Vodafone Q1 FY11–12 management update; business slows, but executives maintain guidance
31 August 2011
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Vodafone’s Q1 Interim Management Statement, covering the quarter to 30 June 2011, featured a challenging mix of promise and pain.
Revenue grew 1.5% at the Group level, but with significant difference between and within divisions. In the European Union, there was clear divide between a solid north and flaky south, while, in the Africa, Middle East and Asia Pacific (AMAP) Region, shadowy weakness in Australia and New Zealand held back the India and Vodacom powerhouses. Turkey, Europe Region’s own emerging market, was another performer.
Initially sounding detached, even bored, Chief Executive Vittorio Colao and Chief Financial Officer Andy Halford presented a satisfactory quarter that delivered expansion of mobile data and emerging markets revenue growth, offsetting continuing decline in traditional voice revenue, with asset sales continuing to strengthen the underlying corporate financial position.
Disconcertingly, however, executives were obliged to concede that momentum slowed on the previous quarter, and spent much time fending off probing questions from analysts who sought to quantify threats from over-the-top (OTT) services, cannibalisation of traditional voice and data services by Internet Protocol (IP) data, and macro-economic pressures.
Exchange rate fluctuations obscured analysis of operating company (OpCo) and divisional performance, flattering the weaker eurozone operations, and sapping the emerging market flyers.
Despite feeling confident enough to reiterate full-year and medium-term financial guidance, Colao and Halford repeatedly had to defend comparatively higher capital expenditure (capex) and weaker free cash generation, claiming these simply reflected phasing over the fiscal year, rather than worrying trends. Possibly departing from his script, Colao interpreted the capex spike as positive, since it predominantly reflected strong demand for data in Germany and South Africa.
The spectre of regulator-mandated cuts in mobile termination rates (MTR) haunted the results, notably decimating growth at the German, New Zealand, and UK OpCos. Vodafone treats MTRs as exceptional, excluding them from its favoured organic measures of performance, but truly they are an intrinsic market dynamic for the foreseeable future, so are exceptional only in timing rather than recurrence.
Vodafone Group, Q1 FY11-12 financial highlights
[Table omitted]
Vodafone, Q1 FY11-12 geographic revenue analysis
[Table omitted]
Vodafone Group, Q1 FY11-12 proportionate revenue analysis
[Table omitted]
Data drives growth, but IP cannibalisation unsettles
Data was again a standout in the quarter, with revenue up 25%, led by increased smartphone penetration and heavy promotion of associated ‘data attach’. Some analysts wondered whether smartphone growth might be slowing, but this was denied. While Halford conceded that momentum may have slowed in Q1, he said this was only because the company was cherry-picking customers.
The Group continues to see great opportunity for data, certainly over the next two-to-three years. Not only is there scope to raise smartphone penetration within the contract customer base, but the prepaid customers have scarcely been tapped. The company highlighted introduction in Italy of an integrated prepaid tariff, targeting the country’s unusually high proportion of premium customers in this segment. Also lauded was introduction of EUR99 smartphones.
“ I have to reiterate, we cannot treat consumer prepaid as one thing. There are high-usage customers that, for example, in Italy, will need to be managed exactly the same way as you manage contract [customers]. So, you give bundles: you give ‘daily bundles’, ‘weekly bundles’, whatever it is going to be. But, at the end of the day, the dynamic of migrating these customers into richer platforms with richer experiences, on data, on voice, on SMS, will actually be exactly the same as contract. ”
– Colao.
Promoting smartphone adoption with data-attach requires heavy commercial investment, activity that recently hurt margins in Spain and the UK. While boasting success growing data revenue, Vodafone clearly wants much more, with Colao repeatedly contrasting far higher data usage in the USA, but investors have concerns about both the impact of IP substitution on traditional voice and messaging revenue, and the danger of OTT interlopers. The Group is now promoting data attach and integrated tariffs with every smartphone sale, as it also seeks more multi-product sales.
“ What you [analysts] call the ‘cannibalisation’, I call ‘substitution’… [IP migration and tariff enrichment is] not cannibalising revenue, it’s substituting usage — or it’s going to. ”
– Colao.
At present, smartphone penetration is put at around 34% in Europe Region, varying widely across OpCos, with the UK highest at about 60%. Associated data attach is in the range of 60%-70%. Michel Combes, Chief Executive for the region, posited that penetration could reach 80% within two-to-three years, noting it is currently “just over 10%” in the prepaid segment.
