ollo/iStock Unreleased via Getty Images Vodafone Group Plc (NASDAQ:VOD) is a leading British multinational telecommunications company headquartered in Newbury, Berkshire. Established in 1991, Vodafone operates in over 20 countries and partners with networks in over 50 more, providing a wide range of services including mobile and fixed-line telephony, broadband, and digital TV. With a significant presence in Europe and Africa, Vodafone serves over 300 million customers. Thesis Following a decade of underperformance (VOD is down 71% in the last 10 years), Margherita Della Valle, the previous CFO, was appointed Group CEO of Vodafone early last year. Under her lead, management defined clear strategic objectives in May 2023, centered around improving customer satisfaction, driving simplicity and productivity, and returning the business to organic profitable growth. So far, despite solid progress against each strategic goal, the market has not given the company any credit. Actually, the stock price is down 20% since May 2023, while the S&P500 is up over 30%. Seeking Alpha In this article, after summarizing the strategic goals and progress made by the company in FY2024 (ended March 31, 2024), I explain why I believe that the Q1 2025 trading update shows a mixed picture, and discuss the critical milestones to watch in the coming 6-12 months. I also take a look at the company’s revised capital allocation plan and potential valuation. If you are looking for the punch line: I believe that the strategic direction and actions taken by management in the past year are good for shareholders, but I am not sure this will be enough to make VOD a market-beating investment. Growth in Vodafone’s largest revenue and profit market Germany is still very fragile, as shown by the organic decline in Q1. Also, the expected merger with Three UK, which is critical for Vodafone to gain critical mass and drive margin accretive growth in its second biggest market, is under CMA (Competition & Market Authority) scrutiny and not a done deal yet. For these reasons, while the stock appears to be potentially undervalued with a base fair value of around $13 and a still attractive 5% forward looking dividend yield, I rate VOD a “Hold” and will stay on the sidelines for now. Execution Momentum On Strategic Priorities In May 2023, freshly appointed CEO Margherita Della Valle, a Vodafone veteran and former CFO of the company, set out new strategic priorities to turnaround the company. Vodafone website The essence is simple, and features elements of a “typical” turnaround plan: Focus on the customer, by increasing consumer satisfaction and shifting focus and resources to business customers, where Vodafone is under-represented; Drive simplicity, by increasing process efficiency, simplifying the product offering, and streamlining operations in Europe and Headquarters to drive profitability; Reaccelerate growth, including through right-sizing the portfolio, focus on growing markets where Vodafone is well positioned to compete and has scale. In this section, I provide a quick progress overview touching on key highlights from FY24 results published in May 2024. For more details, I invite you to review the FY24 earnings presentation or the FY24 annual report. Overall, Vodafone made good progress against its key strategic priorities. Amongst the highlights, the company recognized improved customer satisfaction is all markets (as measured by better net promoter scores and/or a reduced number of detractors). It also eliminated 5,000 roles in FY24 as it started to streamline shared operations and simplify local market structures in Europe. This equated to savings of around €400 million in FY24. The most transformative part of Margherita Della Valle’s agenda has been to “right-size Europe for growth”. Vodafone announced 3 major changes to its European footprint in FY24, including (1) the merger with Three (CK Hutchinson Group) in the UK, (2) the sale of its Spanish operations for €5 billion to Zegona, and (3) the sale of its Italian operations for €8 billion to Swisscom. While all three were still pending regulatory approvals by year-end FY24, Spain just got approved at the end of May. These M&A moves should all be accretive, as Vodafone was structurally unable to cover its cost of capital in all three markets. In the case of Italy and Spain, VOD also struggled with revenue growth due to fierce price competition. Exiting these cut-throat markets for valuations implying operating cashflow multiples of 13x (Spain) and 26x (Italy) looks like a good move for shareholders. As for the UK, this traditional growth market is generally attractive, but requires better scale for increased profitability. The merger with Three UK would address exactly that, forming the largest UK telco provider, but deal closure is still subject to regulatory risks, which I will discuss later in a separate section. In line with these changes, Della Valle also progressively reshuffled the executive committee team and adjusted the compensation plan to drive