February 19, 2015 Vodafone Group PLC ADS Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 02/27/2014 Current Price (02/18/15) $34.85 Target Price $37.00 52-Week High $71.49 52-Week Low $29.67 One-Year Return (%) -43.90 Beta 0.59 Average Daily Volume (sh) 3,277,219 Shares Outstanding (mil) 2,651 Market Capitalization ($mil) $92,387 Short Interest Ratio (days) 1.15 Institutional Ownership (%) 11 Insider Ownership (%) 1 Annual Cash Dividend $1.80 Dividend Yield (%) 5.17 5-Yr. Historical Growth Rates Sales (%) N/A Earnings Per Share (%) N/A Dividend (%) 0.6 P/E using TTM EPS N/A P/E using 2015 Estimate 42.5 P/E using 2016 Estimate 36.7 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page (VOD-NASDAQ) SUMMARY In third-quarter 2014, Vodafone s revenues increased 13.5% year over year on a reported basis and 0.7% on an organic basis. The upside in revenues was primarily driven by considerable improvement in the European and AMAP region. Vodafone s move to expand wireless services in emerging markets and the promotion of M-Pesa in Africa and Europe will prove accretive going ahead. Further, key acquisitions and the divestiture of Verizon Wireless stakes are also likely to benefit the financials. Going forward, we expect the continuous investments in project Spring and the underlying economic weakness in Europe to act as headwinds for the company. However, Vodafone is losing subscribers in Europe which is a major concern. Considering these factors, we maintain our Neutral recommendation on Vodafone. Risk Level * Below Avg., Type of Stock Large-Value Industry Wireless Non-Us Zacks Industry Rank * 179 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) 2013 67,785 A 2014 15,311 E 73,232 A 2015 15,635 E 14,812 E 66,630 E 2016 66,970 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) 2013 $4.38 A 2014 $4.35 A 2015 $0.82 E 2016 $0.95 E Projected EPS Growth - Next 5 Years % 4 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Based in Newbury, United Kingdom, Vodafone Group Plc (VOD) is the world s largest revenue generating wireless communications operator and the second largest (behind China Mobile) carrier based on subscriber count. The company offers an array of products and services, including voice, messaging, data and fixed-line solutions and devices as per customers communications needs. Vodafone operates independently and through affiliates, notably under the Vodafone brand name. Vodafone is the leading wireless operator in the U.K. and has a major presence in Europe, the Middle East, Africa and Asia Pacific. Vodafone owned 45% of Verizon Wireless, the largest U.S. wireless service provider prior to sale of its interest to Verizon Communication on Feb 21, 2014. With the purchase of Hutchison Essar (now Vodafone Essar) in fiscal 2007 for 5.5 billion ($11 billion), Vodafone became a one of the leading provider of wireless service in India. In Apr 11 2014, Vodafone acquired an additional 10.97% stake in its Indian joint venture Vodafone India from partner Piramal Enterprises Ltd. for INR 101.418 billion ( 1 billion). This led to full takeover of its Indian subsidiary. Effective Oct 1, 2013, Vodafone merged its Northern & Central Europe and Southern Europe regions into one Europe region. The company reports operating results of Turkey within the Africa, Middle East and Asia-Pacific region due to the country s emerging market characteristics. The Africa, Middle East and Asia Pacific (AMAP) region includes the company s interests in Egypt, India, Ghana, Kenya, Qatar, Vodacom and Turkey. Vodafone also benefits from interests in Australia, New Zealand and Fiji. Europe region includes Vodafone s operation in Germany, the UK, the Netherlands, the Czech Republic, Hungary, Ireland and Romania, Italy, Spain, Greece, Portugal, Albania and Malta. On Oct 31, 2012, Vodafone acquired TelstraClear Limited, the New Zealand business of Telstra Corporation for NZ$840 million ( 429 million) in a cash consideration. The acquisition is expected to remain accretive to the company s fixed communications business and strengthen the market position for its operations in New Zealand. REASONS TO BUY Vodafone is also building its mobile financial services brand M-Pesa by implementing developmental initiatives mostly in the African continent. Currently, Vodafone has 200,000 active M-Pesa agents globally and it has processed 2.8 billion worth of transactions in 2013. M-Pesa is now available across 10 markets covering 18.5 million customers, highlighting an increase of 16% year over year. For Vodafone, India is a lucrative business opportunity with 700 million untapped customers in the mobile financial services segment. The company aims to tap this market opportunity with nearly 85,000 agents, covering 65% of the rural areas. Further, on Mar 31, 2014, M-Pesa made its foray into the European market with its launch in Romania. To further strengthen its financial services business, Vodafone has signed an agreement with global money transfer and payment services company, MoneyGram, to directly transfer funds from around 200 countries to M-Pesa users. Apart from financial services, Vodafone is also reaping considerable benefits from its machine-to-machine (M2M) business which demonstrated 21% annualized growth in revenues and the addition of 16 million connections. Some of the key clients of Vodafone in this business include Audi Volkswagen and BMW. Accretive mergers and acquisitions play a key role in maintaining Vodafone s leading position in the global wireless industry. In Sep 2013, Vodafone acquired a 76.48% stake in Kabel Deutschland for 7.7 billion ($10.21 billion) and initiated the integration process on Apr 1, 2014. Equity Research VOD Page 2
