Vodafone Collects £7bn In Cash

Published in Company Comment on 17 June 2011

What will the telecoms giant do with its huge cash pile? Buy shares, of course!

Yesterday, Vodafone (LSE: VOD) announced that it had completed the sale of its minority shareholding in SFR.

Banking £7 billion

On 4 April, the telecoms giant announced that, subject to approval from the relevant competition and regulatory authorities, Vodafone would sell its entire 44% shareholding in French mobile operator SFR to Vivendi, the media conglomerate.

Following the sale, Vodafone has now banked €7.75 billion (£6.8 billion) in cash, plus a final dividend from SFR of €200 million (£176 million). In other words, the group now finds itself with an extra £7 billion burning a hole in its pocket.

However, Vodafone and SFR have signed a 'Partner Market agreement which will maintain their commercial co-operation'. In other words, Vodafone will still have some involvement in the French mobile market, albeit at arm's length.

Splashing the cash

When CEOs of listed companies collect a cash windfall, they tend to get pound signs in their eyes thinking about what to do with all this lovely loot.

Generally, company boards tend to splash this cash on:

1. Ill-thought out M&A (mergers and acquisitions) activity, often overpaying for rival businesses;

2. Share buybacks (thus boosting earnings per share by reducing their share bases);

3. Returning capital to shareholders (often though the issue of 'B' shares or loan notes); or

4. Boosting dividends or paying a special dividend.

For me, these options are ranked in order of attractiveness, with 1) being the least attractive option and 4) the most attractive. Here's why:

Show me the money!

First, I'm wary of CEOs spending shareholders' precious cash on ego-boosting M&A activity. All too often, this destroys shareholder value, as I warned in The Worst Takeovers Of All Time.

Second, there is little evidence that share buybacks make company owners richer, but they certainly benefit directors with fistfuls of share options. City grandee Terry Smith is a fierce critic of share buybacks, as I recently made clear in When Share Buybacks Go Bad.

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Third, I've no real objections to directors returning capital to shareholders, such as the more than £1 billion recently returned to investors in oil and gas engineer Wood Group (John) (LSE: WG) after the sale of its well-support division to US behemoth GE.

Nevertheless, for me, there's nothing better than cash in hand, which is why I prefer higher dividends or a one-off special dividend every time. This leaves me free to decide what to do with my cash, rather than rely on directors to spend it wisely for me!

Vodafone splurges £4 billion on shares

Vodafone -- the UK's third-largest company with a market value exceeding £82 billion -- has decided to go for option two, through a £4 billion programme of share buybacks. Buying back 5% of its own shares isn't the best thing Vodafone's board could do with this new-found cash, but it's not the worst, either.

With Vodafone shares trading on a historic price-earnings ratio of 9.6 and paying a dividend yield of 5.6% (covered 1.9 times), Vodafone has a strong case for buying back these 'value shares'.

Indeed, I'd be happy to join Vodafone's board by buying its shares at their current level of 160p.

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Comments

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kiffberet 17 Jun 2011 , 1:11pm

I've got 11% of my portfolio in vodafone, so a special dividend would have been my preferred choice as well.

The price of 160p looks pretty good, but is this the price vodafone are actually going to pay in the buy back? Will they buy all in one go or spread it over a period of time?

Netherwood 17 Jun 2011 , 1:43pm

Excuse me but Wood Group did not return £1bn to share holders it anounced a share buy back scheme which it would appear was largely orchestared to allow the family to divest.

F958B 17 Jun 2011 , 2:04pm

Chief executives have various targets to meet before their full bonus salary is paid. Bonuses usually includes a clause on earnings per share progress, but not as much focus on dividends per share, special dividends or creation of "B" shares.
It therefore seems highly likely that VOD would use the proceeds to boost EPS with a share buyback, to ensure that the executives meet EPS targets.
As I mentioned on the VOD buyback topic this morning: VOD's shares look like good value and I am comfortable with an ongoing buyback unless/until the share price exceeds 200p.

