Vodafone is one of the UK's great corporate success stories. The mobile operator was launched in 1985 as a tiny offshoot of the Racal Radio Group. By the end of that year it boasted just 19,000 customers and, such were the group's ambitions at the time, its initial business plan estimated that its customer numbers would peak at 100,000.

Two decades on, and following aggressive acquisitions including Airtouch of the US in 2000 and the hostile bid for Mannesmann of Germany a year later, Vodafone customers number more than 150 million globally.

Vodafone controls leading mobile operations in every major market in Europe with the exception of France, where it has a minority stake in SFR, the mobile business controlled by Vivendi Universal, the French media group.

It also has interests in operators extending to eastern Europe and Africa, owns a 45 per cent stake in Verizon Wireless, a leading US mobile operator, and runs an established operator in Japan.

Yet this time last year many analysts had expected growth in customer numbers in Vodafone's key European markets to stall. Instead subscriber growth has continued across Europe and, unusually, this growth has not come at the expense of average revenues per user - a measure of mobile phone spending - which have remained robust.

This buoyant market has benefited European mobile operators, driving up earnings and revenues beyond most analysts' expectations.

Bradley McMaster, telecoms analyst at ABN Amro, cites a robust performance at Vodafone in Spain as well as strong performance at Verizon Wireless in the US as two particular bright spots for Vodafone.

These strong performances have largely compensated for a fall in the value of Vodafone Japan, its largest single market in terms of revenues.

ABN Amro has downgraded its valuation of Vodafone Japan from £19 billion (€27.3 billion) to £13 billion.

"The big operational issue for the company is Japan," echoes Christian Maher, analyst at Investec Securities.

"We've underestimated the underperformance of Vodafone in Japan. Vodafone management are predicting a turnround in the next 18 to 24 months but this is a long period for markets to digest."

Vodafone is facing tough competition from the two market leaders in Japan - DoCoMo and KDDI - which have opted for alternative technologies to spearhead their 3G launches.

The result has been that these rival operators with their sleeker handsets are winning the lion's share of new customers.

Over the past year Vodafone Japan revenues are down 4.7 per cent, although cuts to capital expenditure have kept earnings stable.

The other big issue weighing on the stock is uncertainty over strategy following the failed attempt last year to buy AT&T Wireless in the US, the first bold move of Vodafone's new chief executive Arun Sarin.

"When Sarin joined he was seen as the operations guy which the market liked," says Robert Grindle, analyst at Dresdner Kleinwort Wasserstein.

"Then he became the merger and acquisitions guy. The market still has mixed vibes."

Despite these uncertainties, most analysts are mildly bullish on Vodafone.

Expectations are that it will deliver just under £7 billion of free cash flow for the year to the end of March, a generous free cash flow yield of around 8 per cent based on its current share price.

This compares with just over 6.4 per cent for European stocks, according to Grindle.

The shares are trading on a relatively modest price/earnings ratio of just under 12 based on consensus earnings expectations for next year.

Bears point to rising handset and customer acquisition costs as competition intensifies and threats to mobile operators from new technologies.

But the bulls point to Vodafone's strengths as a cash-generating machine. The mobile operator has aggressive targets to cut its capital-expenditure-to-sales ratio to 10 per cent from current levels of 14 per cent by 2008. Mr Grindle, a Vodafone bull, says this would beef Vodafone's annual cash flow by 20 per cent.

Vodafone also insists its unrivalled global economies of scale will boost its free cash flow by £2.5 billion annually by the same date.

If Vodafone can deliver on both these promises, even without a turnround in Japan, there is considerable upside to its current share price. - (Financial Times Service)