1 June 2016
Vodafone Group plc
BUY
Telecommunications Dividend risk reducing
Paul Marsch Analyst +44 20 3207 7857 [email protected]
Laura Janssens Analyst +44 20 3465 2639 [email protected]
Julia Thannheiser Specialist Sales +44 20 3465 2676 [email protected]
ATLAS ALPHA • THOUGHT LEADERSHIP • ACCESS • SERVICE Vodafone Group plc Telecommunications
THE TEAM
Paul Marsch has been with Berenberg since 2009. He was previously head of telecoms research at Morgan Stanley, where he was consistently very highly ranked. Paul has 20 years' experience in telecoms research, as well as having worked for five years in the telecoms industry for Cable & Wireless.
Laura Janssens joined Berenberg in September 2011 and was previously head of global telecoms research at UBS and head of European telecoms research at Merrill Lynch. She has also worked at telecoms consultancy Analysys, and at BT. She has 17 years of telecommunications experience. Laura has been a top-ranked individual analyst in the Extel survey on several occasions.
Julia Thannheiser joined the Berenberg specialist sales desk in May 2013. Prior to this, she spent over three years as a telecoms analyst at UBS. Julia holds a BSc from the University of Maastricht and a MSc from Cass Business School.
For our disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) and our disclaimer please see the end of this document.
Please note that the use of this research report is subject to the conditions and restrictions set forth in the disclosures and the disclaimer at the end of this document.
Vodafone Group plc Telecommunications
Table of contents
Dividend yield appeals on reducing risk 4
Investment thesis in pictures 6
Investment conclusion 7
Juicy dividends and reducing risk profile 7
Changes to estimates 10
Dividend drives valuation appeal 11
Price target unchanged 11
European mobile operating trends deep dive 14
Conclusion – European mobile service revenue trends encourage 27
Margin outlook shows scope for improvement 29
“Good” capex reflects success of project Spring 33
Indian spectrum risk? 38
Financials 40
Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) 43
3 Vodafone Group plc Telecommunications
Dividend yield appeals on reducing risk
● Dividend yield appeal: We continue to like Vodafone’s shares for their 1 June 2016 relatively attractive dividend yield and rapidly declining dividend risk. The outlook of modest single-digit dividend growth is underpinned by a return to stable low single-digit revenue growth, margin expansion, and falling BUY capex that results in FCF growth averaging c18% over the next three years,
and dividend cover rebuilding from c1.0x this year to 1.5x by FY19. The Current price Price target 5.3% dividend yield stands out relative to the peer group, and is the highest cash dividend yield of the “big five” European incumbents. GBP 2.31 GBP 2.50 ● Europe drives group service revenue improvement: Group organic service 31/05/2016 London Close revenues continue to improve (Q4 growth of 1.8% yoy lfl, versus 1.4% in Market cap (GBP m) 60,057 Q3). Our detailed assessment of European mobile service revenue trends Reuters VOD.L shows a material improvement driven by improving ARPU trends rather Bloomberg VOD LN than improving subscriber trends. Blended ARPUs are improving in most EU business units, with declines in postpaid ARPUs being offset by the Changes made in this note ongoing significant mix shift from low-ARPU prepaid tariffs to higher- ARPU postpaid services. We see this mix shift as the single most significant Rating: Buy (no change) evidence that growing demand for mobile data is being monetised. We Price target: GBP 2.50 (no change) believe there remains considerable further potential for growth in Estimates changes smartphone, 4G and data plan adoption which should continue to 2017E 2018E 2019E underpin modest European service revenue growth in the medium term. old ∆ % old ∆ % old ∆ % Sales 41,309 5.1 42,349 4.6 43,254 4.2 ● Good reasons for margins to expand: An estimated £900m of EBITDA Ebitda 12,039 4.9 12,578 4.1 13,022 5.1 headwinds in FY17 should be more than offset by structural margin EPS 4.53 10.9 5.56 6.7 6.41 22.1 Source: Berenberg estimates benefits (faster-growing high-margin segments like AMAP and cable), operating leverage (as project Spring cost growth starts to slow) and Share data efficiency gains (on direct costs, customer costs, and IT and technology Shares outstanding (m) 26,692 costs). We expect group margins to expand by 210bp to 30.4% by FY19. Enterprise value (GBP m) 92,807 ● Higher capex is good capex: Following higher capex guidance from Daily trading volume 42,900,000 management we have raised our cumulative three-year capex by £2.4bn to £20.7bn for FY17-19, with an average three-year capex/sales of 15.6%. Absolute capex will still fall by c20% in FY17. Increased capex will be spent on 4G densification and fibre backhaul in Europe, 4G expansion in AMAP, fibre and DOCSIS 3.1 upgrades in European wireline, and IT transformation. Target areas should benefit both revenues and opex. Despite this higher capex scenario, our FCF estimates for FY17-19 are almost unchanged.
Y/E 31/3 ., GBP m 2015 2016 2017E 2018E 2019E Sales 42,227 40,973 43,406 44,289 45,076 Interactive model click here to explore EBITDA 11,915 11,612 12,629 13,088 13,683 Operating Profit (adj.) 3,507 3,117 3,697 4,153 4,838 Net Income (adj.) 1,471 1,344 1,342 1,582 2,089 EPS (recurring) 5.55 5.04 5.03 5.93 7.83 DPS 11.22 11.45 11.68 11.91 12.15 Capex (accrued) -9,197 -8,599 -6,894 -6,834 -6,936 Spectrum Investment -443 -2,944 -2,570 -570 -341 FCF (company defined) 1,088 1,013 3,109 4,308 4,616 Net Debt 22,271 29,175 32,750 32,399 31,573 GBPEUR= 1.28 1.37 1.27 1.27 1.27 Ratios * there may be a delay for the new estimates to be PE (Adj.) 40.8 44.7 44.9 38.1 28.8 updated on the interactive model Dividend Yield 4.9% 5.1% 5.3% 5.4% 5.5% EV/EBITDA (Berenberg adj.) 7.9 8.0 7.4 7.1 6.8 EV/OpFCF (Berenberg adj.) 14.5 15.8 13.1 14.1 13.2 FCFE Yield (normalised) 7.3% 6.2% 7.0% 7.2% 7.6% FCF Yield (Berenberg adj.) 6.0% 5.2% 5.8% 6.0% 6.3% Capex/Sales 21.8% 21.0% 15.9% 15.4% 15.4% Source: Company data, Berenberg
Paul Marsch Laura Janssens Julia Thannheiser Analyst Analyst Specialist Sales +44 20 3207 7857 +44 20 3465 2639 +44 20 3465 2676 [email protected] [email protected] [email protected]
Vodafone Group plc Telecommunications
BUY Investment thesis
Reuters VOD.L ● We think operating trends at Vodafone will continue to improve, 1 June 2016 driven by rising smartphone and 4G penetration, an improving Bloomberg VOD LN customer mix and a gradual move towards pricing stabilisation.
Current price Price target ● Vodafone’ s cash flow and returns, which have been depressed in
Market cap ( GBP m) 60,057 recent years, should recover strongly from FY 17 onwards, as the GBP 2.31 GBP 2.50 project Spring investment cycle comes to an end. 31/05/2016 London Close EV ( GBP m) 92,807 42,900,00 ● Vodafone shares offer a relatively attractive dividend yield at c5%, Trading volume 0 among the highest of its peer group. As cash flow recovers, the era Free float 100.0 % of the dividend being paid out of Verizon Wireless disposal proceeds will end, and ca sh flow cover of the dividend will move Non-institutional shareholders Share performance into positive territory, reducing the risk of a change in dividend policy. None > 1% High 52 weeks GBP 2.55
Low 52 weeks GBP 2.00 ● Valuation is highly sensitive to smartphone and 4G penetration and
Business description Performance relative to ARPU assumptions. We value Vodafone based on a DCF/SOTP valuation model. Mobile network operator with operations in SXXP SXKP ● Europe, Africa, the Middle East, and Asia. 1mth 4.2% 2.3% 3mth 1.5% 5.0% 12mth 5.1% 4.2%
Profit and loss summary Cash flow summary GBP m 2015 2016 2017E 2018E 2019E GBP m 2015 2016 2017E 2018E 2019E Revenues 42,227 40,973 43,406 44,289 45,076 EBITDA 11,915 11,612 12,629 13,088 13,683 EBITDA 11,915 11,612 12,629 13,088 13,683 Capex -8,435 -8,910 -7,694 -6,834 -6,936 EBITA - - - - - Dividends to subsidiaries -22 -156 -156 -144 -133 EBIT 3,507 3,117 3,697 4,153 4,838 Other -1,375 -507 -626 -705 -926 Associates contribution -63 44 90 98 110 FCF to the firm 2,083 2,039 4,153 5,404 5,688 Net interest -1,290 -1,375 -1,393 -1,462 -1,429 Net interest -995 -1,026 -1,045 -1,096 -1,072 Tax -569 -175 -633 -739 -925 FCFE 1,088 1,013 3,109 4,308 4,616 Minorities -177 -223 -330 -370 -395 Acquisitions, disposals -7,184 -7 -1,087 -300 -300 Net income adj. 1,471 1,344 1,342 1,582 2,089 Other investment CF 895 -1,968 0 0 0 EPS reported 5.55 5.04 5.03 5.93 7.83 Dividends paid -2,927 -2,998 -3,027 -3,087 -3,149 EPS adjusted 5.55 5.04 5.03 5.93 7.83 Buybacks, issuance 0 0 0 0 0 Year end shares 26,615 26,692 26,692 26,692 26,692 Change in net debt -8,571 -6,904 -3,575 351 826 Average shares 26,615 26,692 26,692 26,692 26,692 Net debt 22,271 29,175 32,750 32,399 31,573 DPS 11.22 11.45 11.68 11.91 12.15 FCF per share 4.09 3.80 11.65 16.14 17.29
Growth and margins Key ratios 2015 2016 2017E 2018E 2019E 2015 2016 2017E 2018E 2019E Revenue growth 10.1% -3.0% 5.9% 2.0% 1.8% Net debt / equity 32.9% 43.3% 49.9% 50.5% 50.1% EBITDA growth 7.5% -2.5% 8.8% 3.6% 4.5% Net debt / EBITDA 1.9 2.5 2.6 2.5 2.3 EBIT growth -18.6% -11.1% 18.6% 12.3% 16.5% Avg cost of debt 5.5% 4.0% 3.4% 3.4% 3.4% EPS adj growth -27.8% -9.2% -0.2% 17.9% 32.0% Tax rate 29.4% 15.1% -29.1% -28.5% -27.8% FCF growth -74.0% -6.9% 206.9% 38.6% 7.1% Interest cover 9.2 8.4 9.1 9.0 9.6 EBITDA margin 28.2% 28.3% 29.1% 29.6% 30.4% Payout ratio 203.0% 226.6% 232.2% 201.0% 155.2% EBIT margin 8.3% 7.6% 8.5% 9.4% 10.7% ROCE 2.5% 2.8% 5.6% 7.3% 8.4% Net income margin 3.5% 3.3% 3.1% 3.6% 4.6% Capex / sales 21.8% 21.0% 15.9% 15.4% 15.4% FCF margin 2.6% 2.5% 7.2% 9.7% 10.2% Capex / depreciation 101.1% 104.3% 85.3% 75.7% 77.4%
Valuation metrics Key risks to our investment thesis 2015 2016 2017E 2018E 2019E ● FX is a key risk. Each 1% change in EUR versus GBP/INR/ZAR affects P / adjusted EPS 40.8 44.7 44.9 38.1 28.8 EBITDA by €15m/€20m/€15m and FCF by €5m/€5m/€5m. P / book value 0.9 0.9 0.9 0.9 1.0 FCF yield 7.3% 6.2% 7.0% 7.2% 7.6% ● The entry of Reliance Jio into the Indian market in 2016 may Dividend yield 4.9% 5.1% 5.3% 5.4% 5.5% undermine the performance of one of Vodafone’s key growth assets. EV / sales 1.9 2.2 2.1 2.1 2.0 ● Mobile data growth may exceed expectations, leaving capex abov e EV / EBITDA 7.9 8.0 7.4 7.1 6.8 expectations in the long term, or Vodafone may fail to profitably EV / EBIT 23.5 28.6 25.1 22.3 18.9 monetise the growth in mobile data. EV / FCF 75.7 88.1 29.9 21.5 19.9 EV / cap. employed 0.9 0.9 1.1 1.2 1.2 ● Apple may decide to pursue a “soft-sim” service provider strategy.
