After recent results, shares in FTSE 100 telecoms firm Vodafone (VOD) remain undervalued, according to Morningstar analysts. The company has a fair value estimate of 250p per shares, against a current price just above 150p per share.
Vodafone is successfully transitioning from one of the world’s largest wireless-only telecom companies to a diversified operator offering converged mobile and fixed-line services in many markets. We think this is an important transition as Europe is rapidly moving into a converged world. The acquisitions of Kabel Deutschland in Germany, Ono in Spain, and Cable & Wireless Worldwide in the United Kingdom provide Vodafone with some key fixed-line infrastructure in three of its biggest European markets.
It has now agreed to acquire Liberty Global’s operations in Germany, Romania, Hungary, and the Czech Republic. This deal, if it receives regulatory approval, will significantly strengthen Vodafone’s convergence strategy. However, we remain sceptical of its ability to receive regulatory approval, particularly in Germany. In the past, the German regulators have stopped at least three attempts to consolidate the German cable market. That said, Vodafone claims that the regulatory environment has changed and it expects approval. We think all these deals position Vodafone to compete more effectively. The company has also dramatically increased its enterprise business, which now accounts for 27.7% of revenue and tends to have long-term contracts.
Vodafone has also improved the quality of its networks, enabling it to compete more on quality and less on price. Management believes customers who want the fastest and most reliable wireless network will be willing to pay a premium for that service. We are beginning to see this strategy work, as many new customers are opting for higher-priced packages. We anticipate this will increase as quality becomes increasingly important with the growth of data usage.
Cost and Scale Advantages
We believe Vodafone has a narrow economic moat, or slender competitive advantage, as a result of cost advantages and efficient scale. Vodafone is one of the largest wireless phone companies in the world, with 274.9 million proportional customers, excluding India and partnership networks. Where it doesn’t have its own operations, it has formed strategic partnerships. More important than its global size is the scale it has within its various markets and the quality of those networks. Thanks to Project Spring, the quality of the company’s network is almost always in the top two, allowing it to compete more on quality than on price. As telecom networks are expensive to build and maintain, the more customers an operator has on its network, the more people it can spread its fixed costs over, thus reducing the average cost per subscriber.
Vodafone’s scale also provides it with some advantages over competitors, allowing it to source equipment at lower prices. The company can develop a product in one country and roll it out to others at minimal additional expense. In addition, many countries are selling additional spectrum. Thanks to Vodafone’s scale, it can afford to bid for more spectrum, which improves the quality of its network, thereby attracting more valuable heavy data users. The high costs of building and maintaining a network tend to limit the number of operators in a country, which leads to an efficient scale moat.