increased personal accountability for results. A key hire from the outside was Luka Mucic, former CFO of SAP (SAP), who replaced Della Valle as Group CFO as of September 2023. The below chart summarizes key attributes of the markets Vodafone will play in post-execution of the Spain and Italy divestitures. On a related note, the company already reports operations from both markets as discontinued. In summary, Vodafone is concentrating on markets that organically grow, and where it is well positioned to compete for share and drive returns exceeding its cost of capital. Vodafone Investor Update (March 2024) Finally, looking at financial results, FY24 was mostly in line with expectations, delivering 6.3% of organic service revenue growth, including a sequential acceleration to 7.1% growth in Q4 FY24. Meanwhile, EBITDAaL grew only 2.2%, due to margins compressing from 33% to 30%, mainly driven by higher energy cost and underperformance in Germany (Vodafone’s largest and most profitable market). I will discuss the outlook for Germany in a separate section. In the meantime, let’s briefly review the Q1 FY25 trading updated the company provided in July 2024. Q1 FY25 Results: A Mixed Picture Vodafone published its Q1 FY25 trading update earlier this month, with no major surprises. The previously announced Spain divestiture was officially completed at the end of May for €5 billion (€4.1 billion in cash and €0.9 billion in redeemable preference shares), also triggering the release of the first tranche of a €2 billion share buyback program attached to this transaction (about €462 million spent in Q1, see more details later under the capital allocation update). Meanwhile, the growth picture, while aligned with full-year guidance, came in mixed. Following the sequential quarterly growth acceleration throughout FY24, Q1 FY25 service revenue growth dropped back to 5.4%. This reflects continued sequential growth momentum in Africa (+10%), offset by a slight decline in Europe (-0.3%). Adjusted EBITDAaL grew +5.1% in the quarter, although part of that was attributed to operational expense phasing. Indeed, Vodafone confirmed the full-year guidance of around €11 billion, flat compared to FY24. Vodafone Q1 FY25 Trading Update (July 2024) Within Europe, Germany declined by -1.5% in the quarter, of which -120bps are attributed to the MDU TV transition. MDU stands for Multi-Dwelling Units, and essentially refers to apartment buildings in which each unit is rented out to tenants, including a pre-defined TV subscription agreement as part of the rental agreement. Following a legal change announced over a year ago and taking effect as from July 1st, 2024, such agreements are no longer permitted, now allowing each household to make their own TV subscription choices. Vodafone Q1 FY25 Trading Update (July 2024) Vodafone served about 8.5 million households under such MDU agreements before the change. The company expects to be able to convert about half of the tenants that so far were “forced customers” under MDU contracts into direct Vodafone customers. According to management, actual conversion rates in the first 6 months of 2024 support this assumption. Overall, achieving 50% retention would result in a €400 million revenue headwind vs. prior year, suggesting that if retention was 10 ppts higher or lower, this would result in plus or minus €80 million in sales. As the variable cost associated with these revenues should be rather limited, I assume any deviation would largely trickle down to EBITDAaL and FCF, but the magnitude seems manageable. Here is how Luka Mucic summarized the situation during the earnings call: First of all, obviously, the big theme in Germany all the way through FY 2025 will be, of course, the TV transformation. I think we have done our best to outline the impacts that we are seeing. And what is very positive is that this is becoming more and more certain because we have not only the further data from Q1 now, which has certainly confirmed the conversion rates that we were looking for, but we have also now data for July, which is obviously the biggest impact that we’re expecting. And that is also in line. So, from that perspective, I see this as a very positive. It’s taking, I would say, basically any remaining uncertainty out of the equation, which is good. Shifting gears to the UK, the headline growth (or absence thereof) looks concerning, however management seems confident that this is largely a timing effect, and points to a number of positive lead indicators, including net contract adds, lower contract churn, and a material reduction in the number of detractors. A rebound is expected in the balance of the year. Source: Vodafone Q1 FY25 Trading Update (July 2024) In summary, Q1 results, while in line with expectations, still paint a mixed picture, as Vodafone’s two largest remaining markets struggled with growth. In the next section, I will discuss what (potential) investors should keep an eye on in the months ahead. Key Milestones To Watch There are three key milestones to