Vodafone Acquisition Binge Heightens Debt-Burden Concern

Debt anxieties are stalking Vodafone Group Plc as the company sets about constructing a European fixed-line network after the $130 billion sale of its Verizon Wireless stake.

Vodafone is seeking to become an integrated operator, offering mobile and fixed-line communication services across its core markets. To help achieve that goal, Europe’s largest telecommunications provider is on an acquisition binge, buying fixed-line assets from the U.K. to Germany and Spain.

The most recent of these deals was the 7.2 billion-euro ($9.7 billion) purchase of Spanish cable operator Grupo Corporativo Ono SA in March. Moody’s Investors Service said this week Vodafone could lose its A3 rating -- the fourth-lowest investment grade -- in the absence of action to cut leverage. Standard & Poor’s and Fitch Ratings, which also rank Vodafone four levels from junk, issued similar warnings in March.

“When Vodafone first planned the sale of their U.S. business, they wouldn’t have expected their operations to be declining at this sort of rate and to be doing so much M&A this quickly,” CreditSights analyst Mark Chapman said in a telephone interview. “They wouldn’t have thought they’d need the cash as much as they do now.”

Swaps, Bonds

Vodafone’s shares fell 1 percent to 197.25 pence as of 10:15 a.m. London time. The cost of insuring Vodafone’s debt for five years rose one basis point today to 54 basis points, matching the level it started the year, Bloomberg data show.

That compares with a 12 basis point drop in the Markit iTraxx Europe Index of credit-default swaps on 125 investment-grade companies including Vodafone. Deutsche Telekom AG, ranked one level below Vodafone and also in the index, fell 15 basis points to 51.

Vodafone’s $1.6 billion of bonds due in 2023 handed investors about 5.8 percent this year, compared with a 7.2 percent gain for dollar-denominated investment-grade bonds sold by communications companies, according to Bloomberg bond index data.

In its acquisition of Ono, Vodafone agreed to pay 10.5 times annual earnings before interest, taxes, depreciation and amortization. Last year, it paid 12.4 times Ebitda to buy Kabel Deutschland Holding AG. In the past two years, the average multiple paid for North American and European cable companies was 9.5 in deals of more than 7 billion euros, according to data compiled by Bloomberg.

Investment Mode

Newbury, England-based Vodafone, which declined to comment yesterday on its ratings, is still in investment mode, and has signified that further deals are still possible.

“I strongly believe that if you find a good acquisition, you first have to be very, very convinced of the synergies,” Chief Executive Officer Vittorio Colao said on a conference call May 20. “Then you look at the financing and you do what you need to do.”

Vodafone’s total debt was 28.3 billion pounds as of March 31, according to company accounts. Colao said net debt would be about two times Ebitda at the end of its 2014 financial year.

While that compares with an average of 2.11 times Ebitda among Stoxx 600 telecommunications operators, ratings companies say the acquisition of Ono risks pushing the ratio above thresholds deemed compatible with its existing credit score.

Vodafone still has network gaps to address, with Italy and Portugal among the countries in which it has yet to establish a major fixed-line presence. Should Vodafone pursue similar deals in these countries, there is concern it may struggle to agree on a reasonable price.

Negotiating Position

“Fixed-line assets aren’t freely available to buy, this isn’t a liquid market,” Oriel Securities analyst John Karidis said in a phone interview. “In situations where Vodafone feel they need to buy, this weakens their negotiating position.”

Vodafone has forecast that because of higher spending and weaker underlying operating trends its Ebitda will decline by between 5 percent and 9 percent this year on a comparable basis. The company still intends to increase dividend payouts.

If Vodafone sees better value in building rather than buying the remaining fixed-line networks it requires, it can use the 7 billion pounds of the Verizon Wireless sale proceeds that it put aside for Project Spring, an organic investment program focused on bolstering mobile and fixed networks across all of its markets.

Rick Mattila, a credit analyst at Mitsubishi UFJ Securities International Plc, says Vodafone would not be willing to remain a triple B rated company on a long-term basis.

“Vodafone would only accept a downgrade for the right acquisition opportunity,” Mattila said in a phone interview, “They’d only tolerate it if the situation lasted a year or two maximum. They want to be robust investment grade.”

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