The forthcoming IPO price of UK mobile phone operator Orange casts a valuation shadow over the telecoms sector in Europe.
The current symbiotic relationship in the share prices of Eircom and Vodafone must prompt many of the 450,000 Eircom shareholders to cast a bleary eye over financial data. Perhaps they dream that Vodafone's share price and prospects will be their saviour in recovering much of the losses. After all, most London analysts view Vodafone as a leading telecoms investment opportunity. Some appear to see it as a share for the long haul - which suggests no quick pickings.
Early Eircom shareholders, like their counterparts who purchased Deutsche Telekom in June 2000, have taken an investment hit that looks to have no happy ending - unless a long investment horizon is endured. Vodafone is the world's largest mobile phone operator, with expected sales of around £16 billion (€20 billion) in 2001. Its market capitalisation (at £155 billion) makes it the largest company on the LSE. Its management has a strategic vision and an opportunistic culture that has drawn on strong dealmaking skills in acquisitions, complex mergers and minority shareholdings in Europe and the US (possibly Japan currently).
Analysts suggest that this strategy has put it in first or second position in most major mobile phone markets. It has the potential strengths of a global business platform, economies of scale and technology and services transfers. Vodafone also has a strong financial position - unlike key rivals after the 3G auctions. Vodafone is profitable, but trading margins have recently declined. Return on capital is tiny. The shares are currently on a sizeable price-earnings multiple of 64 times - compared to 26 times for Eircom. Vodafone's dividend yield is less than 1 per cent. These valuation criteria imply that the market expects supernormal earnings growth in the short to medium term.
Out of a recent survey of 24 London houses, 18 rated Vodafone as a "strong buy", three indicated it was a "moderate buy" and two said it was a "hold". One suggested it was a "strong sell". Heavy goodwill amortisation charges will impact on reported profit, but strong cash flows are projected. Despite a diverse range of EPS estimates for 2001, a fall is the consensus view. A strong recovery is projected by analysts in 2002 - if assumptions on revenue growth and margin improvement are achieved. Brokers' reports calculate the fair value of Vodafone in the range 340-375 pence sterling, which is considerably above the current price of 237 pence sterling.
Getting behind the analysts "broker-speak", there are investment meanings that are not the same as every day language. First, they are primarily writing for investment institutions and wealthy individuals who hold a portfolio of shares over different business sectors. Second, the brokers tend to appraise a company's performance and prospects relative to others in its specific business sector. They are not necessarily recommending the sector against others when they report on a specific company. Third, recent US academic research suggests caution about brokers' estimates. Apart from the inherent business uncertainties in companies and industries, there can be issues of relationships and business opportunities between some brokers and the company. Reading between the lines can be an art form. One London broker (with a strong European background) justified its "hold" recommendation having considered the technical overhang in the Vodafone shares allied to the effect of increasing competition on margins. So where does this leave the Eircom investor? First, the situations of individual shareholders, depending on the size of their shareholdings, may not coincide. Second, the typical "windfall" shareholder (Irish Permanent, First Active, etc) broke a cardinal rule about financial risk if they bought much more Eircom stock. Speculation in a small number of equities means risk and an acceptance of larger gains or losses. Wealthier Irish personal investors might have different objectives depending on their age. In contrast, the proposed Vodafone deal is a blessing for Irish investment institutions. They will receive much more liquid - giving them stronger options. The new stock may become an overhang for a while. The lessons from Eircom are that buyers and sellers have very different motivations, greed sways rationality and that share valuations in different business sectors are never constant. The stock market is no place for unlucky amateurs.
Edward Cahill is Professor of Accounting at University College Cork.
