a number of other potential acquirers could take interest in its remaining assets."

Elsewhere, UBS took a "glass half full" approach Wednesday. The broker believes potential synergies from a tie-up between Vodafone and Liberty could range from anywhere between £8.5 billion and £25.4 billion. That's worth between 32p and 96p per Vodafone share.

"We think the dividend yield should support the shares on the downside and see potential upside from M&A and growth being faster than expected," added UBS, which rates Vodafone a 'buy' with 265p price target excluding M&A.