Paul Marsch Laura Janssens Julia Thannheiser Analyst Analyst Specialist Sales +44 20 3207 7857 +44 20 3465 2639 +44 20 3465 2676 [email protected] [email protected] [email protected]
Vodafone Group plc Telecommunications
Vodafone Group plc – investment thesis in pictures
Figure 1: Peer group dividend yields Figure 2: Dividend cover under our new estimates Vodafone shares offer an above-average dividend yield, and the Dividends are covered by recurring FCF from FY17; group highest cash dividend yield of “the big five” dividend policy is to pay a rising dividend
Vodafone FCF and dividend cover profile Free casflow (£m incl Spring - lhs) Dividend yield (2016E) Div cover (ex spectrum - rhs) 9.0% Div cover (with specturm - rhs) 8.1% 8.0% 9,000 1.6 2.0 1.4 1.5
7.0% 6.5% 6.4% 1.0
6.3% 8,000 0.8 1.36 1.49 1.0 6.0% 1.21 5.4%
5.3% 7,000 0.4 0.3 5.2% 4.8% 5.0% 4.7% 4.7% 0.65
4.2% 6,000 0.0 0.22 0.18 5,129 4.0% 3.6% 3.6% FCF £m FCF 3.3% 5,000 4,616 3.0% 4,308 3.0% 4,183 (0.64) (1.0)
4,000 x Dividend cover 2.0% 3,109 3,000 (2.0) 1.0%
0.0% 2,000 0.0% 1,088 1,013 (3.0) 1,000 BT DTE TDC KPN Avg. ORA VOD TEF* TLSN TEFD Tele2 PROX TNOR SCMN 0 (4.0) TI (savs) TI TI (Ords) TI FY14 FY15 FY16 FY17E FY18E FY19E FY20E
Source: Berenberg estimates. Note: * Telefónica dividend includes c35c Source: Company data , Berenberg estimates scrip, without which the cash dividend yield would be 4.3% Figure 3: Group organic service revenues Figure 4: Mobile data monetisation Organic service revenue trends are firmly back in growth The prepaid-to-postpaid customer mix-shift remains the most territory, with future headwinds likely to continue to reduce compelling evidence of mobile data monetisation, in our view
Vodafone Europe mobile data traffic growth 375 70% 65% 325 Quarterly data traffic 60% Group organic service revenue growth (% yoy) (Petabytes - lhs) 2.5% 275 55% 3.0% Growth yoy (rhs) 252 2.0% 1.2% 1.4% 0.8% 229 50% 1.0% 0.1% 225 212 0.0% 45% -1.0% -0.4% 177 -2.0% 175 162 -1.5% 146 40% -3.0% 132 -4.0% Total group organic service revenues 125 108 35% -5.0% -3.8% -4.0% have improved - but why? -4.2% 87 95 -6.0% -5.1% 80 30% -5.2% 67 71 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 75 55 61 49 25% 25 20%
Source: Berenberg estimates Source: Berenberg estimates Figure 5: EBITDA growth despite several headwinds Figure 6: New capex is “good” capex Despite several headwinds, EBITDA should be capable of 3-6% New capex guidance adds £2.4bn to our FY17-19 cumulative organic growth in FY17, with “underlying” growth even stronger capex estimate, but capex will still decline significantly in FY17
Vodafone Group FY17 Vodafone capex - the old and the new Guidance EBITDA (€bn) drivers 16.5 New capex £m +1.3 - 1.8 21.8% +15.7 - 16.2 21.0% Capex (old) £m Capex/sales (new) % 16 14000 Capex/sales (old) % 20.0% +3% - 6% 15.5 +0.5 -0.6 yoy 16.5% 12000 15.9% 15.4% 15.4% 13.9% Project Spring capex 15 15.0% -0.3 10000 14.7% 14.4% 14.2% 14.5 15.3 8000 10.0% 14.8 6902 6848 6950 14 14.4 £m Capex
622 811 % Capex/sales 6000 948 9197 13.5 8599 5.0% FY16 FX/ladder FY16 Roaming, Project FY16 Underlying FY17 4000 6313 6272 6125 reported rebased content, Srping restated growth guidance 5292 5886 EBITDA handset fin. technology MVNO costs 2000 0.0% FY13 FY14 FY15 FY16 FY17E FY18E FY19E Source: Company data Source: Berenberg estimates
6 Vodafone Group plc Telecommunications
Vodafone Group plc – investment conclusion
20-second summary We still like the Vodafone equity story of gradually recovering top-line growth, margin expansion and falling capex, with FCF bouncing back to cover the dividend this year (before spectrum costs), and allowing for growth in the dividend. Our detailed analysis of Vodafone’s European mobile operations shows encouraging trends across most business units. Revenue headwinds should continue to reduce, and there are good structural reasons why margins can increase. Higher capex is “good” capex, in our view, targeted at both revenue and cost opportunities. Our price target is unchanged at £2.50, with increased EBITDA estimates offset by increased capex estimates and higher net debt due to revised India spectrum assumptions. Juicy dividends and reducing risk profile
Dividend yield beats all major peers We primarily like Vodafone for its relatively attractive dividend yield of 5.3% which compares favourably with the sector, and even more favourably with major peers. Against the sector, Vodafone’s 5.3% dividend yield is 13% higher than the peer group. Against major peers, Vodafone’s dividend is 10% above Telecom Italia Savers (Telecom Italia Ords currently do not pay a dividend), 25% above Orange, 40% above BT Group, and 60% above Deutsche Telekom. Of the major peer, only Telefónica has a higher dividend yield for 2016, and that is only when the 35c scrip is included. If we exclude the scrip and just focus on the cash dividend of 40c, then Vodafone’s dividend yield is 23% above that of Telefónica.
Dividend risk to fall as cover rebuilds Vodafone’s dividend risk is set to fall as the cash flow cover of the dividend rebuilds over the next 2-3 years. In the current year, FY17, the Vodafone dividend will be just covered by our projected FCF of £3.1bn (see Figure 7). Beyond FY17, we expect FCF to grow strongly, enabling dividend cover to improve to c1.5x by FY19.
Figure 7: Dividend cover under our new estimates Dividends are covered by FCF (guidance definition), but uncovered in FY17 once anticipated spectrum costs are included in FCF; group dividend policy is to pay a rising dividend
Vodafone FCF and dividend cover profile Free casflow (£m incl Spring - lhs) Div cover (ex spectrum - rhs) Div cover (with specturm - rhs)
9,000 1.6 2.0 1.4 1.5 8,000 1.0 0.8 1.36 1.49 1.0 1.21 7,000 0.4 0.3 0.65 6,000 0.0 0.22 0.18 5,129
FCF FCF£m 5,000 4,616 4,308 4,183 (0.64) (1.0)
4,000 x cover Dividend 3,109 3,000 (2.0)
2,000 1,088 1,013 (3.0) 1,000
0 (4.0) FY14 FY15 FY16 FY17E FY18E FY19E FY20E
Source: Company data
7 Vodafone Group plc Telecommunications
181818%18 % FCF CAGR for FY17FY17----20202020 This growth in FCF, from £3.1bn in FY17 to £4.6bn by FY19 and £5.1bn by FY20, is driven by: ● a steady ongoing recovery in group revenues (we expect c2.5% revenue CAGR over FY16-19); ● EBITDA which grows faster than revenues (we expect c5% EBITDA CAGR for FY16-19) with margin expansion driven by structural factors (AMAP, cable), operating leverage, and efficiency gains; and ● falling capex after the completion of project Spring (we project capex/sales to fall from 21% in FY16 to 15.9% in FY17 and then on to 15.4% in FY19). Group FCF should then grow from £3.1bn in FY17 to £4.3bn, £4.6bn, and £5.1bn over FY18/19/20 respectively. That results in an 18% CAGR in FCF for FY17-20.
Revenue headwinds shshouldould reverse in coming quarters FCF growth starts with the top line continuing to grow. Our ambitions for the top line feel conservative, with a CAGR of only c1.7% for group organic revenue growth (FY16-19), which is a blend of Europe (with a revenue CAGR of 1.2%) and AMAP with a revenue CAGR of 2.8% pa. Our estimates incorporate a level of conservatism regarding the outlook in India to reflect the prospects of pressure from the Reliance Jio launch, and in the Netherlands, where service revenues and ARPU have been under pressure. More positively, Vodafone should see reduced headwinds from regulatory drags (eg mobile termination rates, or MTRs, roaming), from out-of-bundle revenue pressures, and from MVNO revenue pressures. Finally, as we illustrate later in this report with our deep dive into European mobile service revenue trends, the strong ongoing growth in data usage, and smartphone and 4G adoption should underpin a continued mix shift from low-ARPU, high-churn prepaid users to higher-ARPU, lower-churning postpaid users, signifying the most visible evidence of mobile data monetisation, in our view.
Good reasons to expect margins to expand We think there are several good reasons for margins to expand in the mid-term. Structural margin expansion should be underpinned by the faster growth of higher-margin divisions (eg AMAP) and business units (eg German and Spanish cable). Operating leverage benefits should start to accrue as the step-up in project Spring opex starts to level out. These factors should be accompanied by initiatives to improve gross margin through intense focus on direct costs from third-parties (mostly the local incumbent operators), control of customer acquisition costs (lengthening handset upgrade cycles, reduced channel commissions, increased use of online and on-device channels), and improved technology efficiency (zero-based costing, IT transformation, centralised procurement, among others). As a result, we think EBITDA can grow faster than revenues over the next three years, with a CAGR of 3.9% pa.
Blocked consolidation is better than the wrong consolidation Hopes of material further in-market consolidation in mobile have been undermined by the EC’s opposition to the UK merger of Three and O2. We think the readacross to Italy is cautious, although we recognise that some observers believe the Italy merger of Three and Wind is sufficiently different to that of Three and O2 in the UK and so may stand a better chance of being approved. The scenario of remedy-light 4-to-3 in-market mobile consolidation was never one that we strongly believed in. We also thought that deals would be allowed, but with strong remedies which mostly nullified the benefits of consolidation. We also worried that there was the risk that remedies overshot the mark, with the risk of unintended consequences to the detriment of all players in the markets looking to consolidate.
8 Vodafone Group plc Telecommunications
Figure 8: Peer group dividend yields Vodafone shares offer an above average dividend yield, and the highest cash dividend yield of “the big five” (Deutsche Telekom, BT Group, Telefónica, Telecom Italia, and Vodafone)
Dividend yield (2016E) 9.0% 8.1% 8.0%
7.0% 6.5% 6.4% 6.3% 6.0% 5.4% 5.3% 5.2% 4.8% 5.0% 4.7% 4.7% 4.2%
4.0% 3.6% 3.6% 3.3% 3.0% 3.0% 2.0% 1.0% 0.0% 0.0% BT DTE TDC KPN Avg. ORA VOD TEF* TLSN TEFD Tele2 PROX TNOR SCMN TI (savs) TI TI (Ords) TI Source: Company data. Note: * Telefónica dividend includes c35c scrip, without which the cash dividend yield would be 4.3%
Figure 9: Our Vodafone capex estimates and capex/sales Vodafone’s new capex guidance adds £2.4bn to our FY17-19 cumulative capex estimate, but capex will still decline significantly in FY17
Vodafone capex - the old and the new New capex £m 21.8% 21.0% Capex (old) £m Capex/sales (new) % 14000 Capex/sales (old) % 20.0% 16.5% 12000 15.9% 15.4% 15.4% Project Spring capex 13.9% 15.0% 10000 14.7% 14.4% 14.2%
8000 10.0% 6902 6848 6950 Capex £m Capex
630 825 % Capex/sales 6000 962 9197 8599 5.0% 4000 6313 6272 6125 5292 5886
2000 0.0% FY13 FY14 FY15 FY16 FY17E FY18E FY19E Source: Company data
Following the blocking of deals in Denmark and the UK we therefore have mixed feelings as to the implications for Vodafone. Yes, it would have been good to see real in-market consolidation leading to market repair, even if that was accompanied by higher capex. But maybe there is also a way that blocked deals can be good for the sector. In Denmark prices have risen c20% since the Telia/Telenor deal was blocked. We would not be surprised to see prices increase further in the UK given Three’s need to invest in more spectrum and capacity. Italy too seems ripe for price increases should the Wind/Three deal be blocked given the low margins and poor 4G spectrum position at Three Italia, and low bottom-line cash flows of Wind. Prices in other markets are going up (eg Vodafone has raised prices in Germany, the UK and Spain recently), so the backdrop at present seems to be supportive of selective price increases.
9 Vodafone Group plc Telecommunications
Changes to estimates
Figure 10 : Changes to estimates
Post Q4 2016 results Vodafone Group Estimate Changes 2017E 2018E 2019E Rationale Group Revenues £mln New £mln 43,406 44,289 45,076 Very modestly trimming organic estimates to reflect the likely loss of Old 41,309 42,349 43,254 German MVNO revenues from United Internet, and reveue trajectory Change % (ex FX) (0.7%) (1.2%) (1.5%) in Vodacom, Greece, Spain and Netherlands. Changes to our FX Change % 5.1% 4.6% 4.2% assumptions result in an uplift to estimates. Consensus 43,146 43,317 43,882 We are above (below) consensus by.. 0.6% 2.2% 2.7%
Group EBITDA £mln New £mln 12,629 13,088 13,683 Increased estimates relate almost solely to changes to our FX Old 12,039 12,578 13,022 assumptions. Change % (ex FX) (1.1%) (1.8%) (0.9%) Change % 4.9% 4.1% 5.1% Consensus 12,542 12,767 13,379 We are above (below) consensus by.. 0.7% 2.5% 2.3%
Group Operating Profit £mln New £mln 3,697 4,153 4,838 Increased estimates relate almost solely to changes to our FX Old 3,695 4,111 4,449 assumptions. Ex-FX, our near-term estimates are reduced to reflect a Change % (ex FX) (5.9%) (4.6%) 2.4% higher D&A trajectory. Our mid-term esimates are increased to reflect Change % 0.1% 1.0% 8.7% higher expectations for associates. Consensus 3,772 3,718 4,109 We are above (below) consensus by.. (2.0%) 11.7% 17.7%
Group Capex £mln New £mln 6,894 6,834 6,936 Our capex estimates are increased to reflect management's latest Old 6,072 6,086 6,125 guidance for capex/sales in the mid-teens. Our estimates imply c16% Change % 13.5% 12.3% 13.2% capex/sales in FY17 fading to 14%-15% further out. Consensus 6,653 7,045 6,790 We are above (below) consensus by.. 3.6% (3.0%) 2.1%
Group FCF New £mln 3,109 4,308 4,616 Changes to our FX assumptions almost offset reductions to our Old 3,177 4,199 4,617 organic FCF which arise from our increased capex estimates. Change % (ex FX) (10.0%) (3.8%) (6.3%) Change % (2.2%) 2.6% (0.0%) Consensus 3,400 na na We are above (below) consensus by.. nm nm nm
Group Net Debt (reported) £mln New £mln 32,750 32,399 31,573 Our net debt estimates are changed to reflect our increased Old 30,893 30,350 29,322 expectations for specturm spend in India in FY16. We now assume Change % (ex FX) 6.8% 8.4% 10.4% £2bn spend, from £500m before. Change % 6.0% 6.8% 7.7% Consensus 31,260 28,687 28,624 We are above (below) consensus by.. 4.8% 12.9% 10.3% Source: Berenberg estimates Note: FY16/17 consensus is from the company, FY18 consensus is based on Bloomberg
Estimate changes reflect capex guidance, and currency Our organic (ie ex-FX) revenue and EBITDA estimates are subject to very minor changes, with revenues trimmed modestly (c1%) to reflect the likely loss of MVNO revenues from United Internet in coming years, and the Q4 trajectory of revenues at Vodacom, and in Greece, Spain and the Netherlands. Our group EBITDA estimates are modestly trimmed excluding FX effects, and are increased by c4-5% including the benefits of revised FX expectations. The major change to our estimates is at the capex level where we reflect management’s new guidance for capex/sales to settle in the mid-teens percent of revenues. Our capex estimates are increased by 12-14%. Our group FCF estimates are almost modestly trimmed
10 Vodafone Group plc Telecommunications
for FY17, and increased by c2% in FY18 and unchanged for FY19 with currency benefits offsetting higher capex. Our group net debt estimates are increased by 6-8% due to a higher year-end FY16 net debt figure, and an upward revision to our Indian spectrum cost assumption for FY17 (we now assume Vodafone will spend £2bn, from £500m before).
