Mobile Telecommunications: International Operations at Vodafone - Case Study Example

VODAFONE: ANALYSIS OF INTERNATIONAL OPERATIONS Company Overview Vodafone is the largest mobile telecommunications network company in the world having equity networks in 25 countries and Partner Networks in additional 36 countries with an approximate 198.6 million customers worldwide as at December 31, 2006. The company has a total employee strength of 60,000, which grew at a rate of 4.6% for the year 2006. Vodafone was formed in 1984 as a subsidiary of Racal Electronics Plc. In September 1991, it was fully de-merged from Racal Electronics Plc and became an independent company, at which time its name changed to Vodafone Group Plc (www.vodafone.com). Between 1991 and 1999, the Group consolidated its position in the UK and enhanced its international interests through a series of transactions. As of March 1999, the Group had subsidiary mobile network operating companies in six countries - the UK, the Netherlands, Greece, Malta, Australia and New Zealand. Between 1999 and 2003, the Group furthered its transaction activities thereby transforming the company into the world's leading international mobile telecommunications company (Vodafone Annual Report, 2006). Vodafone Group provides a wide range of voice and data mobile telecommunications services, including text messages (SMS), picture messages (MMS), and other data services. The Group is continually expanding its product line and enhancing its service offerings, particularly through third generation (3G) mobile technology. In the wake of fierce competition and narrowing margins, Vodafone is continuously innovating to keep pace with the changing environment. Besides competition, the list of drivers changing the environment also comprises challenging regulatory environment, and continuous development in technology which means there is far more choice for customers. Historically, growth in Vodafone's portfolio has come from developed markets, particularly Europe. Due to high penetration rates (100%) in such markets, Vodafone is now concentrating on emerging markets which poses greater potential for growth due to low penetration rates (average 30%). 2. Strategic Analysis Vodafone has a strategy of expanding business through acquisitions, partnerships and joint ventures in the telecommunication industry. The Group cleanses its portfolio by disposing off underperforming assets that have an impact on its resources. Vodafone has invested only in those geographical regions where it has seen chances of superior returns for its shareholders. Key developments in the history of the Group are as follows: Timeline of Vodafone Group 1999 - Vodafone merged with Air Touch Communications which changed its name to Vodafone Air Touch. The Group had mobile operating subsidiaries in 10 countries and equity interests in an additional 12 countries. 2000 - Vodafone set its footprint in Germany and Italy through acquiring Mannesmann AG. Vodafone also increased its indirect holding in SFR, a French mobile telecommunications operator. Moreover, the Group's US mobile operations combined with Bell Atlantic and GTE Corporation to form Verizon Wireless. 2001 - Vodafone acquired Eircell Limited, a mobile operator in Ireland and set its footprint there. Moreover, the Group acquired 66.7% stake in a fixed line operator in Japan, Japan Telecom Co. Ltd. Since March 2003, Vodafone has undertaken multiple subsidiary acquisitions in Egypt, Greece, Hungary, Japan, Malta, Portugal, Sweden, Netherlands, and UK. Vodafone has had joint ventures in India, Fiji, Kenya, Poland and South Africa. Vodafone Group faces a high degree of competition in each of its geographic markets. It is subject to both indirect competition, from providers of other telecommunications services in the domestic markets and, direct competition from existing mobile telecommunications network operators. Many of Vodafone's key markets are highly penetrated due to a large number of customers having more than one subscriber identity module (SIM), the basis of customer identity for a mobile telecommunications network operator (Vodafone Annual Report, 2006). As stated in the Vodafone Annual Report 2006, Vodafone has established five key strategic objectives: 1. To deliver strong growth in emerging markets Having delivered strong performances over time in markets such as Egypt and South Africa, Vodafone intends to continue delivering strong growth in emerging markets. Vodafone's primary objective is to increase stakes and gain greater control in existing markets apart from conquering new markets. As a step toward entering emerging markets, Vodafone has expressed interest in acquiring an Indian mobile operator, Hutch Essar. Hutch Essar is a rapidly growing mobile operator with over 23 million customers and a 16% market share. This strategic partnership with Hutch Essar will not only give Vodafone a competitive edge over other UK operators but most importantly a slice of market share from the world's second most populated country. Vodafone plans to deeply penetrate the Indian market through an accelerated network investment. Vodafone, through Hutch Essar, can launch its innovative products and services in the Indian market and provide total communication solutions to its Indian customers. By expanding distribution and network coverage, and lowering the total cost of network ownership, Vodafone will be in a strong position to grab a bigger slice of market share. It is believed that this transaction will enhance Vodafone's growth profile and increase its revenue. Moreover, it will provide Hutch Essar with an increased purchasing power and the sharing of best practices. 