watch in the coming 6 to 12 months, which I believe could put pressure on the stock in case of a negative outcome: Clearance for divestiture of Vodafone Italy Clearance for merger with Three UK Return German business to growth navigating MDU transition Here are the latest updates and some thoughts on each of these. #1. Divestiture of Vodafone Italy After months of speculation and exclusive negotiations, Vodafone finally announced on March 15th, 2024 that it entered a binding agreement to sell 100% of its Italian operations to Swiss telecom giant Swisscom AG (OTCPK:OTCPK:SWZCF) for €8 billion in cash (subject to closing adjustments). This values the sale at 7.6 times the FY24 adjusted EBITDAaL, the highest multiple of any Vodafone market transaction in the past 10 years. Following the recently completed divestiture of Vodafone Spain and the intended merger with Three UK (update follows below), this marks the third and last major transaction related to Vodafone’s strategic reshaping of its European footprint. On May 21st 2024, Reuters reported that Swisscom has secured the initial green light from the Italian government, which by law has a veto right to block M&A transactions whenever those present a “threat of serious prejudice to national interests”. This was not deemed to be a concern here. This leaves the approval by the Italian competition authorities as the final hurdle to seal the transaction, which is expected to close in the first half of 2025. From a competition law perspective, this transaction should be relatively unproblematic looking at the mobile network services market, while it may require remedies on the broadband front. Indeed, Swisscom does not yet play independently in the mobile network provider market, where it entered a strategic partnership with Wind Tre to accelerate the roll-out of a nationwide 5G network back in 2019. Supposedly, this agreement would come to an end once FastWeb and Vodafone start operating under the same roof. While this should create synergies for Swisscom (the presumed reason for their interest in the deal) and thus possible competitive advantages, it should not materially affect the competitive balance, leaving essentially 4 main competitors in the market. As a reminder, while Iliad remains relatively small, the French telecom player emerged as the remedy required to clear the Hutchinson/Wind (= Wind Tre) merger back in 2016. Statista On the broadband side, Swisscom operates FastWeb, a leading broadband provider in Italy. The combined market share of Vodafone & FastWeb would be around 30%, creating a second behemoth, following leader Telecom Italia (OTCPK:TIIAY). This would leave Wind Tre as a 3rd relevant player, with no relevant 4th player left. While this did not come to the attention of EU merger regulators, it will likely be the key concern for the Italian competition watchdog, and could require some remedies (i.e., concessions) for the deal to go through. Statista #2. Merger with Three UK Back in June 2023, Vodafone and the CK Hutchinson Group, short CKHG, announced a binding agreement to merge their UK subsidiaries, Vodafone UK and Three UK, to create one of Europe’s leading 5G networks. This £15 billion (non-cash) transaction, after which Vodafone would hold 51% and CKHG 49% of MergeCo, is set to create the UK’s biggest mobile phone network operator with 27 million customers. This compares to 24 million for Virgin Media O2, and 20 million for BT Group. Both parties also agreed on terms based on which Vodafone could fully acquire CKHG’s stake at a later stage. As a result of this merger, the number of major players in the UK telecom space would be reduced from 4 to 3. For Vodafone and Three, so far #3 & #4 in the industry, this presents a critical opportunity to scale up and deliver synergies, notably through the consolidation of corporate functions. At the same time, both companies committed to invest £11 billion into the 5G network expansion over the coming decade, accelerating 5G access across the UK, a critical step in the digital transformation and competitiveness of UK businesses. While the companies claim that customers will enjoy a faster network and better coverage at no extra cost, consumer groups voiced the typical concerns over a reduction of consumer choices, increasing prices, and lower service quality. Competitors, on the other hand, were more concerned about spectrum allocation. Meanwhile, Enders Analysis, a research firm specialized in European media, mobile and telecoms, stated in a recent report that similar mergers in other European markets had not led to price hikes for consumers, and also reported earlier this month that Vodafone, Three and Virgin Media O2 have struck a spectrum-trading and towers-sharing deal, alleviating concerns about the potential new group monopolizing too much of available spectrum bands. After highlighting earlier this year that Emirates Telecom’s (also known as e&) 14% stake in Vodafone poses a national security concern, the UK government provided its conditional approval