We are above the prepre----Q4Q4 consensus on revenues, EBITDA and net debt Figure 10 details changes to key estimates, and also shows where we stand versus pre-Q4 consensus. We are 2-3% above consensus at the revenue level, 2-3% above on EBITDA, and significantly above consensus at the adjusted operating profit level, which may reflect our revised trajectory for the contribution from associates. We seem to be c10% above consensus on net debt in the mid-term, although it is difficult to know why. Spectrum assumptions are the most likely culprit, although it is possible that some analysts are including the Verizon loan note as an asset in their net debt calculation. We exclude it, as it is essentially offset by the £2.75bn mandatory convert issued by Vodafone, the liability of which is not included in group net debt. Dividend drives valuation appeal On our new estimates, Vodafone’s shares trade at a modest discount to peers on most of the metrics we use. The 7.4x EBITDA multiple for 2016 falls to a 4% discount by 2018. On EV/OpFCF the shares trade at a small discount in 2016, but move to a small premium versus peers in 2017 and 2018. On normalised FCFF yield the shares trade at a 1-5% discount, while on normalised FCFE yield they trade at a more interesting 4-10% discount. P/E makes no sense for this stock given the high proportion of legacy spectrum amortisation and PPA in the numbers. The degree of undervaluation of Vodafone’s shares has reduced through the year as they have outperformed major peers. For example, they have outperformed the sector (SXXP) by 5% on a same currency basis, and by 7.5% on a local currency basis. As discussed earlier, the dividend is their key attraction. Price target unchanged We have left our price target unchanged at £2.50, as illustrated in Figure 12, which sums up the following key components of the valuation: ● £91.64bn aggregate value of the consolidated business units; ● £4.64bn value of associates Safaricom, Indus Towers, and Vodafone Australia Holdings (note the negative equity value!); ● £6.3bn value of tax assets based on the discounted value of savings to cash taxes derived from Vodafone’s tax management (note that our business unit DCFs use normalised cash taxes); ● £30.8bn of net debt adjusted for the £2.7bn convertible, the £3.5bn Verizon loan note, and £1.2bn of minority net debt adjustments; Figure 11: Vodafone versus peer valuation comparables Vodafone’s shares trade at modest discounts on EV/EBITDA, and FCF yields, and offer a relatively attractive dividend yield
Vodafone Adjusted EV/EBITDA Adjusted EV/OpFCF Normalised FCFF Yield Relative Valuation Comparables 2016 2017 2018 2016 2017 2018 2016 2017 2018 Vodafone 7.4 7.1 6.8 13.1 14.1 13.2 5.8% 6.0% 6.3% Sector (average) 7.5 7.4 7.1 13.6 13.2 12.7 5.5% 5.9% 6.2% Premium/(discount) vs simple -1.6% -3.7% -3.8% -3.8% 6.9% 4.0% -5.0% -1.4% -0.9%
Vodafone Normalised FCFE Yield Adjusted PE Div Yield Relative Valuation Comparables 2016 2017 2018 2016 2017 2018 2016 2017 2018 Vodafone 7.0% 7.2% 7.6% 44.9 38.1 28.8 5.3% 5.4% 5.5% Sector (average) 6.3% 6.8% 7.3% 16.1 15.4 14.1 4.7% 4.9% 5.2% Premium/(discount) vs simple -9.7% -5.6% -4.1% 178.8% 147.2% 104.5% -10.5% -8.5% -4.8% Source: Berenberg estimates
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DCF/SOTP valuation
Figure 12: DCP/SOTP valuation
Revenue EBITDA EV/EBITD OpFCF EV/OpFCF EV Proportionate adjustment Valuation by Segment £m Code Method 2019E 2019E Multiple 2019E Multiple £m Ownership Vodafone % of AV Minority Germany GE DCF 8,740 2,797 8.1 1,398 16.3 22,753 100.0% 22,753 22.2% 0 o/w KDG GEK DCF 2,031 977 9.3 611 14.8 9,072 76.0% 6,895 6.7% (2,177) Italy IT DCF 4,847 1,793 7.7 1,066 12.9 13,737 100.0% 13,737 13.4% 0 UK UK DCF 6,496 1,462 7.6 552 20.1 11,092 100.0% 11,092 10.8% 0 Spain SP DCF 4,031 1,108 8.2 504 18.0 9,053 100.0% 9,053 8.8% 0 Netherlands NL DCF 1,433 487 7.9 272 14.2 3,854 100.0% 3,854 3.8% 0 Portugal PO DCF 763 282 8.3 168 14.0 2,351 100.0% 2,351 2.3% 0 Greece GR DCF 670 194 4.8 94 10.0 941 100.0% 941 0.9% 0 Other Europe OE DCF 2,287 709 7.8 366 15.1 5,519 100.0% 5,519 5.4% 0 India IN DCF 4,979 1,519 5.9 772 11.6 8,916 100.0% 8,916 8.7% 0 Vodacom VO DCF 4,222 1,816 7.3 1,224 10.8 13,279 65.0% 8,631 8.4% (4,648) Turkey TK DCF 3,005 661 5.2 210 16.3 3,428 100.0% 3,428 3.3% 0 Egypt EG DCF 1,177 530 6.3 353 9.5 3,338 54.9% 1,832 1.8% (1,505) Other AMAP OA DCF 1,500 375 7.2 165 16.3 2,682 100.0% 2,682 2.6% 0 Common function CF DCF 1,160 (50) 66.5 (398) 8.3 (3,323) 94.7% (3,147) (3.1%) 176 Segment totals 45,309 13,683 7.1 6,747 14.5 97,619 93.9% 91,643 96.0% (8,154)
EBITDA Net (Debt) Ownership Equity Associates (proportionate value) Method 2017 Multiple EV £m £m % Value Safaricom Multiple 628 7.4 4,672 145 40.0% 1,927 Indus Towers Multiple 323 10.3 3,311 (150) 42.0% 3,161 Vodafone Australia Holdings Multiple 187 6.5 1,216 (1,660) 50.0% (445) Total Associate Investments 4,643
BV of % that Capitalise Value of tax asset DTA £m benefits tax Years at £m Tax asset 22,382 60.0% 30 7.1% 6,312
Total proportionate asset value Segments + associates + investments + tax assets 102,598
51 Adjustments For Group Net Debt and Other Liabilities £m Group Net debt (@ p/t date) (32,750) Add mandatory convertible (issued with a view to being covered by VZ loan note proceeds) (2,754) Offset with Verizon loan note US$ 5,000 FX 1.43 3,487
Adjust for Minorities Share of Net Debt Net debt % Stake Value £m KDG 3,091 76.0% 742 Vodacom 1,040 65.0% 364 Voda Egypt 0 54.9% 0 Vodafone Qatar 143 38.3% 88 Total Minorities Debt Adjustments to Group EV 4,274 27.9% 1,194
Other Obligations & Liabilities Per 20F Probability £m Vod Esar (Hutch Cap Gain Tax) $2bn (1,295) 30.0% (389) Include? OtherVod Essar (Hutch Cap Gain - Fine) $2bn? (1,295)0 30.0%0.0% (389)0 Total Other Obligations & Liabilities (777) Y
Adjustments to EV for leakage Cashflows £m Spectrum payments (5,514) Disposals of PP&E 2,331 Include? Total EV Adjustments (4,189) Y
Total Net Debt & other liabilities (35,789)
Equity Value 66,809
Equity Value per share £ Number of shares 000's 26,692 Equity Value Per Share 2.50 Source: Berenberg estimates
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● £0.8bn of other obligations and potential liabilities (which reflects our 30% probability that Vodafone ends up paying the Indian capital gains tax demand); ● £5.5bn NPV of future spectrum costs – note that this excludes this year’s Indian spectrum auction which is already captured in our year-end net debt; and ● £2.3bn NPV of PP&E disposals, which reflects the fact that Vodafone typically sees a FCF benefit of c£100m-150m each year from PP&E disposals. Note: For readers interested in how our valuation of Vodafone India compares with IPO expectations, note that our India valuation is split in our DCF/SoTP model between the valuation of the Indian mobile operation in the consolidated segments section of Figure 12 (EV of £8.92bn), and the valuation of Vodafone India’s 42% stake in Indus Towers in the associates section of Figure 12 (valuation of £3.2bn for Vodafone’s 42% stake). In sum, our Vodafone valuation of £2.50 assumes a valuation for Vodafone India, in total, of £12.1bn ($17.3bn, or INR1,160bn or INR1.2 lakh crore).
Vodafone growth and margin valuation senssensiiiitivitytivity We show in Figure 13 the sensitivity of our valuation to variations of revenue growth and EBITDA margin. Each 1ppt variation in mid-term revenue growth would add c22p to our £2.50 price target, while each 1ppt variation in mid-term margin would add 17p. A combination of 1ppt faster revenue growth, with 1ppt higher margin outcome in the mid- term, would therefore add c40p to our valuation.
Figure 13: Valuation sensitivity to incremental revenue growth and margin If Vodafone can grow 1ppt faster than we expect, and deliver 1ppt higher margins than we expect, the price target would be £2.90
Price target (£) as a function of revenue growth and margin Deltas 0.50% Revenue growth variation versus base case 0.50% 2.50 (1.0%) (0.5%) 0.0% 0.5% 1.0% 1.5% EBITDA (1.0%) 2.13 2.13 2.33 2.43 2.53 2.53 margin (0.5%) 2.21 2.31 2.41 2.41 2.62 2.73 vaiation 0.0% 2.29 2.29 2.50 2.61 2.72 2.72 versus base 0.5% 2.37 2.48 2.58 2.58 2.81 2.92 case 1.0% 2.45 2.45 2.67 2.78 2.90 2.90 Source: Berenberg estimates
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European mobile operating trends deep dive
In this section we look in detail at the reasons behind the improvement in Vodafone’s organic service revenue trends, with a focus on European mobile service revenues, which still make up c50% of group service revenues. We start with group organic service revenue trends, then we strip out mobile termination rate effects (which distort the underlying trend), wireline trends, and AMAP revenue trends, and are left with European mobile service revenue trends. We conclude the following. ● Vodafone’s organic group service revenue trends are clearly improving. ● This is not just caused by fading regulatory drags (eg MTRs). ● Nor is it just caused by wireline growth, or AMAP (emerging markets) growth. ● Improving European mobile service revenue trends (ex-MTRs) have been a key contributor to improving group trends. ● The improvement in Europe remains driven more by ARPU than by SIM growth. ● This is despite the material continued ongoing decline in postpaid mobile ARPU (ex- MTRs) trends in its Europe business units. ● The decline in postpaid ARPUs is at least improving. ● Its effect is being offset by a continued significant mix shift from low-ARPU prepaid to higher-ARPU postpaid services across Europe. ● The outlook is encouraging, with significant scope for further growth in smartphone adoption, data plan adoption, 4G adoption, individual data usage, further mix shift from prepaid to postpaid, and selective price inflation. Why focus on European mobile? In this section we peel back the onion of Vodafone’s group organic service revenue trend in order to more closely scrutinise the European mobile business. Why? Well, this business remains the largest segment of Vodafone’s service revenues, generating c50% of group service revenues in FY16.
Figure 14: Vodafone group service revenue segmentation Figure 15: Vodafone service revenue segmentation by type European mobile accounts for c50% of group service revenues in Alternatively, residential/consumer accounts for 66% of group FY16, with AMAP mobile accounting for 30%, and wireline service service revenues, enterprise 33.9% and other (eg MVNOs) 6% revenues making up c21%
Vodafone group service revenue: Vodafone group service revenue: Segmentatation by region (Q4/FY16) Segmentatation by customer type (Q4/FY16)
AMAP mobile, Enterprise, 30.0% Europe 33.9% mobile, Residential/ 49.4% consumer, 66.0% Europe wireline , AMAP 18.2% Other wireline , (MVNO/part 2.4% ner), 6.0%
Source: Company data, Berenberg calculations Source: Company data, Berenberg calculations
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Figure 16: Vodafone group and European organic service revenue trends We peel back the onion of growth, starting with group organic service revenue growth, then incrementally stripping out regulatory drags (MTRs), wireline revenues, and AMAP, to home in on European mobile service revenue trends (ex-MTRs)
Group organic service revenue growth (% yoy) 3.0% 2.5% 1.4% 2.0% 0.8% 1.2% 1.0% 0.1% 0.0% -1.0% -0.4% -2.0% -3.0% -1.5% -4.0% Total group organic service revenues -5.0% -3.8% -4.0% -4.2% have improved - but why? -6.0% -5.2% -5.1% Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16
Group (ex-MTR) service revenue growth (% yoy) 4.0% 3.0% 3.0% 2.1% 1.4% 1.8% 2.0% 0.9% 1.0% 0.2% 0.0% -1.0% -2.0% -0.8% -0.9% Stripping out MTRs shows a strong move -3.0% -2.4% -2.7% back to +ve underlying growth - but why? -4.0% -2.8% -2.9% Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16
Group mobile service revenues growth (% yoy) ex MTRs 4.0% 2.8% 3.0% 1.9% 1.3% 2.0% 0.8% 1.0% 0.0% -1.0% -0.6% -0.5% -2.0% -1.1% -1.1% -3.0% Group underlying mobile service -2.5% -2.9% revenue trends resumed an improving -4.0% -3.0% -3.4% -5.0% trend in Q4 after a pause in Q3. Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16
Europe underlying (ex-MTR) mobile service revenue growth…
0.0% -2.0% -0.8% -1.6% -2.2% -2.1% -4.0% -2.9% -3.5% -6.0% -5.2% -5.7% Europe underlying mobile -8.0% -7.5% -7.5% service revenue trends -8.0% -8.0% continued to improve -10.0% Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16
Source: Company reports
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Also, it is the segment which has suffered the most severe headwinds over the last few years, and as those headwinds unwind we think it is important to understand exactly what role the European mobile business is playing in the improvement in group organic service revenue trends, and how Europe’s contribution to the group improvement is being driven. This may provide clues as to the resilience of the improving trend. First, the good news: service revenue trends are improving Figure 10 presents our first important point. There is a lot of data in Figure 16, but there is no need for readers to spend more than a few seconds perusing it. It is important to realise that the improving trend shown by Vodafone at the group service revenues level (in the top chart of Figure 16), is a function of several factors. Progressing down the figure, each chart strips out some of the key factors in order to home in on the specific contribution of European mobile at the bottom of the chart.
Group organic service revenue trends are impimprrrrovingoving So, working down from the top of Figure 16, it is clear that, in organic terms, group service revenues have been improving nicely in the last nine quarters. However, some of this benefit is due to the fading drag of regulatory price cuts specifically to mobile termination rates (MTRs).
Even excluding MTR effects, group organic service revenue trends are improving The second chart in Figure 16 strips out the benefit of the reducing MTR drag, so show that service revenues have still been improving, even without the MTR effect. However, the swing in service revenue performance is less once MTRs are stripped out; for example, at the headline level (including the benefit of MTR price cuts fading) group service revenues saw a 7.7pt reversal from Q2 2014 (-5.2% yoy) to Q4 2016 (+2.5% yoy). If we exclude the MTR effect, then service revenues saw a 5.4ppt reversal in the trend from Q2 2014 (-2.4% yoy) to Q4 2016 (+3% yoy). However, this ex-MTR trend still includes the effect of Vodafone’s various wireline operations, mostly in Europe, but also in AMAP.
Excluding wireline and MTR effects, group service revenue trends are improving The next chart down in Figure 16 strips out wireline service revenues to focus just on mobile service revenue trends (excluding MTR benefits). It is clear from this chart that group mobile service revenue trends have shown improvement over the last seven quarters, reversing a 3.4% decline in Q1 2015 to growth of 2.8% in Q4 2016. This reversal in fortunes remains in part influenced by the continued strong growth in the AMAP region.
Finally, European mobile service revenues, exex----MTRs,MTRs, are genuinely improving The next chart strips out the contribution from AMAP, so we are left with the growth trend in European mobile service revenues, excluding wireline, and MTR effects. From this chart it is clear that European mobile service revenues have improved their trend from a peak decline of 8% yoy in Q4 2014 (ie two years ago), to a decline of just -0.8% yoy in Q4 2016, due to more than just the unwinding of past regulatory pricing pressures. Something else is going on.
