Vodafone Group Plc, the world’s largest mobile operator in terms of revenue, has signaled the end of its global ambitions after agreeing to sell out its operation in one of its principle markets.
Under the terms of the deal, the Newbury UK-based operator has agreed to sell its troubled Japanese unit, Vodafone KK, to Softbank Corp for JPY 1.8 trillion ($15.5bn), of which 6.8bn pounds ($11.93bn) will be received in cash upon closing. Vodafone plans to distribute 6bn pounds ($10.53bn) to shareholders, either by way of a special dividend, or by issuing new shares.
However, this payout is unlikely to stop the growing number of critics of chief executive Arun Sarin from labeling this payout hush money. Last week, Sarin succeeded in clearing out the old guard at Vodafone, including former CEO Sir Christopher Gent, following widely reported boardroom battle over Sarin’s global strategy and leadership. Specifically, the dispute centered on Sarin’s willingness to offload Vodafone’s crown jewels, namely its assets in Japan and the US. The infighting was said to include an attempt by some of the old guard to remove Sarin, although this has been denied.
I am pleased to announce this transaction which represents a good outcome for Vodafone, said Sarin. It is at an attractive price, will result in a 6bn pound ($10.53bn) distribution of capital to shareholders, and is enhancing to adjusted earnings per share. Sarin justified the sale of the unit by saying it had become increasingly clear that the greatest operational benefits came from strong local and regional scale. We seek to deploy capital only where we can generate superior returns for our shareholders in markets that offer a strong local position, he said.
Yet this is a clear departure from the highly successful strategy of his predecessor Gent, who in the space of a few years transformed Vodafone from a small mobile UK-based operator into the largest mobile operator in the world. Gent did this with an aggressive acquisition strategy. Vodafone’s expansion into foreign markets was characterized by Gent’s strategy to acquire a stake in one of the leading operators in a particular market, and gradually increase the stake until it had achieved a majority shareholding.
However, under the guidance of Sarin, Vodafone has become a much more conservative operation, and since 2003 the only acquisitions he had made have been relatively scale-small buys in Turkey, eastern Europe, South Africa, and India.
Some will question why at a time when many of its rivals are spending huge sums of money acquiring mobile assets, as witnessed by Telefonica SA’s 17.7bn pound ($31.3bn) acquisition of UK mobile operator O2 Plc, Vodafone is instead offloading assets in core markets.
Sensitive to these charges, Sarin insisted that the sale of the Japanese unit does not signal a change in Vodafone’s global strategy. He also said there are no plans to sell its 45% stake in Verizon Wireless, the second largest mobile operator in the US. Vodafone’s joint venture in the US has been subject to much speculation recently, and its partner Verizon Communications Inc has made no secret of its desire to acquire Vodafone’s minority stake for an purchase price in the $40bn region.
We have excellent growth in the US… We are very happy with our position. There are no current plans to exit the business, Sarin said on Friday.
Yet the sale of Vodafone Japan will be something of a personal setback for Sarin, especially as he has spent two years trying to turn around the fortunes of the unit. Vodafone brought into Japan because it was one of the most advanced markets in the world, but after three years Sarin has failed to fix the operation.
In early 2005, he shook up Vodafone Japan’s structure and management, and appointed the Vodafone UK boss Bill Morrow to head up the unit as its president. Vodafone also spent JPY 475bn ($4.3bn) during 2004 to increase its shareholding in the unit to 97%.
It was only in July last year that Sarin pledged to reverse a profit decline in Japan, and while admitting he would be prepared to offload the unit if it didn’t come right, he told reporters that Vodafone planned to be in Japan for the the long term.
On Friday Sarin admitted that the case of Japan, we have been making progress on the turnaround in recent months. However, given the relative competitive position of the business, the reduced prospects for superior long term returns and a good offer from SoftBank, the board took the decision to sell.
This decision by the board, which Sarin now fully controls after his purge, may seem slightly odd to some, considering that Vodafone Japan is still a profitable unit. For the six months ending September 30, 2005, Vodafone Japan posted an operating profit of 191m pounds ($334m), down from 423m pounds ($741m) in the same six-month period in 2004. Revenue meanwhile rose to 3.7bn pounds ($6.49bn) from 3.68bn pounds ($6.47bn) in 2004.
