Vodafone shareholders face long haul

Vodafone share certificates will be popping through letter-boxes across the State in the coming weeks. Eircom shareholders who accepted the British mobile giant's offer may have got them already, while the more recalcitrant will receive them in the next few days once the compulsory purchase of their shares is complete . The timing could not be worse. Last Tuesday Mr Chris Gent, the chief executive of Vodafone, unveiled the biggest loss in British corporate history. The company managed to lose a staggering £8.1 billion sterling (#13.5 billion), compared to profits of £1.3 billion the previous year.

Not surprisingly, the shares fell and continued to slide all week, dipping to 174p on Friday. They are now worth around 25 per cent less than they were when the deal to buy Eircell was done. They are also well below the 220p level at which Eircom could have pulled out of the deal. If you are one of the 450,000 new small Irish shareholders in Vodafone you may be tempted to take your money and run. If you are sensible you will get some professional advice before you do. Should you decide to do so, look forward to hearing about something called Earnings Before Interest Tax Depreciation and Amortisation (EBITDA). EBITDA has replaced plain old profits as the measure by which companies are judged by the investment community - at least when it comes to giving advice to their small clients. The argument is that EBITDA is a measure of the fundamental strength of the business and its ability to generate cash, the lifeblood of any enterprise.

Not surprisingly, the Vodafone picture is much more rosy when viewed through the lens of EBITDA, which rose by more than 25 per cent to £7 billion last year. The headline pre-tax loss of £8.1 billion is really only technical. It is the result of the need to make some adjustments to the accounting policies to reflect the huge growth in the business, or so we are told. Specifically the company wrote off £11.9 billion in respect of the goodwill from its £113-billion take-over of Germany's Mannesmann. To underline the point that it is fundamentally in very good shape Vodafone declared a full year dividend of 1.402p per share, a 5 per cent increase on last year. The other figure that Mr Gent would rather shareholders focus on instead of profit is customer numbers. Vodafone now has 83 million customers, compared to 53 million in 1999. When joint ventures are taken into account some 188 million people across the globe have a relationship with Vodafone.

The time has come, according to Mr Gent, to stop acquiring customers and start making more money out of the ones they already have - this includes Eircell's 1.3 million subscribers. Vodafone has seen its average revenue per user slip behind that of many peers as it has concentrated on establishing its global "footprint". Mr Gent has signalled that he wants to call a halt to this rapid expansion. The other immediate priority for Vodafone will be to roll out third generation mobile phone technology.

The two objectives are intertwined, as the best opportunity for increasing margins will arise through the offering of new services via third generation technology. Vodafone's margins at present are broadly stable, with the exception of Germany - the biggest division - where they fell as a result of a price war with Deutsche Telecom.

One piece of good news is that Mr Gent has said that he will stop diluting the value of the existing shares by issuing new ones to buy things. Vodafone issued 52 billion shares in the past two years, including one billion for Eircell. Institutions have mixed views on the trajectory of Vodafone shares. Merrill Lynch is bullish about the group, which is its "top pick in Europe on a 12-month view". The bank - which advises Eircom and put the Vodafone/Eircell deal together - rates it a buy and predicts the shares could reach 300p sterling by this time next year. Vodafone would have to hit 325p sterling before shareholders would recover the #3.90 they paid out at the initial public offering - this assumes the rump of Eircom is worth #1.20.

Merrill Lynch's predictions are ahead of most of its rivals with the consensus among London merchant banks being that Vodafone will reach 250p in 12 months. Some banks are more pessimistic. Commerzbank is expected to publish a research note shortly saying that the shares will be lucky to retain their current level over 12 months.

The bears argue that Mr Gent will have his work cut out to increase margins, particularly given the cost of rolling out 3G and the risk that it may be slow to take off. In addition, the massive share issues of the last two years created a queue of big shareholders looking to off-load stock. The most recent additions are KPN and Telia, who have 350,000 shares burning a hole in their pockets following the sale of Eircell. Irish investors should also bear in mind the possibility of sterling falling against the euro. The doom-sayers also point out that the "technical" loss recorded this year will be replicated for the next three years as the cost of the recent acquisition spree is digested. If you plan to hang on to your Vodafone shares, expect to hear a lot more about EBITDA and not much about profits.

jmcmanus@irish-times.ie