Business Analysis: Tokyo blues add to the challenges facing Sarin at Vodafone

Trouble in Japan, falling customer revenues in Europe, no control over its US business and an underperforming share price; these are some of the thorny issues shareholders are grappling with at Vodafone, the world's biggest mobile phone group.

Another set of woeful customer numbers from Japan yesterday highlighted the problems faced by Arun Sarin, the chief executive, in trying to impose a truly global brand on what has so far been a patchwork of unconnected mobile phone networks.

Leading analysts are now openly talking about the possibility of Vodafone selling its Japanese business and have gone to the lengths of calculating a sum of the parts break-up value for the group.

One leading shareholder said yesterday that investors were "frustrated" with Vodafone's seemingly insoluble strategic binds, and raised the prospect of the company selling its US investment - a 45 per cent stake in Verizon Wireless - and handing the cash back to investors.

The prospect of more cash being handed back is seen as the only way Vodafone can fix its other challenge - a share price languishing in a narrow trading range of about 140p a share.

No matter how much Mr Sarin talks about the benefits of creating "One Vodafone" - his vision for a global corporation that should generate an extra £2.5bn in free cash-flow through cost and synergy benefits by 2008 - shareholders want cash now. This is despite his announcing a doubling of the company's dividend at its November interim results, plus an increase in its share buy-back programme from £3bn to £4bn this year.

Justin Funnell, Credit Suisse First Boston's top-rated telecoms analysts, said: "With Vodafone down against the sector by 5 per cent since the interims and trading at a 25 per cent sector discount on a 2006 estimated price earnings ratio, Vodafone's share buy-back is not delivering the benefits to shareholders that some were hoping. We believe that the longer Vodafone stock stays around 140p a share, the more the chance Vodafone may consider developing its distribution policy further."

This could be done by raising the dividend further or raising debt for a £10bn special dividend. There is also a third option: disposals. Investors believe this strategy could be applied to Vodafone's US business, for instance, where its 45 per cent stake in Verizon Wireless is worth about $20bn (£10.5bn). The other 55 per cent is owned by its partner, Verizon Communications.

Although the US is one of the world's most important mobile markets, Vodafone's joint venture carries the Verizon brand, not Vodafone's, and it operates on a different technology platform from Vodafone's other operations - two reasons for Mr Sarin's fruitless attempt to get out of the Verizon joint venture last year and buy full control of AT&T Wireless instead.

Shareholders suggest that now would be a good time to cash in after several years of strong growth in an increasingly competitive market. Verizon Communications was keen to buy out Vodafone last year at what was understood to be an attractive price, encouraging talk among shareholders of a disposal. Ultimately, having a minority position in the US is not seen as sustainable.

Other disposals are possible from the sale of more obvious non-core assets, such as the company's German fixed-line business, Arcor, which CSFB believes is already on the block, although a Vodafone spokesman refused to comment yesterday on any pending sale.

There has also been talk of a sale of Vodafone's troubled Japanese business. Yesterday figures showed the company's deepening woes in a market where new, third generation (3G) phones are all the rage.

Vodafone added just 148,000 3G customers in Japan in February, down from 160,900 in January, with its total 3G subscriber base languishing at 675,000 compared with 10.2 million at its rival DoCoMo and 17.4 million at KDDI.

Vodafone's problems in Japan have been obvious for some time and the woeful monthly figures are no longer a surprise. What has shocked analysts has been the decline there of its average revenue per user (ARPU) which, according to Mark James at Nomura, fell 10 per cent year-on-year when the company reported its last set of key performance indicators in January. "Given that this is Vodafone's largest single division, we wonder when investor patience will wear thin waiting for the elusive turnaround," Mr James said.

Vodafone Japan has a new management team which will include the highly rated UK chief executive, Bill Morrow, transferred to a new job of sorting out Japan, starting next month. It intends to boost its marketing spend, rationalise distribution and improve its handset offering to woo customers away from rivals. Having fallen so far behind in the crucial 3G market, fixing Japan will be a Herculean task.

Mr Funnell, at CSFB, said: "Vodafone is understandably committed to assets such as Japan but if Vodafone Japan fails to improve over the next 12 months, we believe a new approach cannot be ruled out."

The potential for such a move has prompted Mr Funnell to calculate a sum of the parts valuation for Vodafone. He puts a break-up value of 175p a share on Vodafone, compared with yesterday's 141p closing price. "Break-up seems fanciful today, in our view, but it is another possible response to the stock's discount in time," Mr Funnell said.

Vodafone's last public announcement on subscriber growth, issued in January, showed that in the quarter to 31 December, the company had its strongest three months for net additions for four years. An extra 5.4 million customers took its total customer base to more than 150 million.

The chart shows that over the past five years it has also enjoyed rapid revenue growth, so not everything is gloom and doom. However, what has unsettled the stock market is that in countries such as the UK, Germany and Italy, ARPUs published in January were either flat or down on the year before. This was blamed on a variety of causes, such as regulators forcing mobile companies to cut termination rates - the amounts they charge for handling an incoming call from another operator's network.

"As subscriber growth eventually slows, Vodafone is running out of time to demonstrate that people will spend more on mobile telephony," Mr James said.

Nowhere will this be tested more than in the UK where Vodafone has embarked on the process of migrating existing customers on to its 3G services. Although Vodafone reckons there will be a marked increase in ARPU from 3G customers, rivals such as Hutchison Whampoa's "3" brand say Vodafone's position is untenable.

Hutchison has launched 3G services at prices about 30-40 per cent lower than Vodafone's tariffs, making it impossible for Mr Sarin to justify his higher prices for long and eroding Vodafone's hopes of sustained ARPU increases. Perhaps, analysts say, Vodafone should be prepared to give up its obsession with being global, a stance that seems to be delivering only questionable benefits.

"What does being a global company actually mean in practice?" Mr James said. "It is strong in Europe, has a problem child in Japan and strategic issues in the US. What does global mean given that the brand doesn't cross the Atlantic and neither does control?"