Time to hang up the Vodafone?

The mobile phone market is booming - but digital competition is threatening its biggest player
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The Independent Online
THEY may be, in the words of former chancellor Norman Lamont, "the scourge of the modern world", but the irritating sound of mobile phones going off in restaurants, bars and other public places is music to the ears of investors in Vodafone, the UK's largest cellular operator.

They have seen the value of their shares jump by almost a third since the beginning of June - a performance only bettered among its blue-chip peers by Eastern, the electricity utility on the receiving end of an agreed bid from Hanson.

The spectacular stock market showing owes much to the recent surge in demand from ordinary users (as distinct from business people). A sheaf of stockbrokers' research notes have highlighted Vodafone's virtues in valuation terms. Enthusiasm has been strongest among US investors, who hold 40 per cent of the shares.

But after such a strong rise, now might be a good time to disconnect and take some profits.

From being the yuppie toy of the late-Eighties City slicker, mobile phones have become affordable for the masses. High- quality, easy-to-use handsets now sell for as little as pounds 9.99, while tariffs have been tailored to attract customers who do not plan to use their mobiles much and want to avoid hefty monthly payments.

A typical low-user tariff with Vodafone costs about pounds 15 a month, with calls charged at 35p-50p a minute. Business subscribers pay more up front - about pounds 25 a month - but only 25p per minute for calls.

Other clever marketing devices are planned, including the introduction next week of a loyalty scheme similar to that offered by large supermarket chains. Anyone on Vodafone's subscriber list on 1 September will get a 5 per cent discount on call charges from next April. The aim is to restrict the churn rate - the number of subscribers leaving the network at the end of their one-year contracts.

The effect of all this promotional activity on sales has been remarkable. Total subscriber numbers are rising at 150,000 a month from a base of 4.4 million or 7.7 per cent of the population.

If these growth rates are maintained, one in ten people could own a mobile phone by Christmas, the peak selling period. According to brokers NatWest, the proportion of business subscribers by 2000 may drop from a half to only a quarter of the total cellular market.

Vodafone is the largest player in this booming market. In the quarter to June, it added 224,000 subscribers to take its customer base to 2.04 million, or 46.3 per cent of the UK market. That puts it on track to beat its target of 800,000 new subscribers this year.

Cellnet, majority-owned by BT, lies in second place with a 43 per cent market share. One-2-One, jointly owned by Cable & Wireless and US West, has 6.8 per cent, while the Hutchison Whampoa-controlled Orange service brings up the rear on 3.9 per cent.

However, Vodafone runs the risk of being a victim of its own success. Six months ago, its chief executive, Sir Gerald Whent, issued what seemed the strangest of profits warnings. New business, he said, was growing so fast that connection payments would reduce profits below expectations. New subscribers to the network take up to seven months to generate enough revenue to offset the connection bonuses Vodafone pays to dealers who sign up new recruits.

In addition, mobile phone handsets are often offered at much less than cost to entice customers to hook up. But once they do, the real money is made from rental and call charges.

Vodafone has reduced its connection bonuses to dealers, all but eliminated a fraud problem which cost pounds 63m last year, and is set fair for strong profits growth after the last year's blip. For the year to next March, brokers at NatWest are looking for pre-tax profits of pounds 465m.

The fear now is that when subscriber growth rates slow - as they must do eventually - Vodafone's margins will be squeezed by increased competition.

Moreover, the advent of digital networks poses as much of a threat as an opportunity to Vodafone. The advantage of digital is a clearer, sharper signal which, unlike analogue, cannot be eavesdropped upon - a strong selling point to members of the Royal family. Digital handsets may also be taken abroad without the need for special registration.

The vast majority of Vodafone's 2 million-plus customers take the older, analogue network, whereas Orange and One-2-One are rolling out an exclusively digital service. They will try to pick off the higher- spending Vodafone customers who want to migrate to digital.

Given these uncertainties, a prospective price-earnings ratio of 27, falling to 21 for 1996-97, looks demanding.

Perennial speculation that American telecoms companies such as AT&T and AirTouch might mount a bid may underpin the price. But after enjoying such a strong run, investors should reach for their handsets, dial their brokers and ring up some profits by selling the shares.

Vodafone Share price 26812p Prospective yield 1.9% Prospective price-earnings ratio 27 Dividend cover 2.5

1994 1995 1996*

Sales pounds 851m pounds 1,153m pounds 1,488m Pre-tax profits pounds 363m pounds 371m pounds 465m Earnings per share 8.1p 7.8p 9.8p Dividend per share 2.78p 3.34p 4p * NatWest estimates