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Vodafone's First Half Results - An in Depth Study
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Vodafone has reported results for the first half of its financial year. In the six months ended 30th September 2007, the company increase its revenues by 9%, to £17bn, just under half of this being "organic". Gross profits were up by 3.2% to £6,782m, implying a lower overall margin, down from 42.1% to 39.9%. Below this, comparison is complicated by a variety of different charges and gains. Adjusted operating profits were 1.6% higher at £5,208m, while the unadjusted numbers show a massive swing - from a loss of £2,952m to a profit of £5,208m.
The unadjusted number for the 2006 half year was depressed by an enormous £8.1bn impairment charge, which happily, was not repeated in the current period. Comparisons are also rendered less than helpful by the fact that last year's numbers excluded a £491m below the line loss from Vodafone Japan. Were we to add that and the impairment charge back in, it seems as though the overall operating margin has dropped from 36.0% to 30.6%. That is still a respectable return, but of course, it includes the profit from such key associates as Verizon Wireless, SFR and Vodacom but none of their revenues.
On a proportionate basis, the company added nearly 9.5m new customers in the quarter, with India leading the charge with 3.2m proportionate adds, well ahead of second placed Germany (0.92m) which in turn was some way clear of third placed Turkey (0.78m). The USA, Egypt and Italy also passed the half million mark, with 0.74m, 0.65m and 0.64m respectively. These numbers have all been adjusted to reflect Vodafone's stakes in the businesses and in some cases are not the numbers Vodafone actually reports.
For reasons at elude us, it uses proportionate consolidation for Italy but not for India or Egypt. This probably has something to do with Verizon being considered a suitable joint venture partner - as Italy is described as a joint venture - whereas the Essar boys and Telecom Egypt are not. Curious.
The chart shows the composition of Vodafone's proportionate customer base by region. The picture is remarkable, as the last two years have seen a huge swing away from Western Europe towards the emerging markets in the eastern part of the continent, in Asia and Africa. Although many investors were sceptical of the decision to buy Telsim in Turkey and most especially, the Hutch Essar business in India, this image goes a long way towards vindicating those moves. Vodafone has hugely increased its exposure to high growth markets - even if some of these lack the quality of the European assets - and in our opinion, it is a pity that management let the institutions stay its hand on several other occasions.
That said, it is the European businesses that have captured most of the headlines this time, mainly because of the take up of 3G and the attendant rapid growth in mobile data services. Vodafone now has over 21m of its customers using 3G devices with Germany (4.75m) and Italy (4.70m) leading the charge, just ahead of Spain (4.33m). Of the major European markets, the UK is in last place, with 3.1m, although this equates to a higher proportion of the overall total (17.2%) than either Germany (14.6%) or Italy (16.1%). However, it is well behind the 28% seen in Spain and that clearly sets the standard for all these other markets.
According to Vodafone's release, messaging revenue is up 8.6% at its European business, data up 40.8% and overall usage up 24.0%. This looks like a strong growth story until one notes that average data expenditure is still less than 8% of service revenues in every market bar Germany (where the figure is 10.9%) so what we have is growth from not very much to not very much more, at least in absolute terms.
At the same time, mobile messaging appears to have stopped growing in most of the mature European markets. This second chart shows that Spain is slightly up and the UK and Italy have hit new peaks (of 17.9% and 16.3% of service revenues, respectively) but Germany is down, the whole EMAPA region is down and so is the group proportion. At 12.2% of service revenue, expenditure on messaging is back where it was three years ago.
Putting the two together, we find that the trend is positive, but far from entirely convincing. Mobile data or perhaps, mobile non voice, is still a fledgling market and in our opinion, it is unlikely to get much further until either the tariffs become more affordable or the range of devices becomes broader and more appropriate, or both. At £29.99 a month or its Euro equivalent, mobile data is not yet within the range of most mobile voice customers.
Despite the ramp in non-voice, overall European revenue is only up 2.0% to £12.7bn, thanks to a combination of increased competition and regulatory intervention. Over the last few months several European countries where Vodafone operates have forced mobile operators to cut their termination rates, while most recently, the EU has obliged all operators to reduce roaming charges. Vodafone calls these interventions "regulatory drag" and for the shareholders, it certainly is a drag, as it has taken most of the gloss off an otherwise excellent performance.
Vodafone has outlined the effect of this and it really is quite striking. Roaming revenue amounted to around £1bn in H1 06/07 (six months to September 06) grew by £126m year on year, through volume effects and was then cut back by £256m thanks to the EU. Bearing in mind that the enforced cuts only came in at the end of June, the annual effect could be as much as £1bn, assuming there are no compensating elasticities. It is probably fanciful to imagine that there will be much help from this direction, as the majority of roaming traffic arises from corporates who are largely price insensitive.
