Trying to turbocharge Vodafone’s inflection - Global Weekly Review

Trying to turbocharge Vodafone’s inflection

Is opening your network to wholesale partners a value-accretive move? This is one of the debates that has raged in European telecoms for as long as any of us can remember and Vodafone seems to have been at the heart of this debate for years. Hence, the announcement last week for Vodafone to sign a wholesale MVNO agreement with Virgin Media (see HERE) marks a substantive turning point that should help to turbo-charge their recovery; make life tougher for existing providers of wholesale access; and help out the MVNOs. We pick the winners and losers from this.

Most carriers would argue that opening up their networks to wholesale operators is not something that they wish to do, as it risks pricing pressure and they lose their perceived network differentiation to rivals. However, the flip side of the debate would be to liken the telecoms industry to the hotel industry. You already have a sunk network cost, so what you really need to do is maximise occupancy on your network. If you can’t achieve this through your own retail brand, then why not open up to third-party sales channels, or as some carriers have tried to do: launch second or third brands to try to fill this space.

Within the European industry, arguably no-one has been more vocal on this issue in the past than Vodafone, as they felt that if they were going to open up their network to wholesale they needed to be adequately compensated for this. The problem we saw with this logic was that the whole European industry from 2002-17 was earning super-normal returns, so any other MNO competitor could arguably bid for wholesale contracts and still convince themselves that it was profitable business. But, was this detrimental to their retail businesses? Did cheaper wholesale offers accelerate the decline in industry ROCE?

If one argues that the European telecoms industry could hold onto superior returns to perpetuity, then clearly opening up to wholesale would have been a negative, but if like King Canute this was trying to hold back the inevitable tide given the backdrop of regulatory intervention, then arguably Vodafone was ceding high-margin revenues to its competitors for no offsetting gain. As we showed HERE, this caused Vodafone’s share of service revenues in its markets to gradually decline from 33% in 2009 to 29% today.

But, this is backward looking. Forward looking, we now see an industry with returns at close to WACC, and potentially as a result of this, Vodafone is now seemingly more active in the wholesale market, as there is likely to be less to lose in the retail market as a result of winning more wholesale contracts.

This arguably started back in September 2018 when they signed a mutualisation deal with Masmovil. This was followed up with a RAN-sharing deal in Spain with Orange (see HERE), and a network merger with Inwit in Italy (see HERE). But until last week, we hadn’t seen Vodafone win an MVNO agreement. In fact, we believe Vodafone still held back from bidding for Masmovil’s wholesale MVNO in Spain.

Hence, the decision to bid for, and win, the Virgin Media MVNO in the UK is quite a substantive change for Vodafone. We estimate that the contract alone is worth 3p/ share for Vodafone, but it could well open them up to winning bigger deals in future that to date have been largely the playground for other MNOs.

For example, what about the Tesco Mobile contract? According to their Companies House accounts (HERE), they are currently paying c.£300m to O2 UK, ie double the size of the Virgin Media contract. This will clearly be harder to win, given O2 UK is a 50% shareholder in Tesco Mobile, but O2 UK still has the Sky contract worth c.£100-200m/ annum, suggesting Telefonica needs to be on its toes to protect this high margin source of revenue.

Looking outside the UK, Vodafone’s one big outstanding contract is United Internet. This contract is still worth €150m/ annum, but if Vodafone were to take a more pro-active approach in the German wholesale market and try to do future business with United Internet, this could be quite transformationally negative for the prospects of O2D (see HERE), and supportive for Vodafone. Our base case is United Internet isn’t going to disappear from the German market, so if they are here to stay, why not try to make the most of it? Clearly there are bigger issues of network differentiation in Germany, but United Internet might be willing to pay the right price to secure a better future for itself.

Over the years, Vodafone also pulled back from other smaller MVNO agreements such as Lebara, whose pan-European MVNO bill is c.€200-250m. This could be a sizeable winback.

These are wholesale arrangements with their mobile network. However, what about the cable infrastructure as well? Vodafone signed a wholesale cable agreement with O2D as a remedy for the Liberty Global, so arguably this wasn’t entirely voluntary, albeit we are supportive of them taking this step. Potentially, they could also sign a wholesale commercial agreement with United Internet for cable access as well?

Vodafone is already starting to see an inflection in service revenues in Europe, and the share price has been closely tied with revenue momentum. Winning these MVNO agreements could 150bp to revenues – pretty attractive on this closely followed metric, but up to 10% uplift to FCF, and helps to give Vodafone more upside optionality. These contracts are worth fighting for, while the other MNOs around Europe need to be on their guard, as BT found out to its cost last week. Meanwhile, for all these MVNOs, this helps to give them more optionality about their future contract renegotiations.