The takeover provided Vodafone a direct access to over 32 million mobile, 5 million broadband and 7.6 million direct TV customers in Germany. Moreover, in the same month, Vodafone reached an agreement with Verizon to sell its 45% interest in Verizon Wireless for $130 billion and closed the deal on Feb 21, 2014. Vodafone believes that the disposal of the Verizon Wireless stake brought better clarity over its future group structure and cleared the uncertainty prevailing over the utilization of tax losses and future income streams. In 2014, the company benefited from a 45 billion pre-tax gain from the sale of its interest in Verizon Wireless and the subsequent disposal of U.S. assets and accumulated total deferred tax assets of 20.6 billion. In addition, Vodafone completed its 100% stake acquisition of its Indian joint venture, Vodafone India, in Apr 2014. On May 7, 2014, Vodafone fortified its relation with French telecommunications company, SFR, by renewing its alliance for a span of four years. The company also entered into a Partner Market agreement with Rogers Communications in Canada on Jun 3, 2014. On Mar 17, 2014, Vodafone announced its plans to acquire integrated television and telecommunication services provider in Spain, T Grupo Corporativo Ono, S.A., for 7.2 billion ( 6.0 billion) on a debt and cash free basis. Apart from providing significant financial synergies, the deal would foster unified communications strategy in key European markets and compliment Vodafone Spain s ongoing FTTH build program. Vodafone stands way ahead of its competitors in 3G and Evolved High Speed Packet Access (HSPA+) networks upgrade. It has 60% of its 3G footprint at 43.2 Mbps speed. India remains one of the key markets for 3G growth given the rapid increase in data consumption in the country. India 3G traffic now represents 21% of the AMAP total. The country is the second biggest data market in the world implying room for future growth. Further, the company is accelerating its 4G expansion and covers 13 countries across both Europe and AMAP with 2 million customers. On Feb 18, 2014, the company also announced that it will roll out the world s largest 4G roaming network in the near term in 18 countries. The company currently offers roaming on its own networks in Greece, Italy, Portugal, Romania and Spain and expects to launch 4G roaming in Australia, Germany, the Netherlands, New Zealand, South Africa, and the U.K. Vodafone will also tie up with other telecom companies for 4G roaming in Austria, Belgium, France, Japan, Singapore, South Korea and Switzerland. Vodafone is presently focusing on enhancing its smartphone penetration, which represents nearly 80% of all sales, and comprises over 62% of the customer base. The company also gained from its new pricing plan, Vodafone Red, which incorporates unlimited voice and SMS, increased roaming services, shared plans, early upgrades, cloud and other value-added services. The company introduced Vodafone Red in 20 European markets covering 12 million customers, representing its largest multinational marketing campaign Vodafone 2015. We believe the prospect of mobile data is better in emerging markets where Vodafone is expanding its presence through partner-market agreements. The alliance between Vodafone and Polkomtel is expected to enhance its presence in Eastern Europe, without any major investments as the company will be offering its services via the local partner s network. Further, the company has also joined hands with China Mobile Limited to form a consortium to bid for mobile license in Myanmar. The telecom giants are aiming to secure one of the two telecom licenses to rollout a nationwide telecom network in Myanmar (Burma). REASONS TO SELL Vodafone s core European wireless markets are highly matured, given the high subscriber penetration rates. Over the next two to three years, the company will likely struggle to counter declining voice revenues. Like the other leading carriers across the globe, Vodafone is not impervious to the existing soft economic conditions. Demand for the company s products or Equity Research VOD Page 3
services in the key European markets are negatively affected by recessionary factors, as evidenced by the organic decline in service revenues. Lower revenue is contributing to margin erosion in key European markets. Further, weak economic conditions have compelled consumers to switch to cheaper alternative services offered by Vodafone s competitors. This will likely mar the company s future performance. In addition, Vodafone expects effective tax rate in the high 20s in fiscal 2015. To add to the woes, the average cost of debt is expected to increase to above 6%, despite retiring U.S. debts, as debt composites in emerging markets like India are moving up. Further, an estimated cash outflow of 6 billion pertaining to the proposed acquisition of Ono is also expected to negatively impact fiscal 2015 earnings. Similar to other telecom companies, Vodafone is seeing deteriorating revenues due to mobile termination rate (MTR) cuts, which is a fee that operators charge each other to connect calls). In fiscal 2014, the company lost around 900 million due to reduced MTRs. The Italian government ordered to reduce MTRs by 40%, to 0.0098 from 0.25 0.35 in 2013. These rate cuts could adversely affect the pricing of wireless services, thereby creating pressure on revenue and margins. In 2015, MTR reductions are likely to stand in the range of 1.3% to 1.4%, taking into account the recent South African rate cut. The U.K. wireless market, Vodafone s home turf, represents one of the most intensely competitive markets in