ARPU trends have been a bigger driver than subscriber trends In Figure 17 we break down the European organic mobile service revenue trend (ex-MTRs) into the two major components of volume (in this case, subscriber growth) and price (in this case, ARPU). Looking back at Vodafone’s historical KPI data, its European mobile subscriber base reached a peak of c139m back in Q3 FY12, since when it has declined in a reasonably consistent manner to the end-Q4 FY16 level of 121.4m. Over the last 12 quarters the decline in the European subscriber base has improved from -5% in Q1 FY14, to -1.6% yoy in Q4 FY16, albeit improvement has been through the occasional setback (eg Q4 FY15 through Q1 FY16). Even so, we can at least say that improvements in the pace of decline of the subscriber base have accounted for 1ppt of the 7.8ppt of European service revenue improvement since the trough in Q4 FY14. APRU trends have thus accounted for the bulk of the improvement in
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Figure 17: European mobile service revenue components The improvement in European mobile service revenues is the result of an improving pace of decline in European organic ARPU (ex-MTR average revenue per user), rather than subscriber growth
Europe average subscriber growth (% yoy) 0.0% -1.0%
-2.0% -1.6% -3.0% -2.6% -2.5% -2.7% -2.5% -3.2% -3.1% -4.0% -3.7% -3.7% -3.4% -5.0% -4.4% Improving subscriber growth in Europe has been a driver of recent mobile -5.0% service revenue growth improvements. -6.0% Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Implied Europe ARPU change (organic, ex-MTRs, % yoy) Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 1.5% 1.4% 1.5% 2.0% 0.8% 1.0% 0.3% 0.0% -1.0% -2.0% -0.7% -1.1% -3.0% -2.6% -4.0% -3.3% -5.0% -6.0% -4.5% -5.6% -5.2% ...but an improving pace of ARPU decline in recent quarters has been the key swing factor behind the improvement in European organic ex-MTR mobile service revenues.
Source: Berenberg figures (calculated from company data)
European service revenues over that period, as illustrated in Figure 17, which shows that European mobile ARPU improved from a decline of 5.6% yoy in Q4 FY14 to growth of 0.8% yoy in Q4 FY16, accounting for c90% of the recovery in European organic service revenues over that period.
Most of Vodafone’s European BUs havhavhavehav e improved mobile serviservicece revenue trends What if we break down the European service revenue performance into individual markets? We do this in Figure 18, which shows that the majority of Vodafone’s European markets have seen an ongoing improvement in organic service revenue trends (excluding MTR drag unwind). Germany shows perhaps the most interesting trend, since the business unit is Vodafone’s largest, accounting for 20% of group service revenues and 30% of European service revenues as of Q4 FY16, and shows a 6.2ppt reversal in its service revenue trend, excluding MTRs, since the trough in Q3 FY14. Beyond Germany though, there is a mix of trends, even across a broad picture of ongoing improvement. Certain markets (eg Italy, the Czech Republic, Portugal, Ireland, Greece) have seen quite radical reversals from significant double-digit annual declines, to recover growth or close to growth. Romania stands out as having maintained organic mobile service revenue growth (ex-MTRs) for the last 12 quarters, with growth accelerating in recent quarters to 8% yoy.
Spain, the UK and the Netherlands stand out for differing reasons Three of Vodafone’s major markets stand out, albeit for differing reasons. Spain continues to struggle with meaningful mid-single-digit declines in service revenues. We calculate that, ex-MTR effects, Spain saw organic mobile service revenues decline 6.4% yoy in Q4 FY16. This was still a major improvement on the prior quarter, and represented a 6.4ppt improvement from the peak decline of Q2 FY14. The improvement in the yoy decline from Q3 into Q4 is notable, we think, given the drag on Spanish service revenues from handset financing, which serves to reduce the handset subsidy recovery from ARPU.
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Figure 18: Vodafone Europe mobile service revenue trends improve Vodafone has seen improving mobile service revenue trends (ex-MTRs) across most of its European business units; the UK and the Netherlands buck the trend Germany (~12%/18%) Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 5.0% 0.5% 0.0% -5.0% -1.8% -1.5% -1.5% -3.2% -3.6% -3.0% -1.9% -2.6% -5.7% -5.6% -5.5% -10.0%
20.0% Italy (~8%/12%) 0.1% 1.6% 0.0% -6.3% -3.2% -3.0% -20.0% -10.3% -11.7% -9.6% -13.9% -14.4% -18.2% -17.2% Spain (~6%/9%) 0.0%
-10.0% -6.8% -6.4% -9.6% -9.8% -9.3% -9.5% -9.2% -12.8% -11.5% -12.7% -11.7% -11.1% -20.0% Romania(~1%/2%) 20.0% 10.0% 7.6% 9.1% 8.2% 10.0% 5.0% 6.3% 4.5% 5.6% 1.3% 1.0% 1.0% 2.0% 0.0% Greece (~1%/2%) 10.0% 0.3% 0.0% -0.5% -0.4% -10.0% -1.7% -2.2% -2.1% -6.6% -6.9% -4.5% -9.1% -11.7% -11.2% -20.0% Czech Republic (~1%/2%) 20.0% 5.7% 3.7% 1.3% 3.0% 2.7% 0.0% -4.9% -3.8% -2.3% -20.0% -10.6% -12.9% -13.8% -11.8% Portugal (~2%/3%) 10.0% 0.2% 0.0% -10.0% -4.7% -3.2% -8.3% -6.2% -7.9% -7.3% -8.8% -11.6% -9.8% -10.5% -9.4% -20.0%
10.0% Ireland (~2%/3%) 0.7% 0.7% 0.0% -1.4% -1.0% -1.3% -1.1% -2.1% -3.8% -3.8% -3.2% -10.0% -5.3% -9.2% UK (~12%/18%) 5.0% 2.0% 1.1% 0.9% 0.0% -0.3% -0.2% -1.4% -0.5% -0.7% -2.5% -1.6% -5.0% -2.6% -3.2% Netherlands (~3%/5%) 10.0% 2.5% 1.5% 0.0% 0.0% -0.6% -0.6% -1.6% -4.2% -3.7% -10.0% -6.1% -6.9% -6.6% -5.8% Source: Berenberg figures (calculated from company data)
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Figure 19: Blended ARPU trends (ex-MTRs) by major market (% yoy) Group organic blended APRU improvement reflects improving ARPU trends in most markets, notably Italy, Greece, the Netherlands and the UK
10.0% Italy 4.8% 5.6% 5.3% 5.0% 2.2% 0.0% 0.0%
-10.0% -4.3% -8.1% -12.2% -13.1% -13.2% -20.0% -16.2% UK 10.0% 7.0% 5.3% 5.9% 7.2% 5.0% 0.0% 0.0% 0.0% -5.0% -3.1% -3.4% -3.2% -2.2% -10.0% -4.5% -3.9%
Germany Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 8.4% 10.0% 7.0% 2.3% 2.2% 5.0% 0.2% 1.5% 1.5% 1.9% 0.0% -5.0% -1.3% -3.2% -4.5% -3.2% -10.0% Spain 10.0% 7.1% 2.5% 1.4% 0.0% -0.5% -10.0% -6.0% -6.1% -3.9% -6.2% -5.4% -6.7% -7.8% -9.6% -20.0%
Portugal 2.7% 4.0% 5.0% 1.7% 0.8% 0.8% 0.9% 1.7% 1.6% 0.0% -5.0% -1.3% -3.3% -5.2% -10.0% -7.0%
20.0% Romania 10.1% 11.8% 11.4% 10.0% 6.3% 4.4% 3.1% 2.2% 0.4% 0.3% 0.0% -3.4% -10.0% -5.1% -6.6% Netherlands 10.0% 4.5% 5.0% 1.9% 2.0% 0.8% 0.0% -5.0% -0.9% -0.4% -0.8% -10.0% -5.3% -6.0% -4.4% -4.8% -4.1%
Greece 0.0% -10.0% -5.6% -6.0% -7.0% -6.0% -10.5% -20.0% -15.5% -13.1% -12.8% -12.6% -18.8% -20.0% -17.1% -30.0%
Source: Company reports
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As this effect (we estimate a drag of c3-4ppt in Q4 FY16) annualises out of the comparison through FY17, there should be, all else being equal, further improvements in the Spanish mobile service revenue trend. The UK and the Netherlands business units strike a cautious tone with their recent mobile service revenue trends. In both markets, the trend has taken a turn for the worse, with the UK seeing a reversal from growth (2% yoy at the recent peak) to a decline of 1.6% yoy in Q4 FY16. In the Netherlands, service revenues have likewise see a reversal from growth of 2.5% at the recent peak to a decline of 5.8% yoy in Q4 FY16. Following on from a protracted period of mobile service revenue declines, it seems that both business units could sustain only a few quarters of growth before reverting to a declining trend. So what is going on?
UK growth numbers do not add up, we blame credits related to billing problems The UK mobile service revenue trends do not seem to reconcile to the trends in the price and volume components of service revenues. For example, according to blended ARPU figures published by Vodafone, UK ARPUs increased by 6.9% yoy in Q4, while the average subscriber base decline by 4.4%, suggesting that mobile service revenues should have shown growth of 2.2% (1.069 x 0.956 = 1.022, or 2.2% growth yoy). In its reportage on the quarter, Vodafone cited the repercussions arising from difficulties with its billing system migration process during the quarter, although the clearest evidence of that is in the very weak contract net adds (1k) in the quarter, as consumer churn stepped up by 1.1ppt yoy to 18.9%. Management also pointed to the impact of 08XX regulation. However, we believe that the disconnect between our calculation of how fast UK mobile service revenues should have grown in the quarter and the pace of decline reported by Vodafone relates to credits granted to customers related to the billing system problems experienced in the quarter, which we infer must be excluded from the UK mobile ARPU calculation.
Netherlands mobile service revenue trends appear genuinely weaker In the Netherlands, the problem seems to be primarily driven by weakening ARPUs, with both blended ARPU and postpaid ARPU taking a turn for the worse in recent quarters, and worsening further into Q4. In the Netherlands, mobile service revenues declined 5.8% yoy in Q4, with blended ARPU falling 4.1%, and postpaid ARPU falling 6.8%, with management citing increased convergence price pressure as the culprit for worsening trends. To drive the point home, management reiterated that the merger deal with Liberty Global’s Ziggo is happening at the right time. Blended ARPU trends are encouraging across most business units As we observed for European mobile service revenues, the improving picture is evident if we look just at blended ARPU trends too (see Figure 19). Again, we have stripped out the benefit derived from the lessening MTR drag in recent quarters. Five of Vodafone’s eight main European markets saw yoy growth in blended ARPU in Q4, while five business units (a different five) saw an improving trend in blended ARPU (either improving growth or an improving pace of decline) in the quarter.
Dutch ARPU trends are to blame for worsening service revenues The Netherlands stand out yet again, with blended ARPU trends taking a turn for the worse in Q4, declining 4.1% yoy, worsening from a 0.8% decline in Q3. The weakening trend in blended ARPU therefore explains the majority of the worsening mobile service revenue trend for Vodafone in the Netherlands.
Greece ARPU decline remains stubborn, but offset by customer base growth Blended ARPU trends in Greece also stand out due to their stubborn double-digit pace of decline, with the company blaming weak macro conditions. The Greek market has also seen aggressive prepaid mobile data promotions somewhat reminiscent of the Italian market in 2014, with 1GB of free data available on a 4GB top-up for c€4.40.
20 Vodafone Group plc Telecommunications
Figure 20: Postpaid ARPU trends by major European market (% yoy) In some key markets (like Italy, Spain and Portugal) postpaid ARPUs continue to fall significantly, diluting any benefit from the prepaid-to-postpaid mix shift Germany Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 0.0% -2.0% -1.3% -0.9% -4.0% -1.8% -3.1% -3.5% -6.0% -4.2% -3.9% -4.2% -5.6% -6.1% -8.0% -6.3% -7.0% 5.0% UK 0.4% 0.0% -0.4% -0.2% -5.0% -3.5% -3.0% -2.8% -5.2% -4.4% -6.6% -5.7% -5.9% -5.6% -10.0% Spain 0.0% -5.0% -2.3% -4.3% -4.5% -5.0% -10.0% -8.8% -10.0% -15.0% -10.5% -11.3% -10.9% -13.7% -15.0% -14.1% -20.0%
Italy 0.0%
-10.0% -7.3% -11.0% -11.2% -20.0% -14.7% -14.8% -14.3% -13.5% -13.5% -14.9% -15.3% -17.5% -18.0%
Greece 0.0%
-5.0% -3.0% -4.2% -5.2% -6.2% -6.7% -10.0% -8.3% -7.7% -7.4% -10.3% -9.7% -15.0% -11.2% -12.0%
Portugal 0.0%
-10.0% -5.8% -7.1% -7.0% -9.0% -11.8% -10.8% -10.9% -12.1% -13.8% -12.9% -20.0% -15.4% -14.5%
20.0% Romania 11.4% 13.1% 8.4% 10.0% 6.5% 2.4% 4.2% 3.6% 2.6% 0.1% 1.7% 2.2% 0.0% -2.1% -10.0% 5.0% Netherlands 0.6% 0.0% -1.2% -5.0% -2.7% -2.1% -2.7% -4.4% -3.6% -10.0% -7.3% -7.7% -6.8% -8.0% -8.3% Source: Company reports
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This has stimulated extremely strong data usage growth (Greek data volumes were up 132% yoy in FY16). Vodafone managed to increase its customer market share in Greece by 2ppt, to 35% during the year, with most of its share gain taken from Wind, and a little from Cosmote. The resulting strong customer growth at Vodafone Greece almost negated the impact from weaker ARPUs, with mobile service revenues (ex-MTRs) almost stable in the quarter – and as the company points out in its press release, total service revenues (including MTR unwind) scraping into positive growth territory.
