Vodafone: Is The Shine Wearing Off?

As Europe's cellular market matures, investors worry growth is starting to slow

Less than 10 months into the job, Vodafone Group PLC (VOD ) CEO Arun Sarin is finding that investors in the world's largest mobile company are a fickle bunch. On May 25, Sarin unveiled "another set of solid financial results," with double-digit revenue and earnings growth for the year ended Mar. 31 and a balance sheet buttressed by a hefty $15 billion cash pile. Even better, Vodafone announced the eagerly awaited rollout of 3G services in Germany, Italy, Portugal, and Spain and a $4.7 billion bid to gain full control of its Japanese subsidiary. Good news, right? Not to shareholders, who sent the stock plummeting more than 5% the same day.

Investors are used to Vodafone's beating, not meeting, market expectations. This year results were in line with analysts' forecasts: Vodafone revenues rose 10%, to more than $60 billion, leading to a 19% surge in pretax profits before goodwill and exceptional items. But after writing down nearly $28 billion of assets acquired in the heady days of the tech boom, the company posted net losses of $16 billion. The company is still generating huge amounts of cash, though, and underlying profitability is still strong.

The conflict between Sarin and shareholders revolves around that hoard of cash. Investors want a bigger chunk of that $15 billion-plus. Although Vodafone announced a share buyback and a dividend hike, many think the company should be more generous. In turn, Sarin wants the flexibility to pounce on an asset if the right one comes along.

The new CEO claims he is more focused on stitching together Vodafone's far-flung operations than engaging in the kind of spending favored by his predecessor, Sir Christopher Gent. But after being surprised by an ultimately unsuccessful $35 billion bid for AT&T Wireless Services Inc. (AWE ) in February, many investors aren't so sure. "We were hoping for a different message from the new CEO," says Andrew Hobson, a fund manager at Exeter Asset Management. "But the AT&T deal just compounded the notion that Vodafone is willing to do big deals to increase its footprint at any price."

Vodafone is also spending to shore up its position in Japan. With a market share of 18.4%, it's the country's No. 3 operator: The leaders are NTT DoCoMo Inc. and fast-growing KDDI. The highly profitable unit provides about 25% of Vodafone earnings, which is why Sarin wants to buy out minority owners and keep all the lucre on his balance sheet. But at the same time, Vodafone is losing momentum in Japan because consumers aren't flocking to its zippy 3G mobile service. Blame a limited selection of handsets and an earlier, smoother 3G rollout by KDDI, which uses a different technology. Operating profit at Vodafone's Japanese unit fell 20% last year, to just under $2 billion: Revenue per user dropped 7%.


That's why Sarin is hoping the rollout of new 3G services in Europe, where existing mobile markets are rapidly maturing, will drive growth. He's counting on the continued success of new products such as Vodafone live!, the multimedia service that has attracted 6.8 million customers in the past 18 months. Vodafone is expanding the service's content beyond music and photos to include video downloads. In February, Vodafone launched a mobile data card giving laptop-toting road warriors access to Vodafone's 3G networks. "Sarin is extremely focused on turning advanced new technologies into product," says Simon Weeden, a telecom analyst at Goldman, Sachs & Co. (GS ).

The Indian-born CEO admits some acquisitions are possible. He has made little secret of his desire to acquire full control of French wireless player Groupe SFR Cegetel, from parent Vivendi Universal (V ). He's interested in snapping up Verizon Communications Inc. (VZ )'s 23.1% stake in Vodafone Italy (GS ). Analysts say Sarin also is looking at investments in India and Russia."Nothing is imminent, and everything is possible," says Sarin. Investors are praying his reach won't exceed his grasp.

By Kerry Capell in London

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