Vodafone changes tack as its once untouchable dividend feels the pain

For many Irish stock investors who were hit hard as some of the biggest names of the Dublin market, led by the banks, scrapped dividends during the financial crisis, Vodafone’s regular cheque was something of a godsend.

Almost 500,000 Irish people received shares in the UK mobile phone carrier 18 years’ ago this month when it took over Eircell from Eircom (now Eir). To this day, it remains the most widely held stock in the Republic.

It's estimated that more than 300,000 people in the State own shares in Vodafone – a company with an unbroken track record of increasing its investor payouts, year after year, over the past two decades. Until now.

On Tuesday, the group's chief executive of less than eight months, Nick Read, said, as he unveiled full-year earnings, that the board had "made the decision, not taken lightly to rebase" – a market euphemism for slash – its dividend. The payment for the year to the end of March has been cut by 40 per cent to 9 cents per share.

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Dividends

It marks a stunning volte face for a CEO who pledged in his first outing with investors in November that one of the safest – and progressive – dividends on these islands remained untouchable.

New CEOs, like newly elected governments, tend to have a plausible get-out clause when it comes reneging on early promises-in that they can argue that they hadn't a proper handle on the finances when they took office. Read, however, was Vodafone's chief financial officer for more than four years before succeeding urbane Italian Vittorio Colao.

Read cited a “disproportionately challenging year” (with Italy, Spain and South Africa proving to be particularly tough markets), and higher-than-expected costs for fifth-generation (5G) spectrum licences in Europe in making the cut. But the CEO was already stretching the finances from the outset with his aim of maintaining a payment that was costing €4 billion a year.

If anything, delaying the inevitable has proved costly for shareholders. Already out of sorts from the start of last year, the stock fell almost 20 per cent during Read’s first 7-1/2 months, in no small part as traders bet aggressively that he was being boxed into a corner.

Before announcing the cut, Vodafone’s stock was trading on a dividend yield of almost 10 per cent – more than double that of the FTSE 100 average and peers such as Deutsche Telekom and Orange in France. It was a clear signal from the market that the annual payment was seen as unsustainable.

Colao spent much of the early part of his tenure unpicking part of Vodafone's expansionist past. Under pressure from shareholders to simplify the business, he sold minority stakes in phone companies in Japan, China and France before disposing the group's 45 per cent holding in Verizon Wireless, the largest US wireless carrier, for $130 billion (€116 billion)). It stands as the third-largest corporate deal in history.

Transition

But before exiting, Colao entered a deal to buy the German and eastern European cable networks of US billionaire John Malone’s Liberty Global for almost $22 billion (€19.7 billion), which would move complete the group’s transition from former mobile pioneer into wider telecoms challenger with the largest broadband provider on the continent.

Read has the job of closing the deal, which he hopes the European Union will finally approve in the coming months. But additional borrowings being taken on will increase Vodafone's net debt to 2.9 times annual earnings before interest, tax, depreciation and amortisation (ebitda), above the peer average at a time when it is struggling to grow.

It will take years for the new assets to deliver a return capable of covering their cost of capital – in other words, making enough money to make the deal worthwhile. Vodafone cannot afford to breach a net debt/Ebitda ratio of 3 times for fear of losing its prized investment grade among credit ratings agencies.

Meanwhile, the underlying business has its issues. Group sales for the full year fell by more than 6 per cent, driven by drops in Italy and Spain as it grabbled with intense competition from low-cost rivals. Service revenues edged just 0.3 per cent higher.

And having completed a £19 billion investment programme in 2016, called Project Spring, which spread 4G mobile broadband coverage across its network, Vodafone is now spending billions on 5G.

Costs

Auctions in Italy and Germany for next generation spectrum have already proven to be more costly than analysts expected. That’s before mobile companies start spending on overhauling their networks. But overpriced frequency auctions are hardly a surprise in this industry. Read has been with Vodafone for 18 years.

Debt ratings agency Fitch – which has a BBB+ grade on Vodafone's creditworthiness is three levels above what it considers to be junk status – estimates that the group's 5G spectrum costs will come to about €8.2 billion between 2018 and 2022.

It suggests that the group, which sold its New Zealand mobile business this week for the equivalent of €2 billion (though it does little to move the dial on its debt burden), has scope to help its finances further.

“Vodafone has a 46 per cent stake in Vodafone Idea Limited in India that could be reduced over time and the company has been creating network-sharing joint ventures in many of its core European markets, which it can subsequently monetise through asset sales,” the agency said in a note this week.

With the stock having slumped as much as 12 per cent this week, pushing it down to levels not seen in almost a decade, cutting the dividend may not be enough.