What Does the Future Hold for Vodafone?

September was quite a busy month for Vodafone (NASDAQ: VOD  ) . The British telecom giant sold its stake in Verizon Wireless for $130 billion and secured full ownership of Vodafone Italy. It also received the go-ahead from Europe's competition watchdog for its approach to buy Kabel Deutschland, Germany's biggest cable operator.

At first glance, things look pretty good for this company since Vodafone now has more financial leeway to enhance its growth strategy. However, on second thought, is there a fly in the ointment?

Cashing in on the Verizon deal
Vodafone plans to plow some of the cash it racked up from the Verizon deal back into its three-year Project Spring, which involves organic investments in broadband and superfast mobile networks across Europe, among other initiatives.

Given the fact that only 25% of the continent's population has access to next-generation 4G networks, Vodafone has a golden opportunity to give its peers a run for their money. For instance, in Spain, it's two steps ahead of Telefonica (NYSE: TEF  ) . It launched its regional 4G services in May while Telefonica just got the ball rolling on upgrading its nationwide network.

If all goes according to plan, by 2017, 90% of the five countries Vodafone serves will be covered by 4G, enabling the company to blaze a trail in the European telecom industry.

Competing in the German cable market
In Germany, Vodafone's biggest market, falling service revenue and intense competition from market leader Deutsche Telekom (NYSE: DT  ) leaves the British telecom in dire straits.

To top it all, Telefonica Deutschland, the Spanish juggernaut's German arm, has been going after RoyalKPN's German unit E-Plus for quite some time, jockeying for position. America Movil, the Dutch operator's largest shareholder, is backing the deal, but Telefonica will have to wait for regulators to give it the green light, as well.

Nevertheless, if regulators sign on the dotted line, this merger could shake things up in the German mobile market. The coming together of E-Plus and Telefonica Deutschland will create the country's largest mobile operator with a 43 million customer base that translates into a nearly 40% market share.

So, Vodafone could hit the jackpot with the Kabel deal. This acquisition will transform it into a top-notch, integrated communications operator in Europe's biggest market and most stable economy. It will be able to tap into "quad play," providing its existing customers – as well as Kabel's 8.5 million connected households – with landline, mobile, broadband and television services, all in one package and via its own network.

Thus far, Vodafone has been relying largely on Deutsche Telekom's network for wireline services. The rental agreement with Deutsche for its cable capacity will remain intact for the time being. Even so, Vodafone will now be able to launch an all-out attack on the German incumbent.

It's interesting to see how that will turn out. Deutsche is hard to beat since it has been doing its best to step its game up. It has been heavily investing in high-performance infrastructure in Germany and expects that around 24 million households will be connected to its fiber-optic network by 2016. It's also the first network operator worldwide to have introduced the Terastream architecture, a revolutionary, IP-based technology that lays the groundwork for network operations and services to be transferred into the cloud.

The Single Market: Friend or foe?
Following the Verizon deal, the bulk of Vodafone's revenue will come mainly from Europe and India. Vodafone has been entangled in a long-running tax dispute with the Indian government that's been a major drag on its regional operations. As far as the situation in Europe is concerned, operators and regulators are at loggerheads over the ongoing overhaul of the telecom sector.

There is no telecom company that operates across the whole 28-nation bloc. Each state follows its own rules, meaning that spectrum prices for 4G and retail prices differ widely. For European operators, achieving cross-border economies of scale that would enable them to clamp down on costs and spend more on investments is, at this point, wishful thinking.

Nellie Kroes, the commissioner managing Europe's digital agenda, is trying to address these issues by promoting a single-market package that breaks down on national barriers. However, this package includes controversial policies, such as making it easier for consumers to switch from one operator to another, eliminating roaming charges, and putting a lid on mobile termination rates (charges mobile operators make to each other for connecting calls).

Skeptics argue that Kroes's plan will not give operators enough elbow room to differentiate themselves from their peers, and think that it will end up just lowering prices for consumers. Consequently, operators' revenues and profit margins could be at stake. Eventually, a possible consolidation of the European telecom industry could be a catch-22 situation for Vodafone, making it a takeover target instead of a hands-down winner.

Final thought
Vodafone is a great company and has a satisfactory track record in creating value for its shareholders. However, fierce competition from the German behemoth and uncertainty over the future of the telecom industry in Europe makes me want to keep away from it, at least for now.

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