for the merger in early May 2024. One condition is that both companies set up a “National Security Committee” to oversee matters relevant to national security. As a reminder, e&, which is 60% owned by the UAE government, initially took a 10% stake in Vodafone in May 2022, and expanded its stake to 14% in February 2023, before appointing e&’s CEO Hatem Dowidar to Vodafone’s Board of Directors in February 2024. Under the strategic partnership, e& could expand its stake up to just under 25%, and appoint one additional board member when its stake exceeds 20%. Overall, it seems that the UK government sees the benefits (of a faster 5G network expansion) outweigh the (geopolitical) risks here. With that, all eyes are now on UK’s Competition and Markets Authority (“CMA”). After launching a formal investigation on January 2024, the CMA has initiated an in-depth (“phase 2”) investigation in April 2024, on the basis that “it is or may be the case that this merger may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom”. The phase 2 investigation was initially set to close on September 18, 2024, but is now expected to be slightly delayed due to a temporary “clock stop” by the CMA following a delayed filing of certain documents by CKHG. So, what to expect from the CMA? Karen Egan from Enders Analysis points out that the CMA has been very “hawkish” with mergers as of late, citing the agency’s initial block of the Activision Blizzard acquisition by Microsoft (MSFT) in the UK, which forced the latter to restructure the deal and divest cloud gaming rights to Ubisoft. Consolidation has been ongoing for some time in the UK telecom industry, starting with British Telecom’s acquisition of EE in 2016, and the Virgin Media and O2 merger in 2021. However, in both cases, regulators pointed out that there was little overlap between the parties, as one was more focused on broadband and the other on the mobile network. This is similar to the case of FastWeb (Swisscom) and Vodafone in Italy. On the flip side, the European Commission had blocked the proposed acquisition of O2 by Hutchinson back in 2016 following an in-depth investigation, on the grounds that this would have left only 3 major competitors in the mobile network market (i.e., BT/EE, Vodafone, and the proposed O2/Three MergeCo), which was considered a “significant reduction in competition” that could potentially result in “higher prices for mobile services in the UK and less choices for consumers”. At the time, the remedies proposed by Hutchinson failed to address the Commission’s concerns, so the deal did not close. Looking at telecom mergers across Europe, the consistent theme has been to keep 4 players in the market, as long as this is economically viable for each of these players. For more details, I recommend this article by Tom Smith, which unwinds the cases of Germany (2014) and Italy (2016). Neither Vodafone nor Three are financially struggling to the point they are at risk of exiting the market without the merger, while on the flip side, it may prove even more challenging for a fourth new player to come in and be successful (as shown by Iliad in Italy, Drillisch (1&1) in Germany, Dish in the US and Rakuten in Japan – all 4th players struggling to compete with the big guys). In conclusion, based on the information I could find, I believe that the CMA will likely require remedies to maintain 4 competitors in the market, and that it may prove difficult to satisfy those remedies without conceding more than would be financially attractive for Vodafone. Either way, I am not a lawyer, but I see this as a relevant risk to the European transformation story. #3. Germany’s path to growth In the recent Q1 2025 Earnings Call, CEO Margherita Della Valle spoke about Germany being about to follow a U-shaped growth recovery. According to CFO Luka Mucic, the bottom should be reached in Q2 2025 (i.e., the current quarter ending September 2024), coinciding with the peak of MDU transitions as the legal changes took effect on July 1st, 2024. MDUs alone are expected to contribute roughly 400 bps of decline in the 2nd quarter. On top, the lapping impact of broadband price increases taken earlier this year and affecting 70% of Vodafone’s customer base is expected to cause another 200 bps of decline from customer churn. Bottom-line, Q2 is expected to show 6-7% decline in Germany. After that, mathematically, there will of course be a sequential improvement in the second half of the year. The real question is: how much underlying organic growth can Vodafone generate in Germany moving forward? Germany was the only market where Vodafone grew less than the market in FY2024 (shown as “2023” in the table below where Statista compiled service revenues from the big 3 German telecom companies), and candidly VOD has been struggling to keep up since FY2021 (shown as 2020 below). While on 4-year basis, Vodafone has roughly grown in line with the top-3 competitors average of about 1.8% p.a., the company has been losing share for the past 3 years straight, staying