Stick With Vodafone

 | Sep 04, 2013 | 2:00 PM EDT  | Comments
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Vodafone (VOD) recently announced its massive deal to sell off the company's 45% stake in Verizon (VZ) Wireless for a whopping $130 billion. This was on the high end of what most had estimated the deal would be worth, and it was certainly good news for Vodafone shareholders.

The even greater news, however, was how Vodafone plans to spend the proceeds. Management says it will pay off a total of $20 billion in debt and return a massive $84 billion in cash to shareholders, and it will apparently spend a more modest $26 billion on acquisitions and investment. To put this into context, the company's American depositary receipt market capitalization is only $156 billion as of today.

For myself, as a Vodafone shareholder, my original fear was that management would plow the majority of proceeds into questing for a newer, bigger buyout, paying an equally big premium and squandering lots of money along the way. But, as we've seen here, Vodafone will actually be quite lean. The acquisitions it is seeking seem focused and thematic.

While many large shareholders wanted to see more fireworks on the M&A front, I believe this mix is ideal and shows tremendous capital discipline. It's really a continued validation of Vodafone's record as the most shareholder-friendly big telecom firm in Europe.

Fortress Europe

Thus far, Vodafone's acquisitions have targeted cable providers in the U.K. and Germany. There is talk of buying Spanish and Swiss cable providers, too. Why cable? It's because Vodafone, as a pure play mobile telecom, faces obsolescence in a world where consumers want the ease and simplicity of "bundled" cable or satellite television, wireless phone, internet and landline services. This is also why Vodafone is building out its fiber optic network in Europe and launching 3G services in smaller countries.

If Vodafone wants to truly leverage mobile data growth in Europe, it needs to be competitive with bundling and raise its numbers in average revenue per user. By making these smaller, strategic cable acquisitions, Vodafone is planting the seeds for the company to grow and remain relevant in Europe without breaking the bank.

To be sure, the company does face an uphill battle in its U.K. and German operations, among others. In both of those countries, it has seen slight revenue declines on stiff competition from BT (BT) and Deutsche Telekom, respectively. But Vodafone is one of Europe's best operators, and I believe it will succeed. Judging from the Verizon Wireless sale and discipline in acquisitions, Vodafone is also a shrewd, lean capital allocator.

To those who say the company must massively acquire in order to avoid being a target, I say this: Let Vodafone be a target. It's better to do that than it is to blow money on "empire-building." Moreover, if Vodafone does get bought, you can bet it will be for a premium.

Valuation

Shares of Vodafone are up approximately 28% on the year, but at 11x forward earnings and a dividend yield of about 5%, I think the stock is reasonably priced. Granted, at the moment there are more sure-fire big telecom deals out there, such as AT&T (T) at 12.4x forward earnings, and a dividend of 5.4%. But, unlike AT&T, Vodafone does have the massive upcoming cash return to shareholders. Despite the run-up, therefore, shareholders should at least hold on to Vodafone.

Conclusion

The biggest drag here continues to be Vodafone's exposure to southern Europe, where revenue is declining in the double digits. However, the company has a number of things going for it -- and, in particular, its unique emerging-market exposure mitigates some of this decline.

If Vodafone is able to boost revenue per user and gain market share through bundling in northern Europe, in the long run the company will increasingly be a play on Europe and any possible recovery there. In the meantime, cash returned to shareholders is a huge gust of wind in the sails, and that juicy 5% dividend yield puts support under the price. Stick with this company.

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