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Vodafone outshines BT

Vodafone is firmly in recovery mode, while BT continues to battle rising costs
February 8, 2018

When regulation and competition constrained the dominance of Britain’s telecoms giants in the early 2000s, Vodafone (VOD) and BT (BT.A) embarked on very different paths. The former looked overseas and focused on expansion in the underserved European and Indian markets. The latter went into the consumer space, taking on Sky (SKY) in pay-TV and – after buying EE in 2014 – O2 and Three in the world of mobile phones.

IC TIP: Sell

Neither strategy has fully alleviated either company’s difficulties. Vodafone continues to be battered by competition and BT has been hampered by its exorbitant spending requirements. But where Vittorio Colao has recently managed to heave Vodafone back into shareholders’ good books, Gavin Patterson at BT is facing rising investor disquiet and growing calls for a management overhaul.

The global expansion strategy has helped Vodafone return to organic revenue growth, albeit modest. In the third quarter of the 2018 financial year, strength in its African and German subsidiaries helped offset challenges in the UK, the Netherlands and Spain, meaning like-for-like service revenues ticked up by 1.1 per cent. By contrast, BT’s third quarter was defined by poor demand in its corporate, wholesale and public sector divisions, which dragged underlying revenue down 2 per cent. The group still seems to be struggling to sort out the problems in the global services division, where management uncovered a major accounting scandal over a year ago.

With much of Vodafone’s stronger top-line performance coming from its high-margin operations, management expects a 10 per cent leap in like-for-like adjusted cash profits in the full year to March 2018. It seems BT will be lucky to maintain its cash profit numbers at the same level as last year, given its onerous spending commitments. Vodafone anticipates €5bn (£4.4bn) of annual cash inflows (excluding the costs of maintaining the mobile spectrum), while BT’s annual free cash flow is expected to fall by a quarter to £1.8bn, according to broker Numis. With cash flows wobbling, BT’s investors have shown little faith in the dividend, which has a forecast yield of 6.6 per cent.

It turns out BT’s expansion into the consumer market was not the right strategy to spur sufficient revenue growth. The telco has been left with too many demands on its dwindling cash resources, which look unlikely to let up in the near term. Later this month, the rights to the Premier League come up for sale and BT (alongside its partner Sky) are expected to have to dig deep. This year, Ofcom will begin its mobile network spectrum auction, which last time cost EE £589m. And before 2020, Openreach (which is a legally separate company but still 100 per cent owned by BT) has promised to provide 3m British households with full-fibre broadband, which is expected to cost £3.6bn. Openreach has already admitted it can’t afford to lay its new full-fibre broadband network without financial support and finding someone to foot the bill might be tricky. Wholesale customer TalkTalk (TALK) said, “it’s crucial the transition to full fibre is not used to conceal large price rises for consumers”.

Spending at Vodafone has also been hefty, but far better managed. Between 2014 and 2016 the group ploughed £19bn into mobile, fixed-line and broadband to help attract higher-margin customers in all its geographic subsidiaries. Last year, the group agreed to help CityFibre (CITY) deploy full-fibre cables to 1m UK homes before 2020 – a move that puts pressure on Openreach. Vodafone has also confirmed it is in talks to buy some of the European assets of peer Liberty Global in a deal that analysts think cost between $22bn and $24bn. A merger would double Vodafone’s German cable broadband footprint and allow it to bundle mobile and fixed-line telecoms contracts across the continent.