Europe, with leading operators currently battling for market share and customer retention. The competitive scenario in the British mobile market has changed radically as Deutsche Telekom and France Telecom recently combined their U.K. units, creating the largest mobile carrier in the region, dethroning Telefonica s O2 U.K. Vodafone faces greater challenge in retaining market share given the potential for more aggressive price competition. Vodafone has taken growth initiatives through acquisitions and partnerships in emerging markets like Asia, Eastern Europe and Africa to sustain its growth. The company continues to aggressively pursue acquisition or investments across incipient markets. However, in doing so, Vodafone may face the inevitable integration risks and unpredictable political, regulatory and legal issues. Vodafone might face difficulty in establishing its data services in the European market given spending requirements amid economic volatilities. Moreover, the financial advantage that Vodafone enjoys from being a large market player is likely to be short lived as no measure is being taken to improve pricing with the introduction of LTE in the European market. RECENT NEWS Vodafone Q3 Revenues Up on Europe, AMAP Region Strength Vodafone Group plc (VOD) reported financial numbers for the third-quarter of 2014. The company recorded consolidated revenues of 10.881 billion (approximately $17.2 billion), up 13.5% year over year on a reported basis and 0.7% on an organic basis. Group service revenues (90% of total revenue) were up 12.4% year over year to 9.789 billion (approximately $15.5 billion) on a reported basis but down 0.4% on an organic basis. Segment-wise Results Europe: Revenues jumped 19.9% on a reported basis but fell 1.7% on an organic basis year over year to 7.273 billion (approximately $11.5 billion). The organic decline can be attributed to poor economic conditions in some markets, competitive pressure and the impact of mobile termination rate (MTR) cuts, partially offset by growth in mobile in-bundle revenues. Service revenues in this segment were up 18.2% Equity Research VOD Page 4
year over year on a reported basis but down 2.7% on an organic basis to 6.626 billion (approximately $10.5 billion). Africa, Middle East & Asia Pacific (AMAP): Revenues at this segment increased 2.9% on a reported basis and 6.8% organically year over year to 3.461 billion (approximately $5.5 billion). Service revenues were up 2.4% on a reported basis and 5.9% organically year over year to 3.062 billion (approximately $4.8 billion) driven by customer additions and favorable pricing as well as increased demand for data. Countries like India, Qatar, Ghana and Turkey delivered strong results as well. This was partially offset by the negative impact of MTR reductions, regulatory pressure and poor market conditions in certain countries as well as decline in revenues from Vodacom and New Zealand. Subscriber Trends At the end of Dec 31, 2014, Vodafone s total mobile subscriber base reached 443.552 million (80.3% represented by prepaid). In Europe, the company lost approximately 0.56 million subscribers, bringing the region s total customer count to 125.372 million. Africa, the Middle East and Asia Pacific added 6.053 million customers, taking the total subscriber tally to 318.180 million. The company s 4G customers reached 13.7 million and the service is now available in as many as 18 markets. Liquidity Vodafone Group posted negative adjusted free cash flow of 11 million (approximately $17.4 million). Capital expenditure totaled 2.134 billion (approximately $3.4 billion), up 39.2% from the year-ago quarter owing to investments in Group s networks for the Project Spring. Guidance The company reaffirmed its financial guidance for 2015. For fiscal 2015, the company expects EBITDA in the range of 11.6 billion to 11.9 billion. The company also expects positive free cash flow. Moreover, the company intends to take up a 19 billion capital expenditure program for two years ending Mar 2016, which will then normalize to 13 14% of annualized revenues in the subsequent years. VALUATION Vodafone is currently trading at a premium to the peer group and the S&P 500 benchmark, based on 2015 earnings per ADS estimates. Vodafone s European markets remain substantially mature owing to high subscriber penetration rates. Our skepticism on the stock is, however, due to a drop in the number of subscribers in Europe, regulatory and competitive pressures, as well as reduced mobile termination rates. However, encouraging subscriber and revenue growth in emerging markets like India, Egypt and South Africa lends optimism to the company s growth prospects. Hence, we have a Neutral recommendation on the company with a price target of $37, based on 45.1x our fiscal 2015 earnings per ADS estimate. Equity Research VOD Page 5
Key Indicators P/E P/E Est. 5-Yr P/CF F1 F2 EPS Gr% VODAFONE GP PLC (VOD) 42.5 36.7 4.0 4.7 P/E P/E 5-Yr High P/E 5-Yr Low Industry Average 16.3 15.7 11.7 6.7 16.5 60.8 9.9 S&P 500 16.7 15.6 10.7 15.3 19.3 19.4 12.0 ORANGE-ADR (ORAN) 15.2 15.8 10.0 4.2 MNC MEDIA INVST (LTONY) 123.0 1.0 TTM is trailing 12 months; F1 is 2015 and F2 is, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA VODAFONE GP PLC (VOD) 0.8 1.5 0.7 35.1 0.3 5.1 18.9 Industry Average 2.2 2.2 2.2-31.8 0.9 1.5 5.8 S&P 500 5.3 9.8 3.2 25.5 2.1 Equity Research VOD Page 6
Earnings Surprise and Estimate Revision History DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of VOD. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform - 15.8%, Neutral - 76.0%, Underperform 7.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research VOD Page 7