Figure 21: Prepaid-to-postpaid mix shift Figure 22: Postpaid subscribers as percentage of total In the last two years the postpaid share of Vodafone’s European The prepaid-to-postpaid customer mix shift has occurred in most base has increased by 5.8ppt to c50%, with a clear acceleration of Vodafone’s European markets, underpinning blended ARPU of the shift over that timeframe and mobile service revenue trends at the business unit level
20.0% 55.0% 16.4% 15.0% 50.0% The mix-shift from prepaid to postpaid continues, albeit at a slowing pace, 10.0% 8.0% 7.1% 7.5% 6.4% 7.0% 45.0% 5.7% 5.8% 5.0% 5.0% 3.3%
40.0% 0.5% 0.6% 0.0%
-1.4% 35.0% -5.0% -4.1%
30.0% -10.0% UK Italy Spain Malta Ireland Greece Albania Portugal Hungary Romania Germany Q2 FY09 Q2 FY09 Q4 FY10 Q2 FY10 Q4 FY11 Q2 FY11 Q4 FY12 Q2 FY12 Q4 FY13 Q2 FY13 Q4 FY14 Q2 FY14 Q4 FY15 Q2 FY15 Q4 FY16 Q2 FY16 Q4 Europe Avg. Netherlands
Czech Republic Czech Source: Company reports Source: Company reports
Figure 23: Prepaid/postpaid mix shift accelerating Figure 24: Prepaid/postpaid ARPUs versus mix shift Vodafone’s European portfolio encompasses a diverse range of Markets like Germany, the UK, the Netherland, and Greece, markets from mostly prepaid (eg Italy and Greece) to mostly where postpaid ARPU is several times higher than prepaid ARPU, postpaid (eg Spain and the Netherlands) should benefit from the mix shift as long as postpaid ARPUs do not decline too rapidly
90.0% European postpaid/prepaid ARPU 78% 80.0% 77% vs 1-year change in postpaid mix (%)
70.0% 67% 67% 10.0 60% 9.0 60.0% 55% GR 50% 50% 8.0 50.0% NL 41% GE 39% 7.0 40.0% UK 6.0 30.0% 28% 21% 5.0 19% RO 20.0% 4.0 10.0% SP 4% 3.0 PT Postpaid/Prepaid ARPU ratio ARPU Postpaid/Prepaid 0.0% 2.0
UK IT Italy Spain Malta 1.0 Ireland Greece Albania Hungary Portugal Romania Germany Europe Avg. Europe
Netherlands 0.0
Czech Republic Czech -4%-3%-2%-1%0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 1 year change in postpaid subscribers as % of base
Source: Company reports Source: Company reports
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Elsewhere, ARPU trends are generally encouraging
Italian ARPUs are growing at c5% yoy, UK ARPUs at c7% yoy, German ARPUs at c2% yoy, Portuguese ARPUs at c4% yoy, and Romanian ARPUs at c3% yoy. The pace of decline in Spanish ARPUs is improving, despite the drag from the change in handset financing, and should improve further as this drag fades. Postpaid ARPU trends illustrate an important point A little more colour can be gained by looking at postpaid mobile ARPUs in more detail. Figure 20 illustrates a key point about what is underpinning the mobile service revenue trends for Vodafone in Europe. Of the eight major European markets that we detail, seven are experiencing ongoing declines in postpaid mobile ARPU (ex-MTRs). Only in Romania is postpaid ARPU actually growing. This may seem concerning but for two observations. ● First, in seven of the eight markets shown in Figure 20, the pace of decline in postpaid ARPUs is improving – only in the Netherlands is the postpaid ARPU trend getting worse. ● Second, despite the general picture of decline in postpaid ARPUs, the trend in blended ARPUs is still one of growth. So, how can postpaid ARPUs be declining, yet blended ARPUs be growing?
The prepaidprepaid----totototo----postpaidpostpaid mix shift continues, with a couple of exceexceptionsptions The answer lies in the mix shift from prepaid to postpaid subscribers. We have pointed out before (see our report Upgrading to Buy on operating momentum , dated 28 April 2016) how the pace of mix shift from prepaid to postpaid customers has accelerated significantly in recent years. Over the last two years the proportion of postpaid customers has increased by 5.8ppt to c50%. In the two prior years the proportion of postpaid customers increased by only 3.9ppt, and in the two years before that, by only 1.9ppt. This matters to blended ARPU because postpaid customers can spend up to 7-9x more than prepaid customers (see Figure 24). The mix shift to postpaid is occurring in most of Vodafone’s European markets (see Figure 22), albeit at very differing paces. Portugal has seen the most radical change in prepaid/postpaid mix, with a 16.4ppt shift to postpaid in the last two years, leaving Portugal with 39% of the base now subscribing to a postpaid tariff. This swing reflects the rapid transition of the Portuguese market to converged tariff offers (wireline plus mobile plus TV) over the last 2-3 years, of which Vodafone has been a part. Spain, Germany and the UK have also seen a significant shift in the prepaid/postpaid mix. At the other end of the scale, Greece and Albania have seen the prepaid share of subscribers increase, counter to the general trend across the rest of the European mobile industry. Italy remains mostly a prepaid market (81% of Vodafone’s Italy base is prepaid), and has seen only a very minor shift towards postpaid in the last two years, albeit this situation reflects government tax policy which applies a tax to postpaid contracts, which in turn disincentivises consumers from taking a postpaid contract. Romania stands out as a business unit which, while below average in terms of the proportion of postpaid in the mix (at 41%), has seen almost no change in the proportion of postpaid in the last two years. It also seems odd that Romania has seen significant growth in data volumes and increased smartphone take-up, two developments which would normally be associated with an increasing mix shift from prepaid to postpaid tariffs, yet the proportion of postpaid subscribers has remained almost unchanged over the last two years.
GGGrowthGrowth in blended ARPUs is underpinunderpinnedned by the prepaidprepaid-prepaid ---totototo----postpaidpostpaid mix shift With one or two exceptions, the overall picture is one of an increasing proportion of customers taking a postpaid contract, resulting in a mix shift towards higher-ARPU services. While postpaid ARPUs are still falling, the mix shift has the effect of underpinning an improving trend, or in many case even growth, in blended ARPUs, as we illustrated earlier.
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Proof of mobile data monetisation remains elusive Is mobile data monetisation another driver of the improvement in Vodafone’s mobile service revenue trends in Europe? We think so, albeit we would be the first to admit that the kind of direct first-hand evidence that we would prefer to see is not available.
However, the mixmixmix shift to postpaid ISISIS the evidence of mobile data monetisation However, to us, the strongest evidence of mobile data monetisation remains the mix shift from prepaid to postpaid mobile subscriptions. In short, we think consumers’ desire to have internet access on their mobile phones is driving the adoption of smartphones and the migration from 3G to 4G services. Smartphones with 4G capability are more expensive devices, and therefore customers are more inclined to spread the cost of the device across a 12- or 24-month postpaid contract, instead of bearing the device’s cost upfront with a prepaid SIM tariff.
Figure 25: Europe and AMAP drive strong data volume growth Figure 26: European mobile data traffic growth Note the stabilisation of the formerly slowing EU data volume Growth continues to be strong, despite a slowing in recent growth trend quarters
Vodafone group data volume growth (% yoy) Vodafone Europe mobile data traffic growth 130% 123% 375 70% AMAP 120% 65% 110% 110% 110% 325 108% Group Quarterly data traffic 110% 60% (Petabytes - lhs) Europe 97% 275 252 55% 100% 94% Growth yoy (rhs) 229 88% 212 50% 90% 84% 225 81% 81% 45% 79% 78% 177 80% 73% 175 162 72% 71% 146 40% 68% 132 70% 66% 64% 62% 125 108 35% 70% 95 80 87 60% 67% 71 30% 64% 64% 61 67 61% 75 49 55 50% 57% 56% 25% 53% 25 20% 40% 44% 42% 30% Q3/14 Q4/14 Q1/15 Q2/15 Q3/15 Q4/15 Q1/16 Q2/16 Q3/16 Q4/16
Source: Company data Source: Company data
Figure 27: Vodafone’s European smartphone growth Figure 28: Individual smartphone data usage Growth continues, with increasing 4G take-up underpinning data Usage continues to show strong growth, with Germany standing traffic growth out as the laggard
Vodafone Europe Smartphone and 4G take-up Smartphone data usage (MB/pcm) as % of phone base in Vodafone's big 4 European markets 4G sim penetration Smartphones with dataplan as % of phone sims 1500 Spain 50.0% 44.2%
43.2% 1300
45.0% 41.7% Italy 39.3% 38.7%
40.0% 37.0% 35.3%
34.2% UK
35.0% 32.5% 1100 30.9%
30.0% 27.5% Germany
25.0% 23.0% 900 20.0% 20.0% 15.6% 15.0% 13.0% 700 10.0%
10.0% 7.1% 5.0% 3.5%
5.0% 1.4% 500 0.0% 300
Source: Company dat a, Berenberg calculations Source: Company data
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Data volume growth remains very strong, although it is slowing Mobile data on Vodafone’s group networks showed growth of 62% yoy in Q4 (see Figure 25). This is a blend of growth of 56% yoy in Europe and 71% yoy in AMAP. The growth trend is slowing, although that is to be expected given the rising take-up of smartphones and 4G.
Vodafone said that in Q4 its European network carried 252 petabytes of mobile data, which was up 56% yoy on Q4 FY15 (see Figure 25). Vodafone reports that smartphone adoption reached 58.1% across its European footprint in Q4 FY16, a healthy increase of 6.4ppt over Q4 FY15.
Smartphone data plan adoption still offers plenty of scope for growgrowthth The proportion of smartphones with a data plan also continues to rise, although at a slower rate of 1.3ppt in FY16, to 76.1% (our estimate, which attempts to correct for an error in Vodafone’s reported data). This means that only 44.2% of mobile phones across Vodafone’s European footprint are smartphones with a data plan. This proportion is still increasing at a decent rate (eg by 5.5ppt yoy in Q4 FY16), but clearly offers considerable scope for further growth. Individual smartphone data usage is also still growing very strongly in the majority of Vodafone’s major European markets (see Figure 28). Of the big four markets, Germany remains the laggard, with smartphone average usage of 764MB pcm in Q4, approximately half the level of smartphone data usage seen in the UK, Italy and Spain. Even in Germany, the pace of growth in smartphone monthly data usage shows no sign of letting up.
OOOperatorOperator evidence of mobile data benefiting postpaid ARPU remains eluelusivesive While the evidence of mobile data usage growth remains robust, operators, Vodafone included, remain very reluctant to publish same-cohort comparisons of consumers’ ARPU before and after smartphone adoption or 4G migration. This suggests that the impact of mobile data tariffing on postpaid ARPU remains dilutive as higher-spending postpaid customers spin down to lower-priced postpaid data bundles. However, as we showed earlier, blended ARPUs are nevertheless still improving due to the mix shift from prepaid to postpaid, as lower-spending customers are increasingly adopting smartphones with 4G capability (see Figure 27). The trick for operators is therefore to manage the balance of this equation so as to underpin improving service revenue trends. The recent emergence of “more-for-more” mobile data tariff bundles where operators are offering even more data (but at a slightly higher price) in several of Vodafone’s European markets is an effort to encourage customers to progress further up the data usage curve, with data volume increases offsetting the decline in price per megabyte of data.
Figure 29: Out-of-bundle revenues are an ever smaller part of the mix Figure 30: OOB revenues are less important OOB revenues continue to decline at a hefty rate They are so small now as a percentage of total and European revenues that their drag has materially eased
Vodafone: in-bundle vs out-of-bundle EU out of bundle revenue growth % yoy 9.5% 5.0 as % of Group service revenues 20.8% - Europe in- bundle EU in bundle as % -5.0 32.5% Q4/FY16 of group service -10.0 Europe out-of- revenues 27.7% bundle -15.0 Q1/FY13 EU out-of-bundle 13.2% -20.0 as % of EU service revenues 29.8% -25.0 EU in-bundle as % -30.0 45.2% of EU service revenues 39.7% FY14 Q3/14 Q4/14 Q1/15 Q2/15 Q3/15 Q4/15 Q1/16 Q2/16 Q3/16 Q4/16 0.0% 20.0% 40.0% 60.0%
Source: Company data Source: Company data
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Figure 31: Churn is falling Figure 32: ‘Big four’ churn rates Consumer postpaid and enterprise churn rates continue to fall Of “the big four” markets, only the UK’s churn has refused to fall
20.0% Vodafone Europe churn rates % pa 28.0% Vodafone Europe Big 4 markets postpaid churn 19.0% 18.6% 26.0% Spain
17.9% 24.0% Italy 18.0% 17.6% UK(1) 17.0% 17.0% 22.0% 17.0% 16.7% Germany Consumer 20.0% postpaid 16.0% 16.4% 16.2% 18.0% 16.4% Enterprise 15.0% 15.4% 16.0%
14.0% 14.6% 14.0% 13.9% 13.0% 12.0% Q3 FY13 Q3 FY13 Q4 FY14 Q1 FY14 Q2 FY14 Q3 FY14 Q4 FY15 Q1 FY15 Q2 FY15 Q3 FY15 Q4 FY16 Q1 FY16 Q2 FY16 Q3 FY16 Q4 Q3 FY15 Q3 FY15 Q4 FY16 Q1 FY16 Q2 FY16 Q3 FY16 Q4 Source: Company data Source: Company data
Other headwinds are reducing too We are encouraged by two other important trends which relate to our earlier observation regarding the ongoing mix shift from prepaid to postpaid mobile subscriptions. ● First, mobile “out-of-bundle” (OOB) revenues are now a much smaller proportion of revenues than they were a few years ago. ● Second, churn seems to be on a steady downward trend.
The drag from OOB revenues has reduced by twotwo----thirdsthirds in recent years The decline in OOB mobile service revenues has been a major drag on total service revenues in recent years as data services have substituted for SMS messaging and voice calls. OOB mobile revenues are still declining in Europe at a mid-teens rate, as illustrated in Figure 29. However, OOB revenues now make up only 13.2% of EU service revenues (see Figure 30), significantly down from almost 30% of European service revenues in Q1 FY13. That means that the drag from European OOB revenues has reduced from c7ppt as of Q1 FY13 to c2ppt as of Q4 FY16. The OOB drag on European service revenues should continue to fade as OOB shrinks further as a proportion of the service revenue pie.
Postpaid and enterprise churn rates are falling in Europe Churn rates are typically volatile quarter to quarter, as can be seen from the detailed country churn rates that Vodafone publishes. However, the long-term churn trend appears to be downwards, as illustrated by the chart displayed by Vodafone at its FY16 results (see Figure 31) which showed both consumer postpaid churn and enterprise churn rates declining in recent quarters. Looking across the major business units in Europe, we note that three of the big four major business units have seen a steady decline in postpaid churn over the last few years (see Figure 32), with only the UK struggling to establish a meaningful downward trend in postpaid churn.
Other headwinds are easing too, according to Vodafone Finally, Vodafone highlighted several other headwinds that are moderating and are likely to be less of a drag on group and European service revenues. These included mobile termination rates, MVNO wholesale revenues, and consumer prepaid revenues (12% of the European pie, and falling at c4.4% yoy in FY16). Vodafone also appears to be outperforming in the enterprise segment, where its European service revenue base was approximately stable in FY16. While Vodafone’s enterprise revenues incorporate carrier revenues, which themselves can be quite volatile, the trend of
26 Vodafone Group plc Telecommunications
stability compares favourably with more severe levels of enterprise revenue declines among peers (eg KPN, Telecom Italia, Deutsche Telekom). Conclusion – European mobile service revenue trends encourage
European mobile service revenues remain the single-largest component of Vodafone group revenues, accounting for almost 50% of the group service revenue pie. In recent years this revenue segment has dragged the most on overall group revenue performance. The situation has rapidly improved in recent quarters such that European mobile service revenues are now almost back to stability. That improvement has been driven by a reversal in ARPU trends, from falling ARPUs 18-24 months ago to rising European mobile ARPU in recent quarters.
The growth in ARPU is being driven by the acceleration in the mix shift from prepaid to postpaid customers, which has been strong enough to offset the ongoing decline in postpaid mobile ARPUs. We see the mix shift as the single most significant evidence of the monetisation of the demand for mobile data.
