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November 15, 2005

Vodafone posts good results but weak outlook

The world's largest mobile operator Vodafone Group Plc has reported rising user numbers and half-year revenue. However, a combination of saturated markets, problems with its Japanese operation, and a prediction of slower growth rates in the future, led the markets to savage the operator's share price, wiping more than 7bn pounds ($12.14bn) off its market capitalization.

By CBR Staff Writer

The Newbury, UK-based operator posted an impressive set of results for the six months ending September 30. Net income fell 23.5% to 2.82bn pounds ($4.88bn) from 3.683bn pounds ($6.38bn) in the year-ago period, but this was partly down to Vodafone being hit with a charge of 515m pounds ($893m) to exit Sweden during the financial period. Sales however rose 9% to 18.25bn pounds ($31.62bn), compared to 16.74bn pounds ($29bn) a year ago.

Vodafone has achieved robust operational performance, and continues to outperform its principle competitors in both the US and Europe, said chief executive Arun Sarin. In Japan, our turnaround is on track.

Yet while most of the group continues to perform well, Vodafone is still finding the Japanese market troublesome. Even though Sarin insisted that Vodafone Japan is still in the middle of its turnaround, the operator forecast a significant decline in profitability in the next fiscal year in Japan.

Japan is Vodafone’s biggest market, but over the past few years the operation there has been losing ground at an alarming rate to rivals such as NTT DoCoMo Inc and KDDI Corp. Sarin admitted that margins have been hit, but said the company has stemmed customer losses and now expects customer gains in the next couple of years.

We expect to see good growth and profitably in Japan in the following years, said Sarin, adding that improved margins should arrive sometime in 2007. I am confident we can return Vodafone Japan to its previous heights.

On a global basis, Vodafone has continued to go from strength to strength. In the last six months it added another 10 million mobile customers to its customer base, which rose from 146.7 million customers this time last year, to 171 million currently. Vodafone owns mobile networks in 27 countries, and has partners in another 14. Yet most of these markets are fairly well saturated, which gives Vodafone little scope to significantly grow its total worldwide customer base. To this end, Vodafone continues to actively look to expand into developing markets. In March, for example, it paid $3.5bn in cash for Romanian mobile phone group Mobifon SA, and rapidly growing Czech wireless operator Oskar Mobil AS. These two acquisitions gave the mobile giant an additional 6 million customers.

Then in late October Vodafone purchased a stake of just over 10% in Bharti Tele-Ventures Ltd, India’s largest mobile operator, for INR 67bn ($1.49bn). India is one of the world’s fastest growing mobile markets, with its huge population and expanding economy. The advent of low-cost mobile phones also prompted a huge increase in demand, and with a mobile penetration rate of only 6% (compared to 30% in China), it is not hard to see why Vodafone was keen to re-enter this market.

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Vodafone also sold its loss-making operation in Sweden to Telenor ASA for 1.03bn euros ($1.25bn). Vodafone found the Swedish market too crowded, too tightly regulated, with not enough population to justify the costs of making itself the leading player.

Days later after the divestment, Vodafone raised its 35% stake in the leading South African mobile operator Vodacom (Pty) Ltd to 50% for approximately ZAR 16bn ($2.41bn). South Africa is also an attractive market because its saturation levels are relatively low compared to western Europe. Only 57% of the South African population of 47 million own a mobile phone. Sarin said he intends to continue to focus on selective acquisitions in growth markets, mostly in eastern Europe and Asia. He also said Vodafone plans to use its stake in Vodacom as a springboard into the rest of Africa.

Where we can buy control, we like to buy control, said Sarin. Where we can’t buy control, we take a significant stake, often with strong control rights. When the right opportunity comes around, we will take up our stake at the right price. He pointed out that 10 years ago Vodafone only had a 20% stake in Italy, Germany, and Spain. Now it owns 100% of the operators there. It just takes time, he said. Yet these acquisitions came with a price, and net debt at the operator increased to a hefty 14.09bn pounds ($24.41bn).

Sarin also touched upon some of Vodafone’s competition. He was diplomatic regarding Telefonica SA’s recent $31bn acquisition of UK operator O2 Plc. The Telefonica/O2 deal has no material affect to Vodafone in the UK or Germany, he said, yet he did hint at the surprise many felt over the price that Telefonica paid for the operator. Telefonica has however paid a full price for O2 and now has to earn a return for the payment.

But in the end, it was the outlook that caused the most worry for the stock market and triggered the share plunge. Vodafone admitted that profitability and sales growth will decline during the next year, triggering the company’s biggest share drop in three years. Shares in the operator fell 8.28% to 133.00p ($2.30) on the London Stock Exchange following the announcement. Such is the size of Vodafone, this drop had a knock-on effect on most European markets.

Despite this, Vodafone’s market capitalization is still a hugely impressive $146bn on the New York Stock Exchange.

For the 12 months ending in March 2007, Vodafone expects revenue growth to slow, and the profit margin to fall due to a combination of intense competition and ongoing investment in its Japanese division.

In an effort to take an edge off the prediction, Vodafone increased its share buy-back program to 6.5bn pounds ($11.27bn), and Sarin revealed that the board is committed to returning 100% of free cash flow of the company to its shareholders. It approved a 15% increase in the interim dividend to 2.20p ($3.81) per share.

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