Interactive Investor

Vodafone shares reflect dividend event ahead of expected Three merger

8th June 2023 13:30

by Graeme Evans from interactive investor

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Speculation that the beleaguered mobile phone giant is tying up with a rival network has failed to trigger much of a revival. Our City writer examines the current situation.

Vodafone shop 600

A morale boost for investors who’ve been snapping up ailing Vodafone Group (LSE:VOD) could come tomorrow with a deal to create the UK’s biggest mobile phone network.

Vodafone’s expected merger with CK Hutchison (SEHK:1)-owned Three will kickstart a period of planned consolidation aimed at improving returns in the key markets of UK, Spain and Italy.

The development comes with the London market’s one-time largest stock trading at its lowest level in 25 years, driven by a fall of 40% since last summer as competition intensifies.

The selling has continued even though new boss Margherita Della Valle has vowed to accelerate change, including by simplifying the organisation, cutting out complexity and taking steps to regain the company’s competitive standing.

The turnaround potential of a former FTSE 100 giant has tempted plenty of retail investors, particularly given the mobile phone giant’s dividend yield now approaches 10%.

Such a lofty level comes with a health warning, with Bank of America among those recently flagging the risk of a 30% dividend cut. However, the bank’s analysts think such a move is a price worth paying if it leads to a more sustainable 6% yield along with a better Vodafone.

The total dividend was an unchanged nine euro cents a share in last month’s annual results, with the full-year distribution of 4.5 euros cents due in shareholder accounts on 4 August. The total dividend is only just covered by earnings of 11.45 euro cents for the year to 31 March.

Today’s ex-dividend date, meaning the stock no longer trades with the right to the latest payout, contributed to shares falling by 3.76p to 74.72p at lunchtime.

UBS has a price target of 105p, believing that a key driver of investor sentiment will be evidence that operational trends are improving in Vodafone’s largest unit of Germany, which accounts for 30% of revenues. The recent annual results showed a 1.6% decline in service revenue growth and 6.1% slide in adjusted earnings.

Price rises in Germany should help support revenues despite weakening subscriber trends, but UBS warns there may be new headwinds from the unbundling of basic cable TV revenues.

It added that the company’s drive to devolve more responsibility to country CEOs has the potential for faster decision making with greater accountability at the local level.

Vodafone is also focused on M&A to improve returns in Spain, UK and Italy. In the UK, this would create a scale challenger to BT Group (LSE:BT.A) and Virgin Media O2.

UBS telecoms analyst Polo Tang said last month: “We think little is priced in for M&A optionality or a recovery in the business. However, investors are likely to adopt a wait and see approach before re-rating the shares.”

Vodafone and Three are the third- and fourth-largest network operators in the UK, with the merger creating a venture with 27 million customers and the scale to invest in network and 5G expansion. The Newbury-based firm is set to have 51% of the combined venture.

Reuters reported on Wednesday that the tie-up, which is likely to attract scrutiny from the competition regulator and Ofcom, could be announced on Friday or early next week.

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