The prospects for further European momobilebile service revenuerevenue growth are good Looking forward, we think that Vodafone’s European mobile service revenue trends should be able to show further improvement for several reasons. ● Smartphone adoption will continue to increase from currently 58%. In Vodafone’s most advanced smartphone markets, the UK and the Netherlands, smartphone adoption is c70% and still growing. ● The proportion of mobile phones with a data plan will continue to grow from currently 44.2%. In its most advanced data markets (the UK, Spain), data plan adoption is at c55- 65% of smartphones, and is still increasing. ● 4G adoption will continue to grow from currently 27.5%. ● Individual mobile data use will continue to grow strongly for the foreseeable future. In its most advanced major mobile data market of Spain, smartphone data usage is already at 1.5GB pcm and still grew at 57% yoy in Q4. ● The mix shift from prepaid to postpaid customers will continue from the current level of 50% postpaid subscribers. In its most advanced postpaid markets (Spain, the Netherlands) postpaid customers make up close to 80% of the base.
Figure 33: Vodafone group service revenue share (Q4 FY16) Germany, UK and India account for almost half of group service revenues, and Italy, Spain and Vodacom for another quarter
Egypt, 3.2% Netherlands, Other, 3.5% 9.0% Germany, Other AMAP, 20.2% 3.7%
Turkey, 4.6% Vodacom, UK, 15.6% 8.2%
Spain, 9.0% India, 12.6% Italy, 10.4%
Source: Compa ny data, Berenberg calculations Note: “Other” includes Portugal, Romania, Greece, Hungary, the Czech Republic, and Albania.
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● More-for-more data tariff plans will encourage customers to move up the spending curve as data volumes continue to grow strongly. ● Some markets will see price inflation as competitors, particularly smaller, capital- constrained pure-play mobile operators, seek to fund increased capex and spectrum costs through higher prices, especially in the new era of EC opposition to in-market consolidation.
The improvement in group service revenue growth will likely pause nearnear----termterm At its FY16 results, management clearly signalled that it expects group service revenue momentum to pause in Q1 FY17, and to look “broadly similar” to the 1.8% yoy organic growth seen in Q1 (ie below the headline 2.5% organic group service revenue growth in Q4 which benefited from the leap-year effect and changes to accounting for certain wireline products), citing several reasons. ● Reversal of the leap-year effect that benefited Q4 – this amounted to a benefit in Q1 of c0.3ppt. ● Increased drag from roaming due to new EC roaming rate rules – estimated impact is c0.3-0.4ppt with a more significant impact in the UK and Germany and a smaller drag in Spain and Italy. ● Vodacom (see Figure 33 for relevance) clearly signalled expectations for a slower pace of growth after a couple of quarters of very strong performance in South Africa (Q4 service revenue growth was 6.3% yoy). ● The unwinding of the carrier revenue boost seen in Q4, particularly in the UK (0.8ppt of benefit). In addition, management cited several other risks to caution analysts from getting too carried away with the near-term organic service revenue outlook, including: ● continued nervousness over pricing in Italy where “below the line” price offers continue to be aggressive; ● increased subsidies by Deutsche Telekom in Germany; and ● the potential for competitive price adjustments in reaction to Reliance Jio’s launch in India. Offsetting some of these concerns are other factors. ● UK billing credits (which we earlier identified as a drag on UK service revenues in the Q4) should start to fade, in our opinion, as Vodafone gets to grips with the billing problems that beset its UK operations in Q4. ● Regulatory drags in India should start to annualise in Q1, removing a 3ppt drag on Indian growth in Q4. ● Prices for certain tariffs should increase in Spain, Italy and Germany. ● Wireline and enterprise segments should show continued growth. ● In Spain, the handset financing drag on service revenues should fade. In summary, consensus expectations for Q1 organic group service revenue trends should start to emerge around +1.8% yoy, similar to the underlying growth seen in Q4, with expectations for the UK, Germany, Italy and Vodacom to see slightly weaker trends, and with Spain and India likely to show better trends.
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Margin outlook shows scope for improvement
Our thoughts on Vodafone’s margin outlook have been positive for some time. In our view, the margin picture was somewhat more convincing than the top line, for five simple reasons. ● Mix effect 1: AMAP has higher margins that Europe, and is growing faster than Europe, thus creating a structural margin expansion driver. ● Mix effect 2: Cable operations in Germany and Spain have structurally higher margins than the rest of Europe, and are growing faster than the rest of Europe. ● Spring effect 1: In executing on project Spring, Vodafone has taken on c£500m of additional opex which will remain in its P&L. These Spring costs should stabilise, allowing for operating leverage to benefit margins. ● Declining churn rates: Falling churn is usually good for margins as operators can achieve the same net customer growth with a lower level of gross additions, and hence lower total subscriber acquisition costs (SAC). In addition, the lower churn allows for experimentation with lower SAC per addition (ie both a volume and a unit cost effect provide the margin benefit). ● Efficiency gains: In a group structure like that of Vodafone there is likely to be ongoing scope for efficiency gains and cost restructuring. Vodafone’s CFO laid out in its recent Q4 results presentation a nice waterfall chart showing how guidance for organic group EBITDA growth of 3% to 6% in FY17 is to be achieved. We show that chart below in Figure 34. The EBITDA figures given are in million euros to reflect the company’s intended move to report in euros for FY17. The guidance range of €15.7bn- 16.2bn translates to £12.4bn-12.8bn. The chart reveals the significant underlying growth in EBITDA (ie €1.3bn-1.8bn) expected by management once various “headwinds” are adjusted for. These headwinds have become more visible as the end of FY16 approached, the primary ones are listed below. ● €225m roaming hit: The introduction of new EC rules regarding EU roaming rates (30 April 2016) is estimated to provide an incremental c€225m drag on FY17 EBITDA, excluding any offsetting benefits from elasticity. ● £100m (€130m) Spanish content costs: Incremental costs arising from the Mediapro sports rights agreement are expected to amount to c£100m in FY17, following a partial year’s impact of £50m in FY16 (seven months’ impact), and higher costs (after the Mediapro auction outcome) expected in FY17. ● €180m Spanish handset financing unwind: In FY16 Vodafone’s group EBITDA benefited from changes to the consumer financing of handsets in the amount of £180m as handset revenues were brought forward and recognised at the same time as handset expenses. EBITDA thus benefited. Service revenues, however, were affected since handset costs previously recovered through ARPU were now not being recovered through ARPU. In FY17, assuming similar volumes of gross adds to FY16, there should be no incremental benefit from the bringing forward of handset revenues, but the impact on service revenues will continue, thus there should be incremental pressure on the Spanish EBITDA in FY17 arising from lower service revenues relating to customers signed last year. We expect an impact of c£100m in FY16. ● £50m (€65m) MVNO impact: Vodafone will continue to see reduced exposure to the MVNO sector, with TalkTalk set to start migrating its UK MVNO over to O2 during FY17, and possible impacts from the ending of 4G MVNO talks with United Internet in Germany (which may increase its focus on the agreement with Telefónica Deutschland for incremental 4G sales). We think the impact in FY17 will be a few tens of millions in terms of EBITDA. ● €254m project Spring technology costs: Management has commented in the past that Spring will bring with it recurring opex totalling c£500m, of which £300m hit the P&L in FY16, and a further £200m (€254m) is expected to hit the P&L in FY17. Beyond this, Spring-related opex should stabilise, allowing for operational leverage from incremental revenue growth in future years.
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Figure 34: Vodafone group EBITDA guidance for FY17 Vodafone guides to 3-6% EBITDA growth despite €900m of expected headwinds in FY17, including roaming, Spain content costs, handset financing unwind, and project Spring costs; without these headwinds, its guidance would imply c10% yoy organic growth
Vodafone Group FY17 Guidance EBITDA (€bn) drivers 16.5 +1.3 - 1.8 +15.7 - 16.2
16 +3% - 6% 15.5 +0.5 -0.6 yoy
15 -0.3 14.5 15.3 14.8 14 14.4
13.5 FY16 FX/ladder FY16 Roaming, Project FY16 Underlying FY17 reported rebased content, Srping restated growth guidance EBITDA handset fin. technology MVNO costs
Source: Company data
Management’s guidance thus implies a net €400m-900m increase in EBITDA in FY17, equating to a range of growth of 3-6% yoy. Were it not for those incremental cost items (several of which will fade from the comps as we progress into FY18) the increase in EBITDA would be more like €2.2bn-2.7bn, or 8.5-11.8% growth yoy. What drives that underlying improvement in EBITDA? On the call, management gave some useful insight into its expectations, citing an expectation that they can: ● drive up gross margin (through price increases, focus on driving down direct costs, wholesale arrangements with incumbents, among others); ● hold down customer costs, where customer acquisition and retention (A&R) costs have been trending lower as a percentage of revenues due to the push for a higher proportion of sales through own-branded channels including online/on-mobile channels, lengthening handset upgrade cycles, lower churn, and the move to value- based commission models in indirect channels; ● exploit improved cost economics of the network upgrades arising from project Spring (for example, Vodafone will lap the £500m opex/EBITDA hit from Spring in the near term, and then further out aims to reduce IT opex and capex as a percentage of revenue from 5.5% to 3.5-4% by year five through migration to the cloud; ● extract more synergies from the Ono acquisition – Vodafone raised the synergy target for Ono from €240m (already achieved) to €300m run rate by year four, through network savings, MVNO migration and FTTH capex avoidance, and savings from procurement and access to Vodafone group central functions; and ● implement other measures to improve operating leverage – these include increased use of centralised procurement and shared services, the introduction of “zero-based budgeting”, and the introduction of productivity targets for group operations. As a result of the return to top-line growth, combined with these drivers of margin, Vodafone expects the number of its business units growing EBITDA faster than revenues over the next three years to increase to 24 (of 26), from 15 last year and 10 in FY12-15. The margin expansion case already benefited EBITDA in FY16 which saw positive organic EBITDA growth in both H1 and H2 (see Figure 35). We acknowledge that group EBITDA benefited to the tune of c€180m (£140m) from Spanish handset financing in FY16, but FY15 benefited too (by c£100m), so the uplift in FY16 was not all incremental. We estimate that group EBITDA would still have grown c1.5% yoy, adjusting for Spanish handset financing benefits.
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Figure 35: EBITDA – organic trends improving In recent years the recovery in revenue has been followed by a return to growth for organic EBITDA, and will be followed in due course by a return to growth for EBIT/AOP
Vodafone group organic revenue and EBITDA trends (HY yoy %) 10.0% Group revenues Group service revenues Adj. EBITDA Adj. Op Profit 3.6% 5.0% 2.0% 1.0% 1.9% 0.0% -0.4% -2.3% -5.0% -2.7% -3.0% -2.8% -3.6% -10.0% -10.0% -11.0% -15.0%
-20.0%
-25.0%
-30.0%
-35.0% H1/14 H2/14 H1/15 H2/15 H1/16 H2/16
Source: Berenberg estimates
We try to reflect specific margin pressures and benefitsbenefits on a business unit level Our estimates also assume that Vodafone can see EBITDA margins expand over the next three years, from 28.3% in FY16 to 30.7% in FY19, implying a three-year EBITDA CAGR of 4.8% pa off a revenue CAGR of c2% pa. In regional terms, we expect Europe margins to expand by 160bp to 30.4% in FY19, and AMAP margins to expand by 330bp to 33.9% by FY19. Embedded in our expectations are the following assumptions on a business unit level. ● Germany impact due to United Internet migration: We assume that Vodafone will see an impact to German EBITDA margins from the loss of MVNO revenues in Germany where we factor in margins reducing from 32.6% in FY16 to 32.0% by FY19. We assume United Internet starts to migrate customers to its 4G agreement with Telefónica Deutschland, and that Vodafone sees increased commercial expenses as it responds to higher subsidies from Deutsche Telekom. ● UK margin progression pauses in FY17: We assume UK margin progression pauses in FY17 as Vodafone gets to grips with the hangover from its Q4 billing problems, combined with 0.5ppt of margin pressure from higher 900Mhz/1800Mhz spectrum fees, with a partial offset from price increases. In the mid-term we assume recovery in margins in the UK. ● Spain margins restrained in the near term: Vodafone has clearly guided to an incremental €180m of EBITDA pressure in Spain from the unwind of prior year’s EBITDA benefits arising from the treatment of handset expenses. In addition, Mediapro content costs will reach a higher run-rate in FY17 (we expect c£100m versus £50m in FY16). We assume the margin benefit of price increases offers a partial offset to these pressures in FY17, resulting in modest margin compression, before margins expansion is reasserted from FY18 onwards. ● Increased competition in India from Reliance Jio: We assume increased commercial expenses and constrained revenue trends in India as a result of the entry of Reliance Jio. This results in India margins remaining at the 30% level through FY17 and FY18, before recovering the expansion trend in FY19 onwards. ● Netherlands affected by revenue turndown: In FY17 we assume 110bp of margin compression in the Netherlands, taking margins to 33%, as Vodafone tackles the increased pressure on ARPU arising from a resurgent KPN, and the emergence of convergence in the Dutch market. Obviously, assuming the Vodafone/Liberty deal in
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the Netherlands is approved, we expect the resulting joint venture to be treated as an equity-accounted associate after deal completion, with returns to benefit from the extraction of synergies and an improvement of the competitive position. ● Margin pressure in Greece: Given the top-line trends in Greece in Q4 we think it makes sense to assume some degree of margin pressure in FY17 – we assume margins will fall from 27.7% to 25% as Vodafone responds to the current price war here.
Where is the risk in our numbers? We worry about India where we have yet to fully see the result of Reliance Jio’s market entry. We are less concerned than Vodafone about pricing in Italy on the basis that it has always been tough, and if the Wind/Three deal gets blocked then both operators will have little choice but to raise prices, in our view. We are keeping a close eye on Germany too, given its important to Vodafone (20% of group service revenues and 22.5% of group EBITDA in FY17), and a small number of red flags in that market (eg Deutsche Telekom raising subsidies, Telefónica Deutschland adding 1GB of data to the bundle with recent offers, lower prices from Drillisch and United Internet, and, of course, the Bundesliga rights auction outcome).
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“Good” capex reflects success of project Spring
We regard Vodafone’s increased mid-term capex guidance as “good” capex, rather than a transition of project Spring into “project Summer”. There are enough signs that Spring has been successful to justify extending the spend into areas that present an opportunity to either support revenues or improve cost efficiencies. Even with the increased guidance for “mid-teens” capex/sales, compared to 13-14% under the old guidance, absolute capex will still show a material fall in FY17, boosting FCF and restoring cash flow cover of the dividend.
New guidance implies incremental cumulative capex of ££2.4bn2.4bn for FY17FY17----19191919 We have factored Vodafone’s higher guidance for capex (to be in the mid-teens as a percentage of sales) into our estimates, and this has resulted in a cumulative additional capex of £2.4bn over the next three years (FY17-19) compared to our old forecasts. To put his additional capex into context, it compares to the original Spring capex guidance of £7bn over FY14/15/16, and lifts our cumulative three-year capex for FY17-19 from £18.3bn to £20.7bn. This looks like good capex to us and seems to not have affected Vodafone’s confidence in generating an incremental £1bn of FCF “post-Spring”. Our estimates imply capex/sales averaging 15.6% over FY17-19, consistent with the company’s guidance of “mid-teens” capex/sales, which in side comments to the results management qualified as meaning 14- 16%, in contrast to the former guidance of 13-14%. The move is consistent with Vodafone management commentary regarding its old guidance which stated clearly that if the results of Spring were good, and the opportunity existed to improve its position in certain markets, then it would continue to invest at above the 13-14% range. We think this is a relatively modest adjustment to guidance which seems consistent with management’s more evident confidence in at least the outlook for EBITDA, and probably also in the outlook for revenues in the mid-term. In the historical context, a significant reduction in absolute capex is still implied in FY17 from the levels of the last two years (see Figure 37).
