Blaming mounting competition and regulation, mobile phone giant Vodafone Group (VOD) spooked the markets with a surprise profit warning on Feb. 27. The Newbury, (England)-based company revealed that it expects revenue growth to cool to between 5% and 6.5% in the year to Mar. 31, 2007, vs. an estimated 6% to 9% for the current financial year.
Adding to the gloom, Vodafone now estimates its assets are overvalued by as much as $49 billion, due to lower than anticipated growth prospects for its businesses in Germany, Italy, and potentially, Japan. That sets the stage for a massive write-down.
The double blow sent shares in the world's largest cell phone player plummeting 3% on the day of the announcement. "The outlook is worse than we had hoped," says Investec Securities analyst Christian Maher.
RESTIVE INVESTORS. What really unnerved investors is not the size of the write-down but the acknowledgement that Vodafone's heady days of growth are well behind it. In Europe, Vodafone's main market, growth is grinding to a halt. Like most of its competitors, the company is facing a saturated market and growing competition -- leading to declining revenues from voice calls.
Moreover, the predicted windfall from next-generation data services has yet to materialize, leaving Vodafone struggling to win new subscribers as a way to make up the shortfall. "The competitive environment is getting a lot nastier and opportunities for growth are a lot fewer," says Robert Grindle, telecoms analyst with Dresdner Kleinwort Wasserstein in London.
Still, the news is just the latest in a string of recent setbacks for Vodafone. In recent months, CEO Arun Sarin has come under increasing pressure from shareholders worried about growth prospects and lackluster share-price performance. In January, one of the outfit's largest investors, British fund management group Standard Life Investments, publicly criticized Vodafone's strategy, claiming "the market has lost confidence in the company's global strategy, rating it more like a utility company."
"VODAFONE IS TOO LARGE." Ironically, it seems Vodafone's size and scale, once its biggest advantages, are now part of the problem. Seven years ago, Sir Christopher Gent transformed Vodafone from a small British wireless company into a global giant through more than $300 billion in acquisitions.
Indeed, the biggest of those acquisitions, the $186 billion hostile takeover of Germany's Mannesmann, is responsible for the vast majority of the current write-down. Since taking over from Gent in July, 2003, Sarin has spent $20 billion on deals in Turkey, Eastern Europe, and South Africa in a bid to rev up revenue and profit growth.
But Sarin is finding that stitching together Vodafone's farflung empire -- with more than 179 million customers in 27 countries -- is proving a slower and more difficult task than expected. Analysts blame Vodafone's unwieldy structure. "Vodafone is too large -- it is a conglomerate, and as a consequence, senior management are spreading themselves too thin," says John Karidis, telecoms analyst at Man Securities in London.
Some of Vodafone's investors think they have the solution. In recent months shareholders such as Standard Life have urged the company to ditch its underperforming Japanese business and offload the 45% stake in Verizon Wireless in the U.S., returning the proceeds to investors. The former, which runs a distant third in the ultra-competitive Japanese market, is in the process of a major overhaul, although analysts say there is little sign yet of any improvement.
WHY NOT SELL? In the U.S., Vodafone finds itself in the awkward position of hanging on to a business it doesn't control and one that uses a different brand and mobile technology from its other global operations. But unlike Japan, Verizon Wireless is still going strong. Mobile phone penetration in the U.S. is still only around 70%, well below that of Europe. Although Verizon has made its interest in acquiring Vodafone's stake clear, Sarin continues to maintain that he has no intention -- at least yet -- of selling.
Vodafone's stake is valued at around $44 billion, and a sale would lead to a hefty tax bill. In a conference call with analysts Feb. 27, Sarin reiterated his commitment to Verizon Wireless but acknowledged that the change in the company's view of its long term growth prospects might lead to other changes. "The board reviews the Verizon situation from time to time," Sarin said. "We'll continue to review."
For a company such as Vodafone, which has made its name through a series of bold transformational deals, pulling out of major markets such as the U.S. and Japan would represent a major defeat. But if this onetime high-flyer is to restore its reputation, it needs to move quickly to get growth on track.
Capell is a senior writer in BusinessWeek's London bureau
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