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Vodafone: Waiting for 3Godot

By Kerry Capell In the last three years, Vodafone CEO Chris Gent embarked on a $300 billion spending spree to create the world's leading wireless-phone company. As its stock soared to dizzying heights, shareholders applauded Gent's vision of a cellular giant whose unparalleled global reach would enable it to dominate the wireless Web. Now those same shareholders are losing patience. The value of cellular companies around the world has nosedived, and the expected rollout of so-called third-generation (3G) wireless technology has been delayed again.

Witness the rapid decline of the British company's fortunes. Vodafone's stock has plummeted more than 60% from its high of $6 per share at the start of 2000. The bad news for investors is that the bloodbath is likely to continue. "The market has been slow to discount just how bad things are for wireless companies, and Vodafone in particular, as its exposure to 3G is so much bigger," says Arnhold & S. Bleichroeder's head of global telecom research, Philip Townsend. He reckons Vodafone's shares are worth 75 cents each, a fraction their current price of $2.70.

STILL DREAMING. Such dire predictions haven't stopped Gent. Despite posting the biggest pretax loss in British corporate history -- $20.6 billion for the year ending in March -- the CEO is committed to his dream of becoming king of the wireless Web. He doggedly insists that exciting new data services will "transform people's lives" and fuel Vodafone's earnings for years to come.

Yet investors increasingly realize -- even if Gent doesn't -- that Vodafone's days as a fast grower are numbered. To date, cellular companies' main revenue source is adding subscribers. But this engine is grinding to a halt. In Europe, which accounts for three-quarters of Vodafone's 101 million customers, cell-phone ownership averages about 70%, indicating that the market is near saturation. And in the U.S., where Vodafone has a 48% stake in No. 1 player Verizon, analysts estimate that 75% of people who might own cell phones already do.

Clearly, the mobile industry is maturing, and in its next phase, the real money won't be made from adding customers but from keeping existing ones and getting them to spend more. For the past year, faster mobile Internet service -- dubbed 2.5G -- has been up and running in most of Vodafone's core markets. But consumers aren't interested. Vodafone refuses to say how many of its customers are now using 2.5G, but the early indications aren't promising.

EMPTY BRIDGE. A dearth of innovative services and applications means few consumers are inspired enough to fork out the $485 price tag for the only handset on the market capable of using the technology. Unfortunately, 2.5G was meant to be the bridge to the even faster 3G technology on which companies such as Vodafone have staked billions of dollars. The seeming failure of 2.5G doesn't bode well for its successor technology, and that's very bad news for wireless companies all around.

Of course, Vodafone's problems are the same as its rivals, just on a much bigger scale. By virtue of its size, Vodafone is the industry's bellwether. The only difference is that no other outfit has as much at stake in the success of 3G. That explains why Gent remains unwilling to write down the value of the wireless assets on its books.

Although Vodafone has $135 billion in intangible goodwill on its balance sheet -- the bulk of which is related to its mobile stakes -- it took only a writedown of $6 billion this past year, most of it associated with fixed-line assets. The market was expecting a much heftier charge, but to do so would put Gent in an awkward position as investors would view it as an admission that the past few years' profligate spending harmed rather than enhanced shareholder value.

LOWERING VOICE. To justify keeping the valuation of his mobile assets high, Gent is predicting strong revenue growth in the coming years. The only two sources for it, though, are voice and data. Voice accounts for 89% of the group's gross income. Its take from data, mainly from short-text messaging, accounts for the remainder.

In the future, analysts say voice revenues will continue to decline, making data all the more important. But average revenue per user (ARPU) is falling across Vodafone's operations, according to telecom-research consultancy Arc Group. Indeed, Commerzbank reckons that ARPU will remain flat for the next decade.

Still, Gent points to Vodafone's better-than-expected recent results. For the year ending in March, revenues were up 52%, to $34 billion, and earnings before interest, tax, depreciation, and amortization were a respectable $15 billion. Only 20% of that revenue growth, however, was organic. The rest came from acquisitions.

STILL SHOPPING. The real good news was the group's strong cash flow: $3.6 billion for the year ending in March. This was largely because capital expenditure was cut by $6.2 billion as the group delayed the buildout of its 3G networks. Moreover, its net debt of $8.3 billion is much less than that of many of its competitors as Vodafone used its highly valued shares to fund acquisitions.

But these numbers aren't sustainable. Capital spending is set to rise as Vodafone funds its 3G network later this year. Gent will also have to ramp up spending to give software developers and content players the incentive to create the kind of cool new data offerings upon which Vodafone's future profitability depends. Meanwhile, the CEO is still in acquisition mode. He hopes to increase the outfit's holdings in the mobile companies in which it has minority stakes.

Of course, with valuations of these concerns falling through the floor, Gent is likely to pick up some bargains. His first target will probably be France's SFR, currently owned by Vivendi Universal and in which Vodafone has a 31.9% interest. Analysts expect that a deal is unlikely to materialize before 2003, but with Vivendi under increasing pressure to divest noncore assets, Gent may get his chance even sooner. Vodafone's management believes the company's shares are seriously undervalued, so it's likely to pay for any future deals with cash.

Such acquisitions will help bolster subscriber numbers and revenues in the short term. And that would help buy Vodafone some time as it waits for revenues to come in for yet-to-be-launched snazzy data applications. But if those revenues are slow to materialize, as many analysts expect, Vodafone's shareholders stand to lose a lot more than they have already. Capell is a London-based correspondent for BusinessWeek

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