Spring success seems evident While Vodafone is able to present plenty of evidence that project Spring has delivered on its objectives, publicly available and independent qualification of the benefits of project Spring is hard to find. Later we reprise Vodafone’s data points showing the success of project Spring, but first, we recap some of the recent independent network tests in some of Vodafone’s major markets. Germany – the clear runner-up: In Germany, the 2015 Connect test showed that Vodafone has increased the network quality gap versus Telefónica Deutschland and E-Plus, and closed the gap on Deutsche Telekom over the last year. Vodafone took a tight win on points in voice telephony, with Deutsche Telekom very close in second place, and Telefónica Deutschland/E-Plus some way off in third and fourth place respectively. In the mobile data/large cities category, Vodafone came second to Deutsche Telekom, with Telefónica Deutschland a close third and E-Plus a distant fourth. In smaller cities, Telefónica Deutschland level-pegged with Vodafone in second place behind Deutsche Telekom. On the streets, Vodafone again occupied second place behind Deutsche Telekom, with Telefónica Deutschland and E-Plus in distant third and fourth places. On trains, Deutsche Telkom’s network performance outstrips the other three by a large margin, with Vodafone in a distant second place. Overall, the Connect 2015 study concludes that Vodafone is “the clear runner-up” and “among Germany’s top networks”, but concluded that Vodafone’s improvement in the voice test (due to early implementation of VoLTE) contrasted with a “slight deterioration” in the data test.
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UK – playing catch-up with EE: In the UK, evidence that Spring has led to an improved network position is difficult to find. EE is typically regarded as having the best network, for example in the recent RootMetrics study, EE led in five of six categories. RootMetrics cited Vodafone for “strong call reliability and improved speeds”, and Vodafone placed second on network speed, and improved its performance in Northern Ireland and Scotland. RootMetrics further concluded that as Vodafone expanded its 4G presence it would see further improvement in its UK ranking. Opensignal’s April 2016 UK market report provides additional colour, supporting the idea of EE as the best network in the UK, and showing that Vodafone has ground to make up. However, according to Opensignal, Vodafone scored second on 4G network coverage, third on overall download speeds, second on 3G download speed, but last on 4G download speeds, and second to last on 3G and 4G latency. Italy – Vodafone is the leader, says Opensignal: In Italy, according to Opensignal, Vodafone’s position looks strong, with top marks in the Opensignal May 2016 report for 4G coverage, 3G latency, overall download speeds, 3G download speeds and 4G download speeds. TIM scored first for 4G latency, with Vodafone in second place, and Three Italy shared top marks with Vodafone on 4G download speeds. Spain – Vodafone is top performer, says Connect: In Spain, Vodafone rates as the top performer, according to the Connect study for 2015, pretty much sweeping the board in the voice test, taking first place for call success ratio, call setup time, and speech quality in big cities in the drive test. In smaller cities, Vodafone rated first in call success and speech quality, and second on call setup time. Vodafone also led on mobile data in large cities, generally scoring the leading success ratio and highest download and upload speeds (except, strangely, in the standard definition YouTube test). Likewise in the small cities mobile data test, Vodafone ranked first. Netherlands – a third place: In the Netherlands, Vodafone occupies third place in the recent Connect test, undermined by its mobile data download speeds. T-Mobile leads in the Dutch market, perhaps a by-product of its low market share, followed by KPN, then Vodafone, then Tele2. Notably, the gap between operators in certain categories of the test is quite narrow. For example, on mobile data access in large cities the top score of 96% goes to T-Mobile Netherlands?, while the lowest score is only 3ppt below T-Mobile Netherlands?, at 93% for Tele2 (tied with Vodafone on 93% too). The distinction is more meaningful in small cities, where T-Mobile Netherlands leads with a score of 96% and Tele2 takes fourth place with 85% (Vodafone comes third with 90%).
Vodafone’s own data points qualify Spring as a success In contrast, Vodafone can list plenty of data points showing the success of the project Spring capex programme. We summarise the key data points in Figure 36, which shows solid progress on group net promoter scores, churn rates, dropped calls, call success rates, 4G coverage, and next-generation network (NGN) coverage, among others. Figure 38 shows Vodafone’s progress on Spring against the original targets, showing that it overachieved its targets in AMAP, but fell slightly short in Europe (although management claims overall that it achieved 108% of total Spring targets). Importantly, these data points coincide with a meaningful improvement in service revenue trends, which have reversed from a decline to growth, and in EBITDA trends that likewise reversed from decline to growth.
We recognise that it is impossible to say precisely what caused this effect. It could be simply that European economies are in a better place than they were 3-4 years ago (our note Misunderstood mobile , dated 6 January 2015, showed that the key driver of the best- performing mobile markets of the prior six years was the state of the economy). At least we can say that Vodafone’s project Spring investment has coincided with a material improvement in revenue and EBITDA trends.
Additional capex targets meaningful areas Vodafone’s additional capex will be spent in several areas, roughly equally split between wireline and mobile projects, and on IT.
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Figure 36: Project Spring signs of success Net promoter scores are up, churn is down, dropped calls and call connections have improved, 3G, 4G and NGN coverage has expanded, and enterprise capability has increased, all coinciding with improved revenue and EBITDA trends Criteria PrePrePre-Pre ---SpringSpring PostPost----SpringSpring Group net promoter score – difference to next best competitor -4.7pts +2.0pts Mobile churn – consumer contract >18.5% 16.7% Mobile churn – enterprise >16% 15.4% Customer experience – 3G/4G data sessions > 3Mbs 76% 91% Customer experience – dropped call rate 1.3% <0.9% Customer experience – dropped call rate EU >0.9% 0.46% Customer experience – dropped call rate AMAP >1.3% 0.86% Customer experience – call setup success EU <98.8% 99.9% Customer experience – call setup success AMAP <98.2% 99.3% Mobile network reach – EU 4G coverage 32% 87% Mobile network reach – India 3G coverage (1) 83% 95% Converged services – HH with own NGN 14m 30m Converged services – fixed BB customers 6.9m 13.4m Enterprise capability – IoT platform country footprint 22 30 Enterprise capability – IP-VPN PoPs 171 268 Service revenue growth (2) -3%-4% +1.8% EBITDA growth (3) -6.9% +2.7%
Source: Company data. 1) In target Indian cities. 2) pre -Spring relates to H2 FY13 and H1 FY14. 3) pre -Spring relates to H1 and H2 FY14.
The capex seems to us to be partly related to projects that will drive more revenues (eg 4G in AMAP, customer premises equipment, or CPE in wireline), and partly to projects that will aid efficiency improvements (eg IT transformation). European 4G mobile: Capex will further increase densification of the network ahead of 5G later in the decade, where Vodafone desires to gain the lead. In the original Spring plan, Vodafone aimed for 82k 4G sites and 101k 3G sites in Europe. Over 95% of EU city sites (cities with over 100k inhabitants) will be backhauled with fibre, compared to 59% at present. This new target is not comparable with the old Spring target of 98% of European sites to be backhauled with “high capacity” connections since that target incorporated microwave Ethernet backhaul as well as fibre backhaul.
Figure 37: Vodafone capex guidance Vodafone’s new capex guidance adds £2.4bn to our FY17-19 cumulative capex estimate, but capex will still decline significantly in FY17
Vodafone capex - the old and the new New capex £m 21.8% 21.0% Capex (old) £m Capex/sales (new) % 14000 Capex/sales (old) % 20.0% 16.5% 12000 15.9% 15.4% 15.4% Project Spring capex 13.9% 15.0% 10000 14.7% 14.4% 14.2%
8000 10.0% 6902 6848 6950 Capex £m Capex
622 811 % Capex/sales 6000 948 9197 8599 5.0% 4000 6313 6272 6125 5292 5886
2000 0.0% FY13 FY14 FY15 FY16 FY17E FY18E FY19E
Source: Company data
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Figure 38: Project Spring progress report as of FY16 Vodafone over-delivered against Spring targets in AMAP, and under- delivered in Europe
Spring category Achieved Target Europe 4G outdoor coverage +55ppt to 87% 91% ** miss ** Single RAN +40ppt to 93% 97% ** miss ** High capacity backhaul +25ppt to 90% 98% ** miss ** AMAP 3G/4G outdoor coverage (ex India) +10ppt to 85% 84% ** beat ** 4G coverage (ex India) +36ppt to 37% na India 3G coverage in targeted urban areas 95% 95% ** hit ** Single RAN +29ppt to 58% 51% ** beat ** High capacity backhaul +28ppt to 63% 52% ** beat ** Group network targets 4G sites 76k 77k ** miss ** 3G sites 77k 73k ** beat ** 2G sites 50k 47k ** beat ** Single RAN 115k 106k ** beat High capacity backhaul 102k 87k ** beat **
Source: Company data
AMAP accelerated 4G expansion: There are no specific targets given for this contribution to higher capex, but at least we can say that 4G deployment in AMAP is currently in its very early stages. Under its old Spring targets, Vodafone aimed for a mere 7,000 4G sites in AMAP, excluding India, but then never gave a 4G target for India. India is likely a key target for 4G expansion given the pending launch of Reliance Jio whose strategy is built on 4G. Vodafone says that it achieves a 2.7-year payback on investment in 4G sites in India, so it makes sense to invest more in this area. At present, Vodafone has 3G presence in 16 circles, accounting for 90% of service revenues, and a 4G presence in 5 circles accounting for 45% of data revenues. Vodafone expects that by year-end (FY17) it will increase the 4G presence to 9 circles which account for over 60% of data revenues. Fixed – fibre footprint expansion (southern Europe): Given that Vodafone has just signed a deal with Enel whereby it will access Enel’s 7.5m households (HH) fibre network as it is deployed over the next few years, we assume that this increased fibre capex for southern Europe will be targeted at Spain, Portugal, and Turkey. There are several factors encouraging Vodafone to be more aggressive in deploying own-fibre in certain markets. ● Record BB net additions: Vodafone is doing very well signing broadband (BB) customers. Q4 was a record quarter with Vodafone signing 416k BB adds (from 414k in Q3 and 230k in Q2). More importantly, Vodafone saw a significant increase in NGN BB additions (ie to cable, fibre), signing 426k, up from 382k in Q3 and 322k in Q2. ● Positive BB revenue growth: European fixed-wire service revenues showed accelerating organic growth of 5.4% in Q4 (3.7% in Q3, 3.1% in Q2). This compares to European mobile service revenues which showed a decline of 1.1% yoy in Q4. In Spain in Q4 fixed-wire revenues showed growth of 4.2% (compared to a mobile service revenue decline of 6.4%). ● Declining churn with convergence: Many operators are reporting that converged customers churn less than single-product customers. Vodafone gave two examples: in Spain, it is citing convergence resulting in churn falling from 26% to 14% on a same- cohort basis, while in Italy it cites churn falling from 21% to 10% when a customer takes a converged service package. ● Margin benefits of own network: The financial rationale for increasing its own NGN footprint goes beyond revenues to margins. Vodafone states that the 5.5m BB customers who are “on-net”, that is, connected to its own infrastructure, are far higher margin than those who are connected through wholesale agreements with the incumbent (ie using bitstream or unbundled local loop (ULL) mechanisms). In essence, investing in own-fibre NGN is effecting a capex for opex swap which provides a recurring benefit to margins in exchange for a one-time investment in capex. Fixed – rapid DOCSIS 3.1 deployment: This must relate to KDG in Germany and Ono in Spain, although again, no targets were specified. We are sceptical that households need
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gigabit speeds and super-low latencies with domestic BB services (in the past we estimated that the average household would require BB speeds of 80-100Mbs). However, we recognise the marketing and brand advantages of being able to compete by claiming the fastest broadband speeds in the market. In Germany, DOCSIS 3.1 will allow Vodafone to stay ahead of the incumbent Deutsche Telekom, whose strategy is based on VDSL plus vectoring and/or G.fast, offering the potential for download speeds of 2- 300Mbs. DOCSIS 3.1 will retain an advantage for cable. In Spain, Vodafone needs to respond to the deployment of fibre-to-the-home (FTTH), capable of gigabit speeds, by incumbent Telefónica. Fixed – customer success-led CPE. We believe this relates to the capitalisation of set top boxes (ie modems, routers, TV set top boxes), and is a clear indication that Vodafone is expecting a higher volume of gross additions in wireline broadband and TV, and hence improved revenues. Again, it is worth reflecting on the improving pace of BB adds and NGN BB adds seen by Vodafone in recent quarters, which must underpin its confidence in investing more in this area, with resultant benefits not only to revenues, but also to churn rates when the sale is made in conjunction with a mobile service. Some basic sums are due: Vodafone had 13.4m broadband subscribers across the group (of which 12.3m are in Europe, and 6.5m are NGN) at end-Q4. Over the prior 12 months, the gr0up saw net adds of 1.3m. If we assume that churn in BB is c15%, and that Vodafone wants to improve the BB adds rate to, say, 1.5m, then that implies Vodafone seeing gross broadband additions in FY17 of 3.5m. We do not know Vodafone’s capitalised CPE cost per gross broadband addition, but it would typically be c£50 for a low-end BB customer, and it could be c£400 for a high-end TV set-top box (STB) addition. If we strike an average somewhere around the £100 mark, then 3.5m gross adds would indicate capitalised CPE capex of £350m. Over three years, that is a cumulative £1bn, or 42% of the £2.4bn increase in our FY17-19 cumulative capex estimates, assuming, of course, that the CPE capex is all incremental, which it would not be.
So where does that leave our new midmid----termterm FCF and dividend cocoverver estimates? We now project FY17/18/19 FCF of £3.1bn, £4.4bn and £4.7bn, for a cumulative £12.3bn. This compares to just below the mid-point (£12.8bn) of management’s long-term incentive programme (LTIP) target range of £10.9bn-14.8bn (€13.8bn-18.8bn, mid-point €16.3bn). Given our modest (c2% pa) dividend growth expectations, that means that our FCF forecasts imply cash cost dividend cover of 1.04x, 1.44x and 1.5x for FY17/18/19 respectively (see Figure 39). If we include anticipated spectrum costs in the dividend cover calculation, then dividends are not covered in FY17, but are covered from FY18 onwards. Vodafone group policy is to pay a rising dividend, and our estimates suggest that this is perfectly possible.