literally flat. Data from Statista, Table from Stock Research Platform Moving forward, management expects to be able to grow alongside the market, at an expected rate of 2-3% per year according to company estimates – which is slightly higher than in recent years, presumably driven by 5G. CEO Margherita Della Valle expects the shift of focus into the business segment, where Vodafone has lower market share, to be one of their growth drivers. The other tangible growth lever lies in the long-term exclusive national roaming agreement signed with 1&1 in August 2023, which is set to provide 5G coverage to 1&1 customers starting the second half of calendar year 2024. The later should allow Vodafone to steal some share back from Telefonica/O2. To conclude, I do believe that coming out of a challenging zero-growth (or even decline) period, management’s commercial focus and interventions to turnaround Germany will result in a return to growth by FY2026. Besides the aforementioned growth drivers, the company also pointed out improvements to its network, and ranks #1 on independent tests assessing broadband speed, price and overall performance. Also, Vodafone is generally priced at a discount relative to market leader Deutsche Telekom, even after recent price increases. All in all, this means that VOD should be able to compete in line with the German market mid-term, but I am still expecting potential bumps in the road in the near-term (e.g., from MDUs and broadband churn). Capital Allocation Update Now that we have reviewed Q1 results and discussed the major upcoming milestones to watch, let us quickly review the updated capital allocation framework (see chart below) that was presented during the March 2024 investor update. Vodafone March 2024 Investor Update In essence, Vodafone is committed to keep its (maintenance) Capex levels in line with historical levels, while continuing to deleverage its balance sheet and returning capital to shareholders in the form of dividends and share buybacks. Following the divestitures of its Spanish and Italian business, the company is “rebasing” its dividend to €4.5 cents per share from FY25 onwards. That’s a 50% cut relative to the €9 cents paid so far, reducing the forward-looking dividend yield to 5% from over 10%. That is still a yield that should satisfy dividend-oriented investors, while providing room for future growth. Indeed, the cash from operations “lost” from assets held for sales (i.e., Spain & Italy), only represented about 20% of total operating cashflows in FY2024. Additionally, the €4 billion share buybacks program using part of the respective proceeds from the divestitures also helps soften the blow of the dividend cut. With the Spain transaction completed, the first €2 billion was already released for buybacks throughout the current year. With that, the total return to shareholders in FY2025 will be up to €3.2 billion, comprised of €1.2 billion in dividends and up to €2 billion in share buybacks. That is a potential 30+% increase in total returns to shareholders compared to the €2.4 billion dividends paid in FY2024. Let’s now take a look at Vodafone’s debt and leverage. As you can see in the table below, the company is making a number of adjustments to get from total borrowings of almost €57 billion to reported net debt of €33 billion (per year-end FY24). A couple of comments on this: Using the “textbook” definition, I get to net debt of €48 billion, which matches what you will find as net debt on Seeking Alpha as well. The major difference is that Vodafone excludes €10 billion of lease liabilities from its debt definition, and subtracts collateral assets, short-term investments and derivative financial instruments (all of which cannot be found as separate lines in the balance sheet) alongside its cash & cash equivalents. I will not debate here the validity of each of these adjustments, although I would say that it’s generally appropriate to add back liquid assets even if they are not visible under cash & cash equivalents in the balance sheet. As for lease obligations, it looks like industry practice to ignore both those in the numerator (net debt) and denominator (adj. EBITDAaL) – not a practice I like as it fundamentally understates leverage, but it seems consistent. Vodafone FY2024 Annual Report, page 243 Putting things together, with an EBITDAaL guidance of about €11 billion for FY2025, net debt by the end of March 2025 should be around €27.5 billion (2.5x leverage) or lower in order to meet the stated objective to land on the lower end of the 2.25x – 2.75x range. That represents a reduction of just under €6 billion compared to March 2024. While it is unclear if the Italian divestiture will close in time to use such proceeds for deleveraging purposes within FY2025, Vodafone has enough levers to pay down the €6 billion. Assuming Vodafone generates another €2.6 billion of FCF in FY2025 (guidance is at least €2.4 billion), and uses only €1.2 billion for the dividend, this leaves €1.4 billion for repaying debt. On top of