Vodafone goes back to basics after failed Liberty deal

With a $120 billion merger with Liberty Global (LBTYA.O) off the table, Vodafone (VOD.L) boss Vittorio Colao needs his strategy of higher network investments and acquisitions of European cable companies to start paying off, quickly.

The world’s second-largest mobile operator abandoned talks with John Malone’s Liberty last week over valuation disagreements that would have seen a swap of assets or a broader merger that could have helped Vodafone, in one fell swoop, offer mobile, broadband and TV in its biggest markets.

Instead the focus now returns to the unglamorous effort to get revenues and profit growing steadily again, especially in Germany and Spain where Vodafone spent 15 billion euros buying cable players Kabel Deutschland and Ono to compete with local leaders Deutsche Telekom (DTEGn.DE) and Telefonica (TEF.MC).

In addition to operational progress, several bankers said Vodafone should also move ahead with floating its Indian mobile business, its biggest emerging market holding, so as to show the value within the company.

One person familiar with the situation said management focus would now return to running its biggest markets, including attacking the former state-owned monopolies that it competes with on regulatory and commercial fronts.

“We really need to see an operational turnaround in Europe in this fiscal year. That is priority number 1, 2, and 3, including the integration of cable assets in Germany and Spain,” said Bruno Grandsard, a portfolio manager at Axa Investment Management, Vodafone’s tenth-biggest shareholder with a 1 percent stake.

“Then they need to continue to develop an approach to accessing fixed assets in markets where they don’t have them like Britain, Italy, and the Netherlands.”

Were Vodafone to make those improvements, it would not only keep investors on side but put the firm in a stronger position for when Liberty comes calling again – as it is expected to do.

Bankers believe a Vodafone and Liberty deal holds the promise of some 20 billion euros in cost savings – largely reaped from Britain and Germany – which could draw the pair back to the table in about 12 to 18 months time.

Another factor is what happens to the relative valuations of telecoms and cable, which could determine who has the upper hand in future talks and whether a largely share-based deal is possible. European telecoms are trading around six to 6.5 times forward earnings for next year, while cable is 8.5 to 9 times.

People close to both companies said the firms had not yet given up on a deal and were separately examining options for a future attempt.

TUMULTUOUS TIMES

The would-be alliance between one of Europe’s biggest mobile operators and its biggest cable provider is emblematic of the tumult in the industry as carriers in the region increasingly sell all-inclusive bundles of fixed and mobile communications, along with television and broadband.

It also comes amidst a wider mergers and acquisitions spree, which has redrawn the map in several markets, and prompted scrutiny from competition regulators who recently blocked a deal over concerns that people would pay higher prices.

The move to so-called triple and quad-play bundles, which is most developed in France and Spain and growing in Britain and Germany, also reflects the need operators have for strong fixed networks to carry ballooning mobile data traffic.

Vodafone’s answer has been not only to buy up some cable companies, but also to spend 19 billion pounds ($29 billion) on upgrading its networks globally. The investment program dubbed Project Spring has six months left to run.

In its biggest market Germany, where Vodafone bought Kabel Deutschland (KDG) in October 2013, the carrier has struggled to keep up with Deutsche Telekom (DTEGn.DE). Service revenue dropped 3.2 percent in the year to March 2015, excluding KDG, although in its most recent quarter, when it included KDG numbers, it was down only 1.2 percent.

Strategic errors such as focusing network investments on rural areas rather than urban, and a badly executed plan to sell more mobile contracts directly to consumers rather than through retail partners also caused problems.

Nor has the picture been much brighter in Britain where Vodafone could be weakened by a wave of dealmaking.

Broadband leader BT (BT.L) has agreed to buy the biggest mobile operator EE, and number four mobile player Hutchison’s (0001.HK) 3 is hoping to swallow Telefonica’s (TEF.MC) 02, which would leave Vodafone in third place in its home market.

Vodafone is planning on launching its own pay-TV service in Britain but the offering is likely to be weak in comparison to those offered by BT and market leader Sky (SKYB.L).

“Vodafone needs to show that quad play works – they spent billions on cable deals, they need to show it was worth it,” a sector banker said. “Usually you need at least 2-3 years after deals to see if it worked well or not, so the crunch period is coming.”

Vodafone’s shares have fallen 4.6 percent this year while the European telecoms index .SXKP is up 4.5 percent.

EMERGING MARKETS

In parallel to the work in Europe, some bankers believe Vodafone must streamline or separate its emerging market businesses, the largest of which are India, South Africa, and Turkey, to facilitate a deal with Liberty, which is only present in Europe and Latin America.

Given the companies respective market capitalizations, with Vodafone worth 57 billion pounds ($83 billion) and Liberty $39.9 billion, hiving off Vodafone’s emerging market units would make structuring a deal easier since it could then combine the remainder of its Europe activities with Liberty.

Liberty saw Vodafone’s emerging market business as a stumbling block in the recent talks because it could not judge its quality or value.

Vodafone has said it is weighing the idea of an initial public offering in India. A long-running tax dispute and an upcoming spectrum auction could make valuing the unit challenging.

“Vodafone needs to maximize value from their emerging market holdings in order to have more flexibility and more optionality to negotiate a better deal with Liberty,” another banker said.

“This is a key step and it doesn’t matter whether the emerging market deals happen before or during negotiations with Liberty, what matters is that the right structure is in place.”

Source: Reuters