Figure 39: Dividend cover under our new estimates Dividends are covered by FCF (guidance definition), but uncovered in FY17 once anticipated spectrum costs are included in FCF; the group dividend policy is to pay a rising dividend
Vodafone FCF and dividend cover profile Free casflow (£m incl Spring - lhs) Div cover (ex spectrum - rhs) Div cover (with specturm - rhs)
9,000 1.6 2.0 1.4 1.5 8,000 1.0 0.8 1.49 1.36 1.0 1.21 7,000 0.4 0.3 0.65 6,000 0.0 0.22 0.18 5,129
FCF £m FCF 5,000 4,616 4,308 4,183 (0.64) (1.0)
4,000 Dividend x cover 3,109 3,000 (2.0)
2,000 1,088 1,013 (3.0) 1,000
0 (4.0) FY14 FY15 FY16 FY17E FY18E FY19E FY20E
Source: Company data
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Indian spectrum risk?
How much will Vodafone spend in the upcupcomingoming Indian spectrum auctions?auctions? At the reserve prices published by the Indian authorities, the implied cost for 5MHz of nationwide low band spectrum is c$5.5bn, which most observers seem to believe is unrealistic. At the same time, Vodafone could do with expanding its spectrum portfolio in India. While Vodafone has not explicitly guided on expected spectrum spend in India, it has given enough data points for us to triangulate a reasonable figure to put into our FY17 cash flow estimates. There are three key data points we can use. ● Vodafone wants to retain its BBB+ credit rating, which means keeping net debt/EBITDA at 2-2.5x. ● Vodafone has given FCF guidance (ex-spectrum costs) for FY17 of “over €4bn”, and has intimated its ambition to achieve the mid-term FCF targets that form the basis of management’s LTIP. The low end of the LTIP calls for cumulative FCF of €13.8bn (£10.9bn), the high end calls for €18.8bn (£14.8bn), and the mid-point calls for €16.3bn (£12.8bn). ● CFO Nick Read said on the Q4 conference call that spectrum costs would be below the average (£2.3bn pa) of the last five years. We can use these data points to estimate how Vodafone’s financial firepower, or headroom, will develop over the next few years, giving us an indication of its flexibility to bid for Indian spectrum. If we assume that Vodafone holds its net debt/EBITDA at 2.5x for FY17- 19, we can see, in Figure 34, that in FY17 it would have headroom of £1.5bn, rising to £4.2bn in FY18 and £7bn in FY19, making for a cumulative total of £12.7bn over FY17-19.
Figure 40: Vodafone financial headroom, assuming net debt/EBITDA is maintained at 2.5x (BBB+) The first chart shows how Vodafone’s net debt/EBITDA develops, using our FCF estimates, but with zero spend on spectrum (not our official spectrum forecast); this provides us with a baseline against which to judge Vodafone’s financial headroom; the second chart shows the financial headroom that would exist if Vodafone was to hold net debt/EBITDA steady at 2.5x. Financial headroom could be used to purchase spectrum (or pay more dividends); note that these calculations take account of our current dividend assumptions
Vodafone ND/EBITDA (no spectrum spend) Net debt £m ND/EBITDA (x) 40000 3.00 38000 2.51 2.80 36000 2.38 2.60 34000 2.18 2.40 32000 2.00 2.20 30000 1.81 2.00 28000 1.80
Net debt£m Net 26000 1.60 30140 24000 29175 29036 27690 1.40 22000 25849 1.20 (x) Net debt/EBITDA 20000 1.00 FY16 FY17E FY18E FY19E FY20E Vodafone - financial headroom if ND/EBITDA maintained at 2.5x 12000 Headroom £m 10000 8000 6000 9801 4000 6989
Net debt £m debtNet 2000 4214 0 1537 FY16 FY17E FY18E FY19E FY20E
Source: Berenberg estimates
38 Vodafone Group plc Telecommunications
Figure 41: Vodafone’s financial headroom assuming net debt/EBITDA is maintained at 2.25x (BBB+) If Vodafone aimed to hold its net debt/EBITDA steady at 2.25x, it would not have any headroom to buy spectrum in FY17, but would have c£0.9bn headroom in FY18, rising to £3.5bn headroom in FY19
Vodafone - financial headroom if ND/EBITDA maintained at 2.5x 8000 Headroom £m 6000 4000 6236 2000 889 3521 0
Net debt £m debt Net -2000 -1631 -4000 FY16 FY17E FY18E FY19E FY20E
Source: Berenberg estimates
That seems to be quite a lot of mid-term financial firepower for spectrum (or for other purposes), especially if Vodafone is prepared to step a little over the 2.5x level for a short period of time. However, what if Vodafone wants to be a little more conservative, and instead aims to keep net debt/EBITDA at 2.25x? We show the headroom from this scenario in Figure 41 above. Under this scenario Vodafone has limited room to splurge on spectrum, as it would be required to conserve £1.6bn of FCF in FY17. In FY 18, it would have headroom of c£0.9bn, rising to £3.5bn in FY19, for cumulative headroom over the three years of £2.8bn. We now compare these two scenarios with CFO Nick Read’s comments from the Q4 conference call when asked about the outlook for spectrum spend: “… over the last five years, we’ve averaged about £2.3bn (pa), given heavy 4G acquisition across Europe and 3G and 4G in India. If we look at the three-year horizon, it will be lower, because essentially Italy is a renewal of 900MHz in FY19. The 700MHz in Europe is not in the next three-year envelope and in India, if you look at the pricing of the low-band spectrum, it looks a challenging business case, so we will definitely be rational on India.” The message seems clear, and is supported by our net debt/EBITDA scenari0 analysis. As such, we are going to include a precautionary £2bn estimate (increased from our earlier £500m plug) for spectrum spend in India in our Vodafone FY17 estimates.
Figure 42: Indian spectrum in 2016 recap
• In January 2016 India’s TRAI published reserve prices for spectrum to be auctioned in 2016 • Auction is for spectrum in bands 700/800/900/1800/2100/2300/2500MHz • In aggregate over 2000MHz of spectrum bandwidth is to be auctioned • In March, the Indian DoT referred the TRAI’s spectrum recommendations back to the TRAI, essentially asking it to reconsider the structure of the auction and reserve prices. • In April 2016 the TRAI responded, essentially maintaining the vast majority of its original proposals. • Most Indian operators have expressed the view that the auction offers too much spectrum and that reserve prices are too high. • If all spectrum was acquired at the suggested reserve prices, we estimate the total cost to the Indian mobile service provider industry would be £57bn. • We estimate the cost of 5MHz of nationwide 700MHz spectrum at €8bn, at the reserve price. • It seems extremely unlikely to us that operators participate fully in the auction. • Instead we expect operators to cherry-pick the auction to pad out their existing portfolios, perhaps with an eye to future consolidation potential. • The auction had been expected to start around mid-July, but Indian authorities do not have a great track record of starting auctions on time. Sour ce: Berenberg data
39 Vodafone Group plc Telecommunications
Financials
Profit and loss account Year-end March(GBP m) 2015 2016 2017E 2018E 2019E Group Revenues 42,227 40,973 43,406 44,289 45,076 Group EBITDA 11,915 11,612 12,629 13,088 13,683 EBITDA margin 28.2% 28.3% 29.1% 29.6% 30.4% Depreciation and Amortisation -8,345 -8,539 -9,021 -9,033 -8,955 Associates -63 44 90 98 110 Discontinued operations 0 0 0 0 0 Group AOP 3,507 3,117 3,697 4,153 4,838 Adj. net finance expense -1,290 -1,375 -1,393 -1,462 -1,429 Group adjusted PBT 2,217 1,742 2,305 2,691 3,409 Adjusted Tax expense -569 -175 -633 -739 -925 Non-controlling interest -177 -223 -330 -370 -395 Adjusted PAT 1,471 1,344 1,342 1,582 2,089 Adjusted EPS (basic) 5.55 5.04 5.03 5.93 7.83 Adjusted EPS (Dil) 5.53 5.05 5.03 5.93 7.83 DPS 11.22 11.45 11.68 11.91 12.15 Shares ranking (dil.) 26,615 26,692 26,692 26,692 26,692 Source: Company data, Berenberg estimates
40 Vodafone Group plc Telecommunications
Revenue and EBITDA segmentation Year-end March (GBP m) 2015 2016 2017E 2018E 2019E Revenue by segment Germany (incl. KDG) 8,384 7,787 8,555 8,698 8,740 Italy 4,587 4,405 4,748 4,788 4,847 UK (incl.CWW) 6,199 6,173 6,287 6,395 6,496 Spain 3,614 3,633 3,850 3,948 4,031 Netherlands 1,482 1,383 1,435 1,431 1,433 Portugal 767 712 762 757 763 Romania - - - - - Greece 576 621 651 660 670 Other Europe 2,168 2,119 2,239 2,269 2,287 EUROPE 27,687 26,718 28,417 28,836 29,155 India 4,309 4,516 4,779 4,836 4,979 Vodacom 4,341 3,887 3,970 4,111 4,222 Turkey 2,026 2,170 2,597 2,830 3,005 Egypt 1,190 1,197 1,119 1,153 1,177 Other AMAP 1,527 1,447 1,486 1,486 1,500 AMAP 13,382 13,208 13,942 14,406 14,874 Total Revenues 42,227 40,973 43,406 44,289 45,076
EBITDA by segment Germany (incl.KDG) 2,659 2,537 2,840 2,783 2,797 Italy 1,535 1,478 1,685 1,748 1,793 UK (incl. CWW) 1,345 1,289 1,352 1,407 1,462 Spain 782 915 963 1,026 1,108 Netherlands 507 472 474 472 487 Portugal 289 250 270 273 282 Romania - - - - - Greece 158 172 163 178 194 Other Europe 619619619 573573573 616616616 658658658 709 EUROPE 7,894 7,686 8,363 8,546 8,833 India 1,282 1,331 1,434 1,451 1,519 Vodacom 1,527 1,484 1,588 1,706 1,816 Turkey 366 405 519 594 661 Egypt 522 499 476 507 530 Other AMAP 389 323 349 364 375 AMAP 4,086 4,042 4,366 4,622 4,900 Total EBITDA 11,915 11,612 12,629 13,088 13,683 Source: Company data, Berenberg estimates
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EBITDA margins (%) 2015 2016 2017E 2018E 2019E EBITDA Margins Germany (incl. KDG) 31.7 % 32.6 % 33.2 % 32.0 % 32.0 % Italy 33.5 % 33.6 % 35.5 % 36.5 % 37.0 % UK (incl. CWW) 21.7 % 20.9 % 21.5 % 22.0 % 22.5 % Spain 21.6 % 25.2 % 25.0 % 26.0 % 27.5 % Netherlands 34.2 % 34.1 % 33.0 % 33.0 % 34.0 % Portugal 37.7 % 35.1 % 35.5 % 36.0 % 37.0 % Romania - - - - - Greece 27.4 % 27.7 % 25.0 % 27.0 % 29.0 % Other Europe 28.6 % 27.0 % 27.5 % 29.0 % 31.0 % EUROPE 28.5 % 28.8 % 29.4 % 29.6 % 30.3 %
India 29.8 % 29.5 % 30.0 % 30.0 % 30.5 % Vodacom 35.2 % 38.2 % 40.0 % 41.5 % 43.0 % Turkey 18.1 % 18.7 % 20.0 % 21.0 % 22.0 % Egypt 43.9 % 41.7 % 42.5 % 44.0 % 45.0 % Other AMAP 25.5 % 22.3 % 23.5 % 24.5 % 25.0 % AMAP 30.5 % 30.6 % 31.3 % 32.1 % 32.9 %
Total Adjusted EBITDA 28.2 % 28.3 % 29.1 %%% 29.6 % 30.4 % Source: Company data, Berenberg estimates
Cash flow and net debt GBP m 2015 2016 2017E 2018E 2019E EBITDA 11,915 11,612 12,629 13,088 13,683 Working capital and other -795 42 100 100 100 Cash generated by operations 11,120 11,654 12,729 13,188 13,783 Cash capital expenditures -8,435 -8,910 -7,694 -6,834 -6,936 Disposal of PPE 178 140 150 150 150 Operating free cash flow 2,863 2,884 5,185 6,504 6,997 Taxation -758 -689 -876 -955 -1,176 Dividend Income (net) 224 67 81 104 128 Dividends paid to non-controlling shareholders -246 -223 -236 -248 -261 Interest received and paid -995 -1,026 -1,045 -1,096 -1,072 Free cash flow 1,088 1,013 3,109 4,308 4,616 Tax settlement 0 0 0 0 0 Spectrum payments -443 -2,944 -2,570 -570 -341 Acquisitions and disposals -7,040 -96 -787 0 0 Equity dividends paid -2,927 -2,998 -3,027 -3,087 -3,149 Purchase of treasury shares 0 0 0 0 0 Foreign exchange 895 -1,968 0 0 0 Dividends from VZW 0 0 0 0 0 Other -144 -2,665 -300 -300 -300 Net debt decrease/(increase) ---8,571-8,571 ---6,904-6,904 ---3,575-3,575 351351351 826826826 Opening Net (Debt) Cash 13,700 22,271 29,175 32,750 32,399 Closing Net (Debt) Cash 22,271 29,175 32,750 32,399 31,573 FCF is after Spring capex of -3,500 -2,950 0 0 0 FCF is after Spring opex of -500 -300 0 0 0 FCF ((per VOD guidance, post Spring, pre-spectrum) 1,088 1,013 3,109 4,308 4,616 FCF (post-Spring and spectrum) 645 -1,931 539 3,738 4,275 FCF (recurring, pre-Spring and spectrum) 5,088 4,263 3,109 4,308 4,616 Dividend cover by FCF (per-guidance) 0.37x 0.34x 1.03x 1.40x 1.47x by FCF (fully loaded) 0.22x -0.64x 0.18x 1.21x 1.36x by FCF (recurring) 1.74x 1.42x 1.03x 1.40x 1.47x Source: Company data, Berenberg estimates
42 Vodafone Group plc Telecommunications
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Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz ––– WpHG)
Company Disclosures Vodafone Group plc no disclosures
(1) Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as “the Bank”) and/or its affiliate(s) was Lead Manager or Co- Lead Manager over the previous 12 months of a public offering of this company. (2) The Bank acts as Designated Sponsor for this company. (3) Over the previous 12 months, the Bank and/or its affiliate(s) has effected an agreement with this company for investment banking services or received compensation or a promise to pay from this company for investment banking services. (4) The Bank and/or its affiliate(s) holds 5% or more of the share capital of this company. (5) The Bank holds a trading position in shares of this company.
Historical price target and rating changes for VodafoneVodafone Group plc in the lalastst 12 months
Date Price target --- GBP Rating Initiation of coverage 02 September 15 2.64 Buy 25 January 10 29 December 15 2.50 Buy
Berenberg Equity Research ratings distribution and in proportion to investment banking services, as of 1 April 2016 in respect of section 5 paragraph 4 of the GermanGerman FFinancialinancial Analysis Regulation (Finanzanalyseverordnung ––– FinAnV)
Buy 50.75 % 78.79 % Sell 13.86 % 0.00 % Hold 35.39 % 21.21 %
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43 Vodafone Group plc Telecommunications
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44 Vodafone Group plc Telecommunications
Company Disclosures Vodafone Group plc no disclosures
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46