Indian inflection? When EM can become very relevant for DM

In the past, EM growth has been a major driver for some of the developed market equity stories. Telefonica’s expansion into Latam was one of the big telco stories from the mid-1990s. Telenor’s aggressive Asian expansion in the early part of this millennium also made their equity story stand out as core EU earnings were under pressure. However, EM exposure for developed market telecoms companies has been gradually diminishing over the past 5 years and Telefonica’s announcement this week that it now defining all of its Latam assets ex-Brazil as non-core (see HERE for our view) marks a further retreat. However, arguably no EM market has been more volatile than India. Last week we took Vodafone management around London (see HERE for more details), and one of the key concerns that shareholders were bringing up was India and whether Vodafone could be liable for yet more cash injections into India on top of the £17bn already committed over the past 10 years. However, just as the roadshow was entering its final meeting, the Government announced a moratorium on spectrum fees, potentially marking a major inflection point in Government thinking and suggesting the risk-reward is now skewed to the upside (see HERE for more details) and EM exposure could potentially become a major driver for a developed market telco again.

Why so? The changes mentioned (price increases, HERE and spectrum holiday)  mean Vodafone’s Indian asset, Vodafone IDEA (VIL) is likely to be cash flow neutral until spectrum payments resume. The government is still publically insisting on full payment of the SC order ($7bn for VIL, HERE) but we think privately may be pushing for only the principal ($1.5bn for VIL). In any event, the size of any SC fine will decide whether VIL survives. We showed that a figure less than $4.5bn could be covered by VIL’s cash and an equity offer that Vodafone could probably participate in without breaking the ring-fence. Only if the SC ruling is greater than $4.5bn does the question of the ring-fence come into play. And we think it is unlikely that in this event Vodafone would break the ring-fence given their belief that the fine is unfair, which in turn means the worst likely scenario is that India is a zero to Vodafone. But what of the recovery case? If the SC ruling is cut to a manageable level, and mobile ARPUs return to 2015 levels by 2025 India would be worth roughly 20p/share to Vodafone (HERE), adding over 10% to its equity value. This latter scenario would certainly not be anyone’s central case, but stranger things have happened in India, and we think it is a realistic optimistic case. Investors in Vodafone plc need to be alive to the fact that after everything, India still has the potential to be a meaningful positive driver of Vodafone’s share price.

Vodafone’s foray into India has been disappointing and most shareholders have been wishing it to end for some time. The value ascribed into India in Vodafone’s share price is almost certainly zero, and might well even be negative. Arun Sarin’s decision to switch from Japan into India back in 2006-7 turned out to be almost as costly as the returns Vodafone made from its holding in Verizon Wireless. Vodafone sold KK in Japan to Softbank for £9bn, and the asset is now worth £76bn to Softbank, while Vodafone in turned has invested c.£17bn in India with little to show in return. It’s water under the bridge now, but if Vodafone had stayed in Japan and delivered the same performance as Masa Son, our Vodafone target wouldn’t be 205p – it would be 520p instead.

So the Indian debacle has been a major misstep in the Vodafone journey, and there have been plenty of false dawns in India before, but maybe now there could finally be the chance of real change.