We have commented on the role of the EU before and continue to be surprised that none of the operators are taking any kind of stand against it. It seems staggering that a company can suffer a £1bn annual drop in revenues and take it on the chin with no retort. How many other industries allow their prices to be determined by the central planning committee in Brussels? The EU has only assumed these powers over the past few years - none of the prospectuses issued by the governments of EU member states, as they privatised their PTT in the late 90s, carries any warning about the possible impact on the company's business of this kind of directive.
Vodafone's numbers show just how much damage the EU is doing - operators in other parts of the world do not suffer from this kind of meddling. Post-privatisation, operators have an obligation to maximise their returns and we believe that they should be allowed to do so. That this almost certainly involves lowering charges, especially for data services, is beside the point.
Vodafone, perhaps, has decided that there is little to be gained from alienating the bureaucrats as this isn't a fight it is likely to win. Moreover, with a growing presence in regions far removed from Brussels' clutches, it maybe isn't a fight it needs. Growth rates in the EMAPA region (Eastern Europe, Middle East & Africa and Asia Pacific) exceed those in Europe, as the 16% organic growth rate demonstrates. To this, we must add a £1.3bn in revenue from India (included from 7th May) and Turkey to bring the divisional total to £4.3bn. This is still just one third of the European total, penetration rates are lower and at the same time, usage is higher. The chart below shows the growth in total network minutes across both of Vodafone's regions along with the contribution from joint ventures.
As expected, Vodafone has passed the 100bn minutes per quarter milestone now, thanks in large part to the enormous contribution - 33.9bn - from India. The comparison with Germany - Vodafone's next largest market - is instructive: the Indians are far more talkative and generate over three times as many minutes per customer. In the chart below, we show the average minutes of use at each of Vodafone's subsidiaries: the variation is really quite striking and arguably, all Vodafone has to do is persuade its customers outside India to emulate usage patterns and the financials will look after themselves.
Interestingly, countries that might be thought to be culturally similar have very different usage patterns. The Spanish spend more than half as much again on the phone as do the Portuguese, while Australian usage is 80% higher than that of their neighbours across the Tasman Sea.
Happily for Vodafone this extra usage now appears to be showing through to ARPU. Up until recently, usage seemed to be rising steadily but without this making much difference to average expenditure, which continued to drop. The much-hyped "inflexion point" after which ARPU would begin to rise again seemed increasingly to be the stuff of myth…but no more. The next two charts show the trend in ARPU at the 16 subsidiaries Vodafone has consolidated over the last three years, split between Europe and the EMAPA countries. All but three of the ten European operations are now reporting higher ARPUs than they did in Q1 05. This compares with only four of six last years and none at all in the same quarter of 2005.
The EMAPA figures are similar. Four of the six are now up on Q1 05 and one of the remaining two is only 1% down. This compares with two of six in 06 and three of six in 05. What conclusions can we draw from this? It seems that usage is only heading in one direction and that there is, in most cases, sufficient momentum to offset regulatory pressure and increasing competitive pressure. This looks to us to be fixed mobile migration and if it is, it suggests that there is still scope for growth at well above 100% average penetration.
Finally, the last six months has been a period of revived M&A activity for Vodafone. Apart from the Indian business, the company has bought three fixed line operations, in Italy, Spain and most recently, Ireland. This process is not likely to stop just yet: the Rumour Mill suggests that the company is looking to increase its ownership of Vodacom in South Africa from the current 50%, while Vodafone's name has also been linked with the proposed Telekom Malaysia mobile spin off. Elsewhere in this report, we comment upon the latest results from Telekom Austria. We think that Vodafone should buy this business. This would give it access to several markets in the eastern part of Europe where it currently has no presence and would allow it to create a contiguous network stretching from Ireland to Turkey covering 15 countries with a combined population of 375m. (These numbers become 20 and 535m respectively, if we include Vodafone's French and Polish associates in the calculation.) Is there any merit in a single network such as this? If it could help lower the cost of roaming traffic now that the charges are lowered then yes. The government of Austria may have something to say about it, but it's certainly worth considering.
The company once again seems more interested in buying than selling. Although investors effectively forced management to divest Vodafone Japan two year ago (and its 25% interests in Proximus and Swisscom Mobile) we doubt that this kind of pressure will succeed again, at least not in the short term. The same investors tried to persuade Vodafone to sell its stake in Verizon Wireless; management can point to an increase in the value of that stake and can demonstrate that it is generating superior returns for shareholders without the need for one-off fire sales. As we have suggested before, there are a limited number of really good mobile franchises in the world, Vodafone has more than its fair share and should do nothing to change this.
Posted to the site on 21st November 2007
This article was extracted from The Mobile World Briefing, the weekly newsletter from The Mobile World.
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