Should I buy shares in Vodafone?

Shares in Vodafone Group rose on Thursday despite the telecoms giant reporting a worse-than-expected fall in revenue.

For the quarter ended 31 December, overall revenues from voice - which accounts for nearly half of Vodafone's sales - fell almost 12% year-on-year to c. £5.5 billion. Revenues from data service, meanwhile, rose only 7.1% year-on-year to £1.7 billion. Overall group revenues fell 2% year-on-year to £11.4 billion.

"Difficult market conditions"

The operator itself warned of "very difficult market conditions in Europe".

Italy suffered from "intense price competition" as revenues fell 18.8% to £1.1 billion. In Spain, revenues fell 16.4% to £887 million year-on-year as Spanish customers moved to cheaper tariffs. The Portuguese mobile market has been declining since late 2008 and has lately deteriorated from an already low base.

Revenues in the UK and Germany both slipped, with increased competition and lower out-of-bundle usage knocking the UK business, where revenues fell 4.5% to £1.2 billion. In Germany, revenues sank 5.9% to £1.8 billion. Increased revenues from data services, which rose 10.8% year-on-year, helped plug only some of the gap created by lower customer acquisitions.

Emerging markets disappoint

To add to its woes, Vodafone also experienced slower growth in emerging markets such as India and South Africa.

Turkey and India grew 18.4% and 9% respectively, but this was slower than in previous quarters.

Verizon Wireless to the rescue?

But it wasn't all doom and gloom. In the US, Verizon Wireless, in which Vodafone has a 45% stake, saw its service revenues grow by 8.7%, thanks to the strong addition of new customers. Vodafone is seen by investors as a potential seller of this stake, given that its interest is non-controlling.

However, this seems unlikely given that Vodafone is receiving an income dividend from Verizon Wireless - an outright sale for cash for the stake would likely result in a sizeable capital tax gains bill, rendering it less attractive for Vodafone than remaining invested and taking the dividend.

"Quad-play" to be led by TV

So far, the trend has been for consumers to purchase a "triple-play" of pay TV, broadband and fixed telephony, while "quad-play" adds mobile.

This preference for triple-play is already evident in Portugal and the Netherlands, where take-up is already over 40% of households, and the UK (27%). Further behind are Germany (14%) and Spain (11%), while Italy, with no cable industry, sits at only 1%.

However, analysts at Citigroup warn that this bundling is likely to get tighter as super-fast broadband and internet-based content become more prevalent, negatively impacting Vodafone.

"In our view, the experience of many customers will become so defined by the TV entertainment package... that this will be the primary driver of the purchase decision for TV, broadband and voice, and even possible voice in some markets," warned Citigroup.

"The implication is that if quad play becomes more popular, then the choice of mobile supplier will be far more dependent on which supplier the customer chooses for TV."

There is already evidence that this is happening - Citigroup rates Portugal as the market where Vodafone is most at risk, with an aggressive quad-play offer of two to four SIM cards per household from the incumbent. Spain is the second-most at risk due to the incumbent's aggressive bundled offer of fixed voice, broadband and mobile, with customers opting to add TV. This is followed by the Netherlands, where the incumbent has already announced a quad-play offer.

Vodafone not a merger target

Vodafone has jumped almost 13% year-to-date, despite cuts to the company's cash and earnings consensus estimates. Most of the stock's outperformance took place between 8 and 24 January, and coincided with speculation of a possible bid by Verizon to acquire Vodafone, or its stake in Verizon Wireless.

"As the old saying goes: There is no smoke without fire," noted Ottavio Adorisio, analyst at Societe Generale. "However, seven years after speculation of a Verizon bid first emerged, investors may wonder whether the speculation is actual 'smoke', signalling a fire, or merely fog, clouding up their investment process."

Analysts at Citigroup were also wary of Vodafone being a bid target: "Any buyer would presumably want the same reassurance that Vodafone's management and shareholders do about the cost of defending the European operations in a quad play and super-fast broadband world.

"The size of Vodafone limits both the number of potential bidders and the size of a premium they might be prepared to offer," they added.

Birds of a feather flock together

Other telecoms operators have also found current trading conditions difficult - Dutch telecoms group KPN, for example, on Tuesday announced plans for a €4 billion (£3.4 billion) rights issue, in part because it paid more than expected for a 4G mobile licence.

This was followed by Belgium's mobile phone operator, Mobistar, on Wednesday warning it would miss 2013 earnings forecasts and cut its dividend due to cut-throat competition.

Shareholder returns "generous"

"The company's cash returns to shareholders, including a stock repurchase funded by a dividend from Verizon Wireless, are generous," noted Citigroup.

Vodafone shares offer a dividend yield of about 6%, with about £7.6 billion estimated to have been set aside for share buybacks to March 2013.

Additionally, its balance sheet is strong, with net debt of about £23 billion. "We would expect [Vodafone] to be able to finance any increase in debt that it requires at a lower interest cost than cable typically pays," stated Citigroup. Additionally, the company has hinted at a potential compromise with Indian tax authorities over a tax and interest bill of £1.6 billion.

Analyst recommendations

Societe Generale had a 'sell' recommendation on the stock.

Citigroup rated the stock 'neutral', summarising: "We expect Vodafone to benefit from its high exposure to its fast-growing US associate Verizon Wireless and its emerging market assets, but the company faces ongoing revenue pressure in Europe, where regulatory focus on increasing fixed-line fibre speeds and introduction of discounted offer bundles risk leaving it at a disadvantage."

Tom Gidley-Kitchin, analyst at Charles Stanley, rated the stock 'accumulate', stating: "Overall, we believe that investors should be able to ignore some possible volatility in the share price while they receive a very decent yield, and that the company's position in 12-18 months, with some improvement in Europe either occurring or at least anticipated, will be better than it is today."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.