The buyback should to three things, in proportion to the size of the buyback;

Underpin or increase the share price.
Increase earnings per share.
Increase dividends per share.

A £7bn buyback would remove 8.5% of VOD's shares from circulation.

Dozey1 17 Jun 2011 , 2:50pm

I'll never know why it is so difficult for these high-flyers just to increase the dividend or pay a special dividend. Such a simple, transparent, shareholder friendly thing to do. At the very least they should make sure the buy-back is completed before the Verizon Wireless issue is sorted, which will be when the share price truly starts to reflect the company's assets.

eccyman 17 Jun 2011 , 3:33pm

Just a simple question

Why not have two EPS figures? One of them adjusted to strip out effects of buy backs, with this figure being used to calculate directors bonuses of course!

michaeljohnhale 17 Jun 2011 , 4:02pm

Am I wrong in thinking that there can be a tax advantage in increasing share value a.o.t. a special dividend, in that you have the option of using your CGT allowance at your discretion rather than take a hit on income?

equitybore 17 Jun 2011 , 7:01pm

I keep banging on to companies that they need to include share buybacks as part of their investment appraisal process - if it meets their internal hurdle rate for rates of IRR return it is fine - if not don't. Most don't answer my letters - oh well.

UncleEbenezer 17 Jun 2011 , 7:02pm

When the money comes from a one-off sale, what remains is a smaller company. So it makes perfect sense to buy back sufficient to maintain the like-for-like value of remaining shares. And as michaeljohnhale points out, a special dividend means an extra tax bill for many: I'd be pissed off to find myself paying that for the privilege of holding a smaller company.

(I hold).

Jimi97 17 Jun 2011 , 7:41pm

Netherwood,

I am not sure about £1bn, and it doesn't happen until next month, but Wood Group is returning £1.40 per share (either as income or return of capital).

jaizan 17 Jun 2011 , 11:19pm

Be thankful they are no longer wasting money on overpriced acquisitions.
Now it's a share I'm happy to own, unlike 10 years ago.

DIYIncome 18 Jun 2011 , 9:19am

They could spend the money buyubg CW Worldwide... (I hold both!)

duffmanchon 18 Jun 2011 , 9:24am

I bought my first shares in VOD a few weeks before they went ex dividend, so I'm down on what I paid. But I bought at 5% yield and single digit P/E and I was aware of the forthcoming buy backs which will help increase my returns over the long run. Also they have increased dividends for years.
I don't particularly like the business, they are always the most expensive mobile network and spend way too much on advertising. Although they probably have the best coverage and they seem to be able to screw the tax man pretty well. In terms of their fundamentals for investment they are right up there!

SevenPillars 18 Jun 2011 , 11:37am

Share buy backs can be just as bad for investors as any of the other options listed, but then I suppose it depends on the company and the quality of the management to deliver in future. HBOS bought back shares for years to add "shareholder value", then when the game was up for them later they had a couple of rights issues (later as part of Lloyds) screwing more money out of shareholders. I think Vodafone is a much better bet, provided they stay out of banking.

lemondy 18 Jun 2011 , 9:53pm

duffmanchon, buybacks are unlikely to "increase your returns" unless the share price is severely undervalued.

VOD have lost the ongoing revenue from SFR, so they reduce your future returns by selling out. Either they have to invest that cash somewhere to get a similar return, or they have to reduce the amount of shares outstanding thus reducing the amount of revenue required to maintain the current divi level.

Think of it this way: if they paid out all that cash as a one-off special divi, they should also reduce future divis, otherwise the divi cover would be reduced.