“ The first battle was to put the smartphone in the hands of our customers. The second is now to drive up in the base by introducing more data. ”
– Combes.
What you call ‘cannibalisation’, I call ‘substitution’
Attention was drawn to the 18% of Europe revenue said to be ‘out of bundle’, with the company willingly playing up the idea that this is exposed to IP substitution, albeit hopefully to Vodafone’s integrated propositions.
Vodafone continues to deny it is seeing any material impact from OTT, saying, for example, that only about 2% of network traffic is voice-over-IP, such as Microsoft’s Skype. The Group claims that its enrichment and promotion of integrated tariffs will make IP substitution academic, with consumer choice influenced by features and services, rather than price. However, the Group’s ambitions to raise average revenue per user (ARPU) may place it at odds with low-cost, data-rich propositions, although these currently seem mainly the domain of smaller players.
“ The reality is that, the more we go into big bundles, the less people care about the economic element of VoIP, and they care more about the functionality. So, our job is to make sure the economic element is not a concern, i.e. that there are big bundles, and big offers and big promotions on prepaid, and big bolt-ons that can take away the economic concern, and then work either ourselves or in cooperation with third parties to provide good communication platforms, address books, social integration of different communication platforms, and so on. ”
– Colao.
Migration to integrated tariffs is also raising questions over Vodafone’s revenue segmentation because, ostensibly, allocation is astonishingly simplistic. According to Halford, an integrated tariff is merely pro-rated against comparable pricing of the full complement of components. This appears to ignore actual usage, while permitting all manner of shenanigans around transfer pricing and revenue allocation. Vodafone appeared to protest that anything more sophisticated is too complicated, which may indirectly be a criticism of the Group’s supposedly capable reporting and analytics capabilities.
Mobile internet overshadows mobile broadband; tablet disruption ahead?
With the rich data revenue growth, mobile broadband expansion (+6%) was far lower than mobile internet (+44%), but Vodafone played this down, noting that the former segment is lower margin and more demanding on network resources.
Interestingly, the company noted that, while young as a segment, tablet usage bears more similarity to smartphones than laptop computers. This was presented as a positive, portrayed as less demanding on network resources and more profitable, but could also be ominous.
Currently, tablets seem used primarily for media consumption and communication, typically via Wi-Fi. This could have worrying implications for a fast-growing segment that some consider very promising for mobile operators.
Further, on-network data usage by tablets could prove marginal, cannibalising mobile broadband while boosting smartphone mobile internet usage (through personal hotspots), rather than adding new data subscriptions. At present, tablets and e-readers both appear to be selling more in Wi-Fi-only format, suggesting the mobile industry may need to work harder to make mobile connectivity ubiquitous, or risk replicating the poor penetration achieved with portable computers, and creation of a disruptive new ghetto.
Together, this could accelerate awareness and acceptance of OTT applications and services, untethered off-network, and uncontracted or out-of-contract, ad hoc commoditised usage.
“ I’m a great believer and, personally, a great fan of tablets. However, keeping in mind that tablets, for the time being, have a behaviour which is more similar to the one of smartphones than to the one of heavy broadband — in the sense that they are media-lite consumption objects. And, of course, they also work a lot on Wi-Fi when they are in the home. ”
– Colao.
Mixed message: hints of slowdown, and uptick
Beyond the obvious sign, that revenue growth slowed despite eurozone operations being lifted by favourable currency movements, Vodafone’s quarterly statements were littered with hints of a slowdown. However, these were offset by suggestions of upturn elsewhere.
Having in recent years become notoriously cautious, executives’ lack of overt concern suggests they actually veer towards optimism, although their statements did precede a period in August 2011 when the worldwide geo-political situation started to seem unfathomable to everyone.
Slowdown?
- Denied as a wider trend by Vodafone, which pointed to growth at Group-level, Vodafonewatch detected pressure on messaging revenue, notably in AMAP and Spain. It is unclear to what extent revenue cannibalisation, IP substitution, and tariff optimisation are playing a part.
- Vodafone is facing challenges in Australia (customer disconnect following network outages) and New Zealand (MTRs).
- Growth in Turkey is predicted to slow, and price elasticity of demand may now be tested as Vodafone endeavours to raise prices.
- Maintaining competitiveness in Europe could be expensive, with a double-hit from raising value (lowering prices or ‘enriching’ tariffs) and subsidising smartphones. The situation is exacerbated by dangers from IP and OTT substitution, and economic weakness in southern Europe and possibly also the UK. This transition is particularly pronounced in Spain, where the historically strong OpCo is haemorrhaging revenue while it reinvents itself as a lower cost, value operator, in the face of aggressive competition from smaller players.
