Jeremy Warner's Outlook: Vodafone's performance is lost in translation

Monetary paralysis; Split-caps fiasco
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The Independent Online

Market expectations of Vodafone are not nearly as high as they were, yet the mobile phone giant is still struggling to please. The shares fell nearly 5 per cent yesterday after news of double-digit growth in both Ebitda and revenues for the year to end of March. For virtually any other company of Vodafone's size, this would be regarded as a stonkingly good set of results. Not so at Vodafone, where once-inflated expectations have plainly still got a way to fall before they fully align themselves with reality.

Market expectations of Vodafone are not nearly as high as they were, yet the mobile phone giant is still struggling to please. The shares fell nearly 5 per cent yesterday after news of double-digit growth in both Ebitda and revenues for the year to end of March. For virtually any other company of Vodafone's size, this would be regarded as a stonkingly good set of results. Not so at Vodafone, where once-inflated expectations have plainly still got a way to fall before they fully align themselves with reality.

The new factor in yesterday's statement was the extent of the pasting that Vodafone is taking in Japan, where even the supposed marketing clout of David Beckham has failed to halt a precipitous slide in operating profits and average revenue per subscriber. Vodafone's Japanese arm seems so far to have derived few benefits from being part of a global mobile phones behemoth. To the contrary, Vodafone's attempt to have its Japanese platform conform with international standards for next-generation services may have further undermined its position in this viciously price competitive market.

Vodafone occupies either the number one or two positions in nearly all the markets in which it operates. Japan is unusual in that Vodafone has had to settle for the number three slot. This is proving to be a more uncomfortable position than anyone anticipated. Still, Vodafone is already so committed to Japan in terms of sunk capital that it has no option but to soldier on and hope that the strategy of attempting to ween Japanese consumers on to more internationally based 3G technology will eventually work.

Rather than reducing his exposure, Vodafone's chief executive, Arun Sarin, is therefore further increasing it by paying £2.6bn to buy out remaining minority investors in the business. New handsets due for delivery later this year should improve greatly the situation, he believes, and in any case, can Vodafone really afford not to be in the world's second largest industrial economy?

None of this has reassured investors, who quite apart from Japan continue to worry about the wider issues facing Vodafone. One of these is quite how much of their money Mr Sarin is intent on spending. The dividend and share buy-back news yesterday was widely thought of as mean, and highly suggestive of a company that's holding back capital for more deals. Mr Sarin has already proved his fondness for the cut and thrust of acquisition by attempting to sell his stake in Verizon Wireless in the United States in order to buy the weaker mobile phone interests of AT&T. Investors fear that he's hot to trot.

In fact, Mr Sarin's interest in the AT&T Wireless has been somewhat misrepresented. The AT&T assets became attractive to Vodafone only because its partner in Verizon was offering spectacularly good exit terms. It therefore made every sense from a shareholder value perspective to try to do the asset swap deal.

Mr Sarin is still a bit of an unknown quantity in the City, but I think it can safely be said he's not about to surrender shareholder value for the purpose of empire building. Much more concerning is the progressive commoditisation of mobile telephony as it becomes price competitive with fixed line methods of communication. No one's yet sure what this will do to the mobile phone industry's profitability and outlook. Until things become clearer, Vodafone's shares will struggle to break out of their current, depressed trading range.

Monetary paralysis

Everyone's got a view on where interest rates are heading, but here's an intriguing one garnered from a recent chinwag with a leading British banker. In his view, if the Bank of England's repo rate rose even as high as 6 per cent - only 1.75 per centage points higher than it is at the moment - it would so poleaxe British business that the Monetary Policy Committee couldn't possibly contemplate such a tightening. If he's right about this, then it means that any attempt by the Bank of England to use interest rates to bring the housing market under control is pretty much doomed to failure.

The Bank of England has raised interest rates three times since last November, but so far it has had nil impact on house price inflation. In fact, house prices have further accelerated since interest rates started to rise. There's little reason to suppose a further gradual tightening will have much impact either. Yet as the Council for Mortgage Lenders has highlighted, there plainly is a level of interest rates that would stop the market dead in its tracks.

Perhaps regrettably, this level may be a good deal higher than anything that would be tolerable in the business economy. If my banker is right, then house price inflation is going to be extraordinarily difficult to tame, for the last thing the Bank of England wants to do is bring about a recession in business. As well as further unbalancing the economy, the ultimately effect would be to bring about the very housing market crash that the Bank wishes to avoid, for recession in business means growing job insecurity. There's nothing more deadly to the housing market than rising unemployment.

So what conclusions should be drawn from these observations? One is that it is still most unlikely that rates will rise beyond the cyclical peak of 5.5 per cent the markets anticipate. Indeed, they may not rise even that far. Another is that monetary policy should not, and perhaps cannot, be used for the purpose of puncturing an asset price bubble. The collateral damage of trying to do so is just too great. The MPC must therefore rely on other factors to bring house prices under control. One of these might be the natural caution of lenders, many of whom are beginning to worry about people's ability to service the very substantial loans they are taking on. Some are already reining back, if only a little as yet.

With or without interest rate rises, house prices will eventually fall of their own accord. It's not yet clear when or what the impact will be on the wider economy when they do.

Split-caps fiasco

The attempt by the Financial Services Authority to wring voluntary compensation out of the split-caps investment trusts industry is in danger of turning into an even bigger fiasco than the scandal itself. Voluntary compensation was always a good idea in theory, if only because it promised to expedite a process that would otherwise be tied up in years of costly and debilitating enforcement.

In practice, there has been bad faith on both sides, and you have to wonder whether it would ever have been possible for the 21 firms involved to agree voluntary compensation when the FSA was refusing to promise that this would be an end of the matter. Instead, there was the threat of disciplinary action and fines to follow. The FSA seemed unwilling to allow for the payment of compensation without any admission of guilt. No business in its right mind is going to agree that kind of open-ended liability.

If these difficulties were not enough, the two sides have also been worlds apart on price. The FSA's failure to resolve the matter is proving a growing embarrassment to John Tiner, the chief executive. Matters had to be brought to a head eventually, but Mr Tiner seems to have grasped the nettle in a manner guaranteed to scupper all possibility of a voluntary deal. With the gun held firmly against the industry's head, he's said pay £350m or we'll pick you off one by one in enforcement and disciplinary procedures.

The most the industry has been prepared to consider so far is £120m, so it seems rather unlikely those in the frame would be prepared to pay more than double whileother issues remain unresolved. The FSA's failure to reach agreement will undermine all prospect of voluntary settlements in such matters for years to come. This is perhaps a shame, but then it always was naive of the FSA to think that such a complex and many-layered scandal could be settled by voluntary means. Agreeing the global figure would have been just the start of it. Attempting to establish who would be liable for what would have been doubly fraught.

jeremy.warner@independent.co.uk

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