2. To satisfy customer needs by delivering innovative total communication solutions Vodafone plans to deliver total communication solutions to its customers, including richer business applications and integrated fixed and mobile services, by extending its reach into the home and the office. This will not only make Vodafone a complete service provider, but also equip Vodafone Group with a competitive edge. 3. Active management of portfolio to maximize returns Management at Vodafone Group seeks to invest only in geographic regions that turn out to be profitable for the company and provide superior returns to its shareholders. For instance, Vodafone Group wishes to maintain its stake in Verizon Wireless in anticipation of continued strong growth in the United States (Vodafone Annual Report, 2006). 4. To focus on cost reduction and revenue stimulation in Europe. Cost reduction is Vodafone's primary objective. One of the approaches used to reduce costs and maintain Vodafone's competitiveness is outsourcing, particularly for IT development of billing and customer management systems. Vodafone also intends to take advantage of economies of scale benefits, either at a global level in areas such as network supply chain management, or regionally through the establishment of data centres to support European operations (Vodafone Annual Report, 2006). Revenue stimulation is the other side of the coin. Vodafone aims to stimulate revenue in Europe where majority of voice traffic continues to travel across fixed lines. Vodafone aims to stimulate additional voice usage and substitute fixed line usage for mobile in a way that enhances both customer value and revenue. Moreover, in order to stimulate voice usage, Vodafone aims to reduce tariffs and deliver innovative bundles in areas such as 3G, family plans, and roaming through Vodafone Passport (Vodafone Annual Report, 2006). 3. Financial Review Revenue for Vodafone in 2006 surged to 29.4 billion, a growth of 10% over the prior year. Principally, revenue for the Group is generated from its operations iin Italy, UK, Spain and Germany. As the graph below substantiates, 63% of the Group's revenue is a result of operations in these four countries. Source: Vodafone Annual Report, 2006 Similarly, these four countries account for almost half (44%) of the Group's total customer strength. This is evident in the following graph: Source: Vodafone Annual Report, 2006 Revenue in general for the Group has seen a fluctuating trend in the last five years. As indicated in the table below, years 2003 and 2004 marked healthy turnovers which dipped in 2005. 2006 turnover surged primarily due to operations in Germany which accounted for 19% of its total revenue. However, in terms of profitability, Vodafone did not satisfy its shareholders. Impairment losses dipped into the equity of the company with the result that return on equity and return on assets saw a negative figure. Despite the losses incurred by the company, it returned a dividend yield of 46%. The current ratio of the company, which assesses the capacity of the company to meet short-term obligations (Cinnamon, Helweg-Larsen, 2006), fell in 2006 to 0.49 from 0.64 in 2005. This drop is largely due to shortfall caused by the net loss that the Group faced in 2006. However, on a stand-alone basis, a current ratio of 0.49 is generally viewed as an acceptable figure particularly in the telecommunications business. The total assets of the company marked a fall of over 20 billion. This fall in the assets and, in turn the equity of the company, has primarily been due to the impairment losses that Vodafone faced. The long-term debt-to-equity ratio of the company stands at 0.23 in 2006 which substantiates that Vodafone is not very much inclined toward long-term debt in financing its resources. Vodafone Group's ordinary shares are listed on the London Stock Exchange and the company's American Depository Receipts (ADRs) are listed on the New York Stock Exchange (NYSE). As at May 26, 2006, Vodafone Group had a total market capitalization of 72 billion making it the fifth largest company in the Financial Times Stock Exchange 100 index and the twenty second largest company in the world in terms of market capitalization (Vodafone Annual Report, 2006). The share price of Vodafone has depicted a long-term uptrend in the last 5 years with intermittent dips in between. Year 2006 experienced a substantial dip in the share price primarily driven by impairment losses. This is evident in the graph below: Source : www.lse.co.uk The earnings per share, which is profit divided by the number of issued shares (Emery, 1998), have seen a significant drop in 2006 since the Group reported a net loss of over 13 billion. Basically, the loss per share was 27.66p in 2006 from a profit per share of 8.12p in 2005. The trend for EPS is downward in the last few years. Beta, which is a measure of the volatility, or systematic risk,of a security or a portfolio in comparison to the market as a whole, of Vodafone, taken from its website, is 0.83 which means that every time the FTSE moves up, Vodafone stock will follow the market in the same direction, however, with relatively less sensitivity. Beta < 1 is indicative of defensive shares. These shares will generally experience lesser than average gains in a rising market and lesser than average falls in a declining market. Following table shows a summary of some important ratios for the company over the last few years: Ratio Analysis Ratio 2006 () 2005 () 2004 () 2003 () Turnover 29,350m 26,678m 33,559 30,375 Net Income -21,916m 6,410m -9,015m -9,819m Assets 126,738m 147,197m 147,129m 163,239m Liabilities 41,426m 33,549m 32,198m 31,746m Equity 85,312m 113,648m 114,931m 131,493m EPS -40.01p 11.06p -15.13p -16.47p Dividend 6.94p 4.65p 2.32p 1.93p 4. Risk Management Every company in its operations faces a number of risks that deter its revenue and warrant efficient risk management strategies. Vodafone Group is no exception. Being a multinational organization, the Group faces various kinds of risks which need to be analyzed and reduced, if not eliminated. These risks are outlined below: Business Risk Any company must seek to understand the nature of its competitive environment if it is to be successful in achieving its objectives and in establishing appropriate strategies. It is important to analyze factors outside an industry