It is true that the financial markets and their fascination with ARPU figures have consistently pointed to the weakness in Vodafone’s Japanese operation. Yet ARPU figures have been declining in many markets over the past few years, not just in Japan. Vodafone recently said Vodafone KK had recorded a 4.5% fall in in service revenue on year due to the decline in ARPU, while voice revenues fell 6.2%.
This is hardly surprising because Vodafone is battling two highly entrenched mobile goliaths, NTT DoCoMo Inc and KDDI Corp, in a market said to worth a total of $78bn. According to Morrow, the Japanese market conditions were challenging. Yet as recently as January, he was pointing out the positives from Vodafone KK’s expanded 3G handset range, improved network coverage, and popular services such as Love Flat-rate for the improvement. Love Flat-rate is an offering that enables unlimited voice calls and messaging to one designated Vodafone KK number, and Family Call Flat-rate, a service that allows unlimited voice calls to family members for a fixed monthly charge. Both were introduced in November.
During the last quarter from October to December, Vodafone KK added 125,200 subscribers, its highest level since early 2004, which increased its customer base to 15.1 million. The Japanese operation seemed to be finally benefiting from the introduction of new flat-rate tariff plans and a steady improvement in the range and quality of its 3G handsets. Vodafone KK had a total of 2.3 million 3G subscribers in Japan. In addition, its churn figures improved from 19.1% in the prior quarter, to 17.6% in the last quarter, as the operation sought to focus on retention and upgrading customers to 3G.
In the quarter ending December 31, 2004, ARPU was at JPY 6,149 ($52.87), but in the quarter ending December 31, 2005, ARPU was down to JPY 5,918 ($50.88). Yet when the Japanese ARPU figures are compared to figures for another major market for Vodafone, the UK, ARPU has been declining in that market as well. In the quarter ending December 31, 2004, Vodafone UK’s ARPU levels in the UK were at 24.9 pounds ($43.69). In the quarter ending December 31, 2005, UK ARPU figures were down at 23.8 pounds ($41.75). Likewise, in Germany, in the last quarter of 2004, ARPU was 24.9 euros ($30.31), but in the last quarter of 2005, they were down to 22.9 euros ($27.87). In all Vodafone’s principal markets (Germany, Italy, Japan, and the UK), ARPU has fallen over the past year. The exception was Spain, were ARPU rose slightly.
Another interesting detail comes when we compare the average purchase cost per user. For example, when Cingular Wireless LLC paid $41bn for AT&T Wireless Services Inc, which had 21.8 million customers, the average cost per user was $1,880. Softbank on the other hand is paying $15.5bn for Vodafone KK, which has 15.1 million customers. This works out at an average cost per user of only $1,026.
So there are sure to be questions about why Vodafone would be willing to sell off its asset in Japan, the market that delivers to Vodafone the highest ARPU figures of all its principal markets. It is clear that Japan has had troubles, but some will feel that the sale is a short-term view aimed squarely at placating disgruntled shareholders unhappy with the performance of the operator’s share price in recent years and slowing growth in its core European markets.
SoftBank is Japan’s largest internet service provider, and is one of the bidders for a new batch of cellular licenses that are expected to be auctioned off in Japan later this year. It was also awarded another mobile license last autumn. It has well-publicized intentions to take on that country’s dominant mobile carriers, and the acquisition of Vodafone Japan now allows it to offer a combination of broadband, mobile, and internet services and content.
Softbank said it would borrow JPY 1.1 trillion ($9.47bn) to JPY 1.2 trillion ($10.33bn) via a bridge loan to fund the acquisition. It was only last week that concerns surfaced over Softbank’s credit rating, and its ability to pay full market value for Vodafone KK.
Concerns that Sarin has sold the Japanese unit too cheaply will no doubt persist, especially considering the fact that the US hedge fund Cerberus, and its partner Providence Equity Partners, made a similar all-cash deal earlier last week.
Sarin however ruled out a bidding war for the unit and instead opted to press ahead with its more advanced negotiations with Softbank. In return, Vodafone will get a seat on the company’s board, giving it some much-needed exposure to the Japanese market, which is widely regarded as the world’s most advanced.
Vodafone expects the transaction to complete in the first quarter of the financial year ending March 31, 2007 and said there are no underlying changes to the group’s outlook statements. Year-end results are expected in late May.