I'm a holder and think the buyback makes sense.

djpreston 19 Jun 2011 , 6:46am

King of the buybacks? Next - over 55% of it shares bought back and still they continue to buy them in. Now that's a text book example of how to add value.

duffmanchon 19 Jun 2011 , 10:37am

lemondy, I'm pretty new to this game but I think a single digit P/E makes it undervalued (using Graham's criteria). If it goes up to a fair value of say 15 I'll have some good capital growth and their track record of increasing dividends is encouraging. As there are only a small number of competitors and high barriers to entry in their industry they should be able to raise prices (a bit like the energy companies) and dividends. The prospects for growth in the developing world are still good even with their recent asset sales.

Mutandis13 19 Jun 2011 , 2:12pm

VOD should be commended for the transparency of its buyback programmes. On their company website they produce the detail of their buyback programmes, showing shares purchased and the cost by year. Their regular RNS announcements are also more detailed than all of the other companies I have researched. They detail the cost of the purchase, the number of shares being purchased along with the highest & lowest amount paid and the cumulative number and cost paid to date on that programme.

This transparency makes it easier for an investor in VOD to determine whether the use of funds for buybacks was a good allocation of capital.

During the period 1 April 2003 to 31 March 2011 the company purchased 10.6bn shares at a cost of £14.7bn that's an average cost per share of 139p.

If those shares purchased were held as an investment on the balance sheet, as some people propose, what sort of return would have been achieved?

Taking the timing of cash payments used for the buybacks and the dividend payments saved over those 8 years, I have calculated the Internal Rate of Return (IRR) as 7.6%, based on Friday’s closing price of 160p. This compares with the return VOD makes on its enterprise value of 7.2% (9.8% excluding impairment and sale of interest) and its average ROCE of 7.6% (10.4% excluding impairment and sale of interest) for 2011.

This comparison is only relevant if there were alternative uses for the cash within the business, but does highlight whether the use of the cash would have diluted the returns for the business, if it were accounted for in this way and the asset value was marked to market.

Another way of looking at VOD’s buyback performance, is on an alternative use basis.

If an investor purchased shares at the average buyback price during the financial year 2004 of 136p, what return has he made compared to the return he would have made if those buybacks had been used as increased dividends?

Making the assumption that the shares were purchased in September 2003 and dividends were paid in Feb & Aug each year, the return under the status quo is 6.1% pa, whereas the return utilising the buybacks as enhanced dividends is 5.6% pa.

The enhanced dividend calculation uses an inferred SP from the diluted EPS (from an increased number of shares in issue) and a constant P/E ratio.

This leaves me with the feeling that buybacks were probably the better course of action for VOD over the past 8 years.

Gengulphus 20 Jun 2011 , 3:24am

Third, I've no real objections to directors returning capital to shareholders, such as the more than £1 billion recently returned to investors in oil and gas engineer Wood Group (John) (LSE: WG) after the sale of its well-support division to US behemoth GE.

Nevertheless, for me, there's nothing better than cash in hand, which is why I prefer higher dividends or a one-off special dividend every time. This leaves me free to decide what to do with my cash, rather than rely on directors to spend it wisely for me!


I fail to follow that argument for preferring dividends over a return of capital via (say) a B share scheme. Every such scheme that I've been involved in has had an immediate redemption option, which means that it's just as good at providing me with cash in hand as a dividend. And they've generally given me the choice of two different ways to receive that cash, one counting as income and the other as a capital receipt, plus an option to keep the B shares and defer receiving the cash. That provides significant tax flexibility, potentially making the cash in hand I receive more valuable to me...

The only argument I can think of for favouring dividends over that sort of scheme is the extra costs incurred by the scheme, not whether the shareholder gets cash in hand.

Gengulphus

catandfiddle 20 Jun 2011 , 4:49pm

Share buy-backs often seem a bit of a lazy option - I would rather seem them investing in their business / products - probably better in the long term.

jaizan 20 Jun 2011 , 11:25pm

Some people may have taxation advantages.

Any higher rate taxpayer who holds Vodafone outside his ISA has to pay significant tax on those dividends.

Share buybacks should result in capital gains, so he can utilise the annual capital gains tax allowance.

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