that influence the nature of competition within it (Thurlby, 1998). Increased competition may reduce market share or revenue. Delays in supply of equipment may hinder deployment of new technologies. Expected benefits from investment in networks and licences may not be realised. The main business risk facing Vodafone is the success of its products and services offered in competitive environments like Italy, Germany, Spain, UK and other countries where it is located which offer similar products at competitive prices. Exchange Rate Risk Vodafone is primarily listed on the London Stock Exchange, therefore, its share price is quoted in sterling. The sterling share price, however, represents the value of its multi-currency cash flows, principally in euro, yen, and dollars. To protect any unfavourable exchange rate movements, the Group has a policy to hedge external foreign exchange risks on transactions denominated in other currencies that are above a certain threshold. When the Group's international net earnings for the year ended March 31, 2006 are retranslated assuming a 10% strengthening of sterling against all exchange rates, the operating profit for the year would have increased by over 1.3 billion. On the contrary, a 10% weakening of sterling against all exchange rates would have decreased the operating profit by over 1.6 billion (Vodafone Annual Report, 2006). This shows how critical it is to effectively manage foreign exchange risk. Moreover, the Group also maintains the currency of debt and interest charges in proportion with its expected future principal multi-currency cash flows. As at March 31, 2006, 113% of net debt was denominated in currencies other than sterling (Vodafone Annual Report, 2006). Market Risk Under market risk, the most important consideration is prudent interest rate management. According to the Vodafone Group's interest rate management policy, interest rates on monetary assets and liabilities are maintained on a floating-rate basis. However, these rates are converted to fixed rates when interest rates are statistically low, so as to protect the Group from unnecessary losses caused due to reckless interest rate management. As at March 31, 2006, the Group's gross borrowings were fixed for a period of at least one year (Vodafone Annual Report, 2006). Liquidity Risk It is imperative for any company to ensure there is sufficient cash flow to meet short-term obligations so that business viability is not questioned. As at March 31, 2006 Vodafone had 10.9 billion in committed undrawn bank facilities available to manage its liquidity. Operational Risk The occurrence of major operational problems could have an adverse effect on the Group's financial condition. The Group's revenues are dependent on its continued operations. Vodafone is exposed to operational risks such as equipment and systems failures, supply disruptions, labour shortages, events leading to increased operating costs, etc. Though Vodafone Group maintains insurance, some of these operational risks could result in losses and liabilities in excess of its insurance coverage. 5. Conclusion & Recommendations Analysis of the international operations of the company has revealed that geographic dispersion works in favor of the Group by significantly contributing to its revenue. In line with such a finding, Vodafone should continue to expand its operations in countries that pose scope for growth which can be primarily determined by the penetration rates in markets. For instance, China is a growing economy and poses many opportunities in the telecommunications sector. This is evident by the fact that telecommunication sector's growth rate in China between 1997 and 2002 was about 20%. As a result, China became the single largest telecom market in 2002 (Uria-Recio, no date). Just like Vodafone has decided on an acquisition strategy in India to take advantage of the growing subscriptions from the world's second most populated country, China can be a consideration along the same line being the most populated country in the world. Such a diversification will not only enhance revenue for the Group, but also provide benefits in terms of risk reduction. For instance, weak performance from operations in any other country may be compensated by growing revenue from China and India. Business cycles and economic conditions vary across each country and investing in markets whose business cycles are not correlated can further magnify the diversification benefits. It is also recommended that Vodafone embarks on a prudent risk management strategy. Efficient management of its foreign currency operations can potentially have a significant positive impact on the Group's aggregate revenue. Moreover, Vodafone should emphasize on employee training to create a sound awareness in employees of how to reduce operational errors at workplace. Such an effort can likely bring down operational risks facing the company. In terms of cost-control and efficient resource utilization, the Group can consider outsourcing certain operations where it sees potential for reducing costs. For instance, Vodafone can outsource its IT operations regarding billing and customer information management systems. WORKS CITED ADVFN Financials (no date). Retrieved on May 7, 2007 from http://www.advfn.com/p.phppid=ukfinancials&symbol=L%5EVOD Cinnamon, Robert, and Brian Helweg-Larsen. How to Understand Business Finance. New Delhi: Kogan Page, 2006 Emery, G.W. (1998). Corporate Finance: Principles & Practice. Addison- Wesley, New York. Porter, M.(1998). Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York: Free Press. Thurlby, B (1998). Competitive Forces are also subject to Change, Management Decision, London. Uria-Recio, P. (no date). China Telecommunications Panorama. Retrieved on May 7, 2007 from http://chinese-school.netfirms.com/articles/Telecommunications-China.html Vodafone (no date). Retrieved on April 23, 2007 from http://www.vodafone.com Vodafone Annual Report 2006. Retrieved on April 23, 2007 from http://www.vodafone.com Read More