“ I see a protracted period of pressure for us on revenues in Spain because of this lower pricing structure, but, overall, in the long term, I think it’s going to be a much better structure than what we came in (with high prices and high commercial costs). ”
– Colao
Uptick?
- Fixed-line business appears to be strengthening, with both consumer and enterprise (notably One Net) flavours. Strong broadband additions in Italy and the re-emergence of Total Communications as a strategic mantra led Vodafonewatch to wonder whether fixed access may play an increasing role in strengthening customer relationships in developed markets. With the business in IP transition, and competition, pronounced, greater stickiness provided by multi-play and fixed access may be highly valued. Strengthening converged and IP television propositions would fit here.
- The Indian market continues to show signs of stabilisation, and even improvement, in terms of outlook and stabilisation of ARPU. Churn levels remain appalling, however.
- Vodacom’s international operations appear to be rebounding fast, Ghana strong, and the Egyptian market showing ‘initial signs of recovery’. Declines in Greece, Italy, and Portugal may also have bottomed out, although Vodafone is understandably cautious in the light of further fiscal tightening in these markets — the Group believes it has successfully rebased its competitive position in its southern Europe markets.
- Vodacom may be rapidly maturing into an advanced market, with the proportion of revenue derived from data already higher than Italy and Spain, and matching the average for the Europe Region. It makes an interesting contrast with its regional sister India, where total voice minutes are almost twelve-times higher and the customer base more than three-times bigger, but ARPU barely one-quarter and revenue lower. Consequently, Vodafone must desperately be hoping that India sees further market polarisation and consolidation, and rapid adoption of 3G and mobile data (where it is far behind Vodacom).
- The Europe Region grew its enterprise customer base by 7%, providing a fillip to German and Italian OpCos — markets where fixed line also out-performed. Vodafone appears to consider these customers less exposed to IP cannibalisation and OTT, due to separation of user and buyer relationships, with the latter group’s predominant pursuit of price reduction said to be offset by growing purchases of multiple products.
Other positives
- Vodafone’s debt position is the best it has been for four years, giving flexibility for in-market acquisitions across both of its regions, or other strategic activity. Debt may now reinflate somewhat, as the current £4bn share-buyback proceeds over the next twelve months, and further spectrum and licences are acquired, but additional cash will be booked from operations, sale of the Polkomtel stake, and a large dividend from Verizon Wireless (see separate report). The buy-out of Vodafone Essar is not significant here because the related options were already accounted for.
- Viability of Long Term Evolution (LTE) technology, which is being commercialised in Germany, appears promising, with executives saying the Group believes it can maintain the 9Mbps average usage speeds and utilise the technology for fixed access ‘replacement’ in rural and lower density urban areas, and as part of mixed access solutions in denser conurbations.
- The network demands from meeting growing data usage are apparently being managed comfortably, with the Group seemingly benefiting from the rebalancing of growth from mobile broadband to mobile internet.
Mixed messages
- Europe increased its proportion of contract customers to 38.1%, but big jumps in Turkey and the UK masked decline in Germany. AMAP’s emerging markets’ contract base slid, pulling down the Group-level proportion.
- Yet again, Vodafone practically ignored its not insubstantial Australia and New Zealand operations, fuelling perception they are not just out of favour, but likely being hawked around private equity and regional communications groups. An ideal exit might see an exchange involving Hutchison Whampoa’s European 3 assets. Indeed, likelihood of such a transaction is seemingly heightened by Vodafone’s reluctance to ensnare the Hong Kong group in the Vodafone Essar tax dispute in India, where Hutch, as the seller involved, might naturally be considered to be ultimately liable.
- Vodafone did nothing to deny expectations that Vodafone Essar will go public via an initial public offering (IPO), but Colao noted that this is very unlikely to take place within twelve months, and not before ownership, tax, and regulatory challenges have been resolved (see seperate report). However, the IPO of the Indus Towers infrastructure-sharing joint venture is said to be proceeding, albeit slowly.
Key performance indicators
Vodafone customer base analysis, 30 June 2011
[Table omitted]
Vodafone OpCo average revenue per user and churn analysis, Q1 FY11-12
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[Further reference: Vodafone Group plc Interim Management Statement -- Vodafone Group (PDF), 22 July 2010.]
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