Vodafone (LSE:VOD) shares pushed upwards on Wednesday before giving back some of the gains. The movement came as investors mulled news of the merger of its telecoms business with CK Hutchison‘s Three UK mobile network.
However, Vodafone shares are still down a phenomenal 42% over the past 12 months. Meaning if I’d invested £1,000 in the stock, today I’d be left with £580, plus dividends. A year ago, the yield would have sat around 6%, I’d have received £60. Clearly, a very poor investment.
A change of fortunes?
Vodafone shares have been on a downward trajectory, not just over one year, but over five years and even longer. The stock — once the largest-listed company in Europe — has hugely underperformed in recent years.
But are things about to change? Well, there’s certainly hope the merger can change the company’s fortunes.
With the Three UK merger, Vodafone and its new partner are creating a “best-in-class 5G network” in Europe. The combined business is expected to reach over 99% UK population coverage with a 5G standalone network by 2034.
Vodafone will own 51% and Hutchison 49% of the combined group, which could be worth around £15bn, including debt. These stakes would be achieved by adjusting the ownership of debt. This could be beneficial for Vodafone, as debt — which stood at €33.4bn (£29bn) — is sizeable.
The merger will likely contribute to the company’s competitive advantage indicated by its high return on capital employed (ROCE). It may also help lower its cost of capital, through economies of scale and other means — in the UK, Spain and Italy, ROCE is below cost of capital.
The Three deal, if approved by Britain’s Competition and Markets Authority, would also see the group become the largest network in the UK, while supporting investment plans to develop its 5G network and other innovations.
So certainly, things could improve.
Transitioning
The telecoms giant is very much in a period of change, even before the merger.
Net debt is down 20% year on year — this is positive. Now, Vodafone has 2.5 times net debt to core earnings multiple on a pro-forma basis.
But falling debt has been facilitated, partially, by the sale of operations in places like Ghana and Hungary. The company is also planning to lay off 11,000 staff in the coming years. This isn’t problematic, but it demonstrates that the company is attempting to rationalise the business. Clearly, something needed to change.
On a similar note, it’s a shame to see the firm sell business units when the market is growing. Over the past five years, the global telecoms market has expanded nearly 13%, while Vodafone’s revenue has increased by less than 5%.
Moreover, I expect this period of cutting back to be reflected in the dividend soon. Dividends are only covered by earnings 1.3 times. I’d expect new CEO Margherita Della Valle to slash the payment by around 30% to increase sustainability.
This would still mean a dividend yield — at the current price — of around 6.5%. It’s index-beating, but maybe the cut hasn’t been priced into the share price.
Clearly, there are many things to consider here. Personally, I want to see how things pan out before buying the stock. But I do think it’s cause for optimism.