that, the company just announced the sale of an additional 10% of its stake in Oak Holdings (the majority owner of Vantage Towers) for €1.3 billion, which will be used for deleveraging. Moreover, it stated that it will use up to €2 billion from the Spanish divestiture for share buy-backs, leaving a minimum of €2.1 billion for debt pay-down. The above adds up to €4.8 billion of debt reduction, which ceteris paribus would result in a leverage ratio of 2.58x. There are several options left to get to the 2.5x, including delivering an EBITDAaL of €11.4 billion instead of €11 billion. On the flip side, if EBITDAaL ends up trending low, Vodafone could decide not to use the full €2 billion in FY2025 (€462 million was used in Q1 2025), paying down debt instead. With the Italy sale expected to complete by Q1 of FY26 at the latest, the speed of buybacks vs. debt pay-down is just a matter of choice of where in the leverage range Vodafone wants to land by year-end FY25. Either way, they should manage to hit the range. Vodafone Valuation Scenarios Let us now finally move into valuation scenarios, using a simple discount cashflow model. After the divestitures, almost 60% of Vodafone’s adjusted FY2024 EBITDAaL (and by extension, operating cash flow) comes from Germany and the UK. We discussed the rather soft growth prospects in Germany (even if there is room to be better than in recent years), and the uncertainties surrounding potential CMA requirements to approve the UK merger (which will be key to determine the growth and margin potential). The other 40% comes from the rest of Europe, Turkey and Africa, where at least revenue growth has been more impressive. All in all, I believe it is fair to assume growing operating cashflows of the core retained business over the coming years, but I struggle to assume it will be more than mid-single digits on average over 10 years. For that, Germany and the UK are just too big a part of total profits. Another important variable is capital intensity. It may be appropriate to assume that maintenance capital will see directional growth with inflation, but in this industry, you have to assume some level of growth capital investment (e.g., related to the 5G network expansion) as part of the equation. This means that Capex is likely to grow higher than inflation, and at least in line with operating cashflows. Let’s therefore assume for simplicity that FCF will directionally grow in line with operating cashflow over time. Bottom line, starting from the FY24 free cash flow of €2.6 billion (=$2.8 billion), I am running 3 scenarios, respectively with 2%, 4% and 6% annual FCF growth for the next 10 years. After that, I assume terminal growth rates of respective 0.5%, 1% and 1.5%. I apply a weighted average cost of capital (“WACC”) of 6%, reflecting VOD’s capital structure with a cost of equity around 10% and a cost of debt around 5%. With that, and using Vodafone’s own definition of net debt (translated to USD) for purposes of equity valuation, I get to a fair value per share between $8 and $20, with a base scenario of $13.36. Stock Research Platform That is not far away from analysts’ price targets, averaging $14. Whether or not the stock moves toward this mark in the coming 12 months will significantly demand on the outcome of the UK merger and the trajectory of Germany’s expected U-shape recovery. Yahoo Finance Conclusion On the Stock Research Platform, I am looking for asymmetric low risk, high reward opportunities. Vodafone is potentially undervalued and offers a forward-looking dividend yield of 5% (post dividend cut). The actions taken by management on increasing customer satisfaction, streamlining business operations, and exiting Spain & Italy where the company was structurally unable to earn back its cost of capital, are moves in the right direction. I believe that continued strong execution of the current strategic plan will likely prevent the stock from moving much lower. At the same time, Vodafone still lacks proof points that it can return its two biggest markets, Germany and the UK, to sustainable profitable growth. However, I believe that this is precisely what the company will have to achieve in order to generate sustainable shareholder returns in the years ahead. While FY24 trends were cautiously promising, Q1 FY25 showed decline in Germany and a flat business in the UK. While management pointed to reasons to believe in a sequential improvement in the 2nd half of FY25, uncertainties about the speed of recovery in Germany as the country transitions through TV law changes, as well as the final verdict by the British Competition & Market Authority on the merger with Three UK, are key factors to watch. Bottom-line, while Vodafone could be an interesting investment, particularly for dividend-oriented shareholders, I am rating the stock a “Hold” for now. I will remain on the sidelines, and would reconsider the stock once there is a clearer line of sight on sustainable growth in Germany and the UK.
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