Vodafone's Gent May Be Making the Wrong Call

He still believes in a wireless data bonanza, while competitors have scaled back

By Kerry Capell

Wake up, Chris Gent. Two years ago, the Vodafone Group PLC (VOD ) chief executive pulled off the biggest corporate merger in history when he acquired Germany's Mannesmann for $163 billion--at the top of the telecom bubble. Other telco execs who made monster deals in that heady time have written off billions in assumed value, as they saw the market for cell-phone services head south.

Not Christopher Gent. He steadfastly maintains that the billions he spent creating the world's largest wireless-phone operator was money well spent. Gent's still in all-out-growth mode, convinced both customers and revenues will power along indefinitely. Vodafone will introduce new services for its cell-phone network later this year that will "sustain long-term growth for years to come," he says. Gent feels customers will soon be accessing messages and other data in huge, profitable batches.

But Vodafone's days as a high-growth outfit are over. The British company's main source of new revenues is new customers. This engine is grinding to a halt. In Europe, which accounts for three-quarters of its 101 million customers, cell-phone ownership averages about 70%, indicating the market is near saturation. In the U.S., where Vodafone has a 45% stake in the No. 1 player, Verizon, analysts estimate 75% of all the people who will ever own cell phones already do.

And data? That has turned out to be a dud. The next-generation mobile Internet, a faster service known as 2.5G, has yet to win over consumers, because there are few innovative applications. As a result, some analysts think Vodafone's average revenue per user will be flat for the next decade. And in key European markets such as Germany, it is already falling. Gent's bold dream--to become King of the Wireless Web--is likely to remain just that. "Gent fell in love with his own rhetoric and thought the incredible growth of the past would go on forever," says Philip Townsend, director of global telecom research at London brokerage Arnhold & S. Bleichroeder Inc.

No other company has as much riding on the success of the mobile Internet as Vodafone. It embarked on a three-year, $300 billion spending spree. But by taking a relatively small $9 billion write-down on these purchases, Gent is saying that he believes his company is immune from the precipitous drop in the value of mobile assets. Vodafone's write-down was paltry in comparison to the $135 billion in goodwill on its balance sheet, and well below those taken by much smaller rivals such as the Dutch company KPN, which booked a $13.6 billion charge on its mobile assets last year. Gent's credibility is on the line, says London-based Robertson Stephens telecom analyst James Stanzler.

Gent shrugs off the criticism. True, amortization charges pushed Vodafone's pretax losses to $20 billion for the year ended in March--the largest in British corporate history. But Vodafone has stronger cash flow, and lower debt than its rivals. Revenues for the year ended in March were up 52%, to $34 billion. Free cash flow was strong at $3.6 billion, largely because Gent delayed the buildout of 3G networks and cut capital expenditures by $6.2 billion. Moreover, Vodafone's net debt of $8.3 billion is much smaller than many of its rivals' because Gent used Vodafone's shares to fund acquisitions.

These numbers aren't sustainable, however. For one thing, 80% of that revenue growth came from acquisitions such as Ireland's Eircell, and by Vodafone increasing its holdings in mobile players such as J-Phone in Japan. Capital expenditures are set to rise as Vodafone funds its 3G network later this year. Gent also will have to ramp up spending to encourage software developers and content players to create the kind of cool new data offerings upon which Vodafone's future profitability depends. Meanwhile, Gent is still in acquisition mode. He hopes to increase the company's holdings in the mobile-phone companies in which it has minority stakes. His likely first target: France's second-largest mobile operator, SFR, which is indirectly controlled by Vivendi Universal. With the French media giant under pressure to sell assets, a bid from Gent could be imminent. Gaining majority control is a wise move, especially at today's low prices. But if mobile asset values deteriorate further, Gent may be forced to take the massive write-downs he has resisted.

New acquisitions will help bolster subscriber numbers and revenues in the short-term. That helps buy Vodafone some time as it waits for revenues to come in from yet-to-be-launched data applications. It's currently testing a picture-messaging service in Germany and Portugal. But the service requires sophisticated phones, and Vodafone may end up having to swallow some of the cost of the $500-plus handsets to encourage customers to buy them. And it's unclear how popular such services will be after the novelty value wears off.

If Gent is to make wireless data the money-spinner he claims it can be, he'll need to invest as heavily in its promotion as he did in acquisitions. To make money, you have to spend money. Trouble is, in telecom it can be a lot easier to spend big and lose even more. Gent has yet to prove he has a strategy that's grand and not just grandiose.

Capell covers the European technology market from London.

    Before it's here, it's on the Bloomberg Terminal.