Big spender Vodafone feels the pinch

Yikes. Nick Read, Vodafone's affable, smiling boss, might not have anticipated a 7% drop in his company's share price this morning amid preparations for his socially distanced speech to camera about results.

The UK-headquartered operator just about hit its own targets as it flopped over the finish line of the 2021 fiscal year. But investors dumped stock because the latest spending plans will chew into free cash flow.

The aim, it seems, is to invest about €8 billion ($9.8 billion) in capital expenditure this year, up from €7.85 billion ($9.6 billion) for the one just ended and €7.41 billion ($9.1 billion) before that.

This "capex creep," said Jefferies somewhat insultingly, "overshadows relatively solid 4Q results and promise of consistent margin expansion into the mid-term." The bank sounds unimpressed.

It is not that Read's streamlining efforts are having no impact. Free cash flow of €5.2 billion ($6.4 billion) is expected this year, up from €5 billion ($6.1 billion) previously, but Vodafone has issued guidance for basic earnings of between €15 billion ($18.3 billion) and €15.4 billion ($18.8 billion), compared with €14.4 billion ($17.6 billion) last year. Only a sliver of what would be an impressive increase will find its way into free cash flow.

Figure 1: Vodafone CEO Nick Read is plotting an increase in investments.

Still, the "capex creep" should probably not have come as a massive surprise. In the last two or three years, Vodafone has splurged billions on new spectrum licenses to provide 5G services.

It has taken a bigger role in the fixed-line telecom sector and promised new services in partnership with US technology giants. None of this would make sense without subsequent product and network investments.

The operator is also very confident that its latest investments will pay off. In the "medium term," it is guiding for "mid-single digit" percentage growth in basic earnings and free cash flow. One-third of the extra spending has been earmarked for "growth areas" realized mainly through Vodafone Business, the part catering to other organizations.

Executives are salivating over the European Union's €750 billion ($917 billion) pandemic recovery fund as a source of future profits.

Another third is intended for Vantage Towers, the Vodafone subsidiary that owns and manages all its passive mobile infrastructure in Europe.

"We want to have the flexibility for Vantage Towers to invest when good business cases come up," said Margherita Della Valle, Vodafone's chief financial officer, on a call with analysts.

The remaining additional capex will go toward network improvements to cope with the extra usage seen during the pandemic. Levels of fixed traffic are growing 50% faster than they were before the coronavirus outbreak, according to Della Valle. An acceleration in 5G deployment is also in the Vodafone spending plans.

Show me the money

Investors are probably right to be skeptical. Vodafone's sales last year fell 2.6%, to €43.8 billion ($53.5 billion), and its service revenues were more or less unchanged on a like-for-like basis, at €37.1 billion ($45.4 billion).

The operator was clearly hurt by lockdowns, which tore hard into the "roaming" revenues it makes when people travel and use their devices abroad. Concern still simmers about virus mutations that can dodge vaccines, though. And telco diversification has been a futile endeavor so far.

That said, Vodafone Business, which accounts for nearly a third of group revenues and is already growing by 2% annually, seems worth the attention if European governments are in such a generous mood.

"The EU recovery fund will be targeting SME [small- to medium-size enterprise] digitalization and we are SME champions," said Read on today's call. Other than Vodafone, there is usually only the telecom incumbent in each country serving the business sector. And Vodafone's share of it appears to be growing.

Read's efficiency program is a further cause for shareholder optimism about profitability. Vodafone claims to have saved about €1.3 billion ($1.6 billion) in the last three years, a reduction of about 15%, by automating processes, phasing out duplication and standardizing systems.

Some euphemistic language in its financial report hints at substantial layoffs ("we have introduced 5,500 role efficiencies in our shared service centers ... and optimized our retail footprint").

The recent impact on headcount will not be known until Vodafone publishes its annual report in the coming weeks, disclosing full details of employee numbers. But a combination of divestments and cutbacks have claimed nearly 16,500 jobs across the group between 2015 and 2020, leaving Vodafone with about 95,200 employees in March last year.

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Thanks to "role efficiencies," reliance on AI assistants, robotic process automation and similar cost-saving measures and technologies, basic earnings fell just 1.2% last year, on a like-for-like basis, to about €14.4 billion ($17.6 billion).

When it wrote off the value of its Indian business – now Vodafone Idea following a merger with Idea Cellular – it had to report a €500 million ($611 million) net loss one year ago. Today it swung to a net profit of roughly the same amount.

Vodafone is slowly chipping away at its net debt, too. That dropped from about €42 billion ($51.3 billion) in March 2020 to €40.5 billion ($49.5 billion) a year later.

Around €2 billion ($2.4 billion) in funds raised from the public listing of Vantage Towers, combined with €5 billion ($6.1 billion) in free cash flow, was used to reduce the figure after Vodafone incurred additional expenses due to spectrum fees, restructuring charges and dividend payments.

Net debt is currently about 2.8 times Vodafone's annual earnings, way up on the ratio of 1.9 the company reported two years ago. Unlike some of Europe's other big phone incumbents, Vodafone is at least worth a bit more than it owes, with its current market capitalization of about £37.2 billion ($52.8 billion) in London. But today's share price slippage will not have helped.

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— Iain Morris, International Editor, Light Reading