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It is tough to paint Vodafone's share buyback plans as a bad thing

04/12/2012

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

US mobile network operator Verizon wireless’s (VZW) announcement on 12 November that it will pay an $8.5bn (£5.4bn) dividend by the end of the year has provoked an interesting response from the UK market. The company is 55% owned by Verizon communications and 45% owned by Vodafone, meaning the British mobile phone giant will receive some £2.4bn, £1.5bn of which will be used to buy back shares.

This appears to have disappointed the market for a couple of reasons – the first being that VZW’s latest dividend is down on the $10bn it paid to its two shareholders at the start of 2012. In addition, the percentage of the distribution Vodafone plans to return to shareholders through its proposed share buyback programme is lower than it was in January when, it chose to pay a special dividend.

Apparently there is no pleasing some people because, looked at another way, VZW is set to have paid out the not inconsiderable sum of $18.5bn to its two shareholders over the course of 2012. The business is sufficiently cash generative and has a strong enough balance sheet that it could continue to pay out similar amounts in future. Vodafone’s share of VZW’s annual free cash flow is over £4bn a year.

Any cash Vodafone may or may not have paid out to shareholders on this occasion has not disappeared but remains within VZW to either be invested in the business or used to reduce debt – both of which should increase the equity value of the business. It is still the shareholders’ money and so the fact they do not actually have it in their pockets – at least, not yet – misses the point to some extent. One way or another, it will be returned to them in the end.

Some income investors are unhappy that, with this latest pay-out from Verizon; Vodafone’s chosen mechanism of return is a share buyback rather than another special dividend. They maintain that, this time, they are not receiving the income they feel they deserve and the £1.5bn buyback programme is a waste of money.

However, the reality is that, unless you believe Vodafone shares are overvalued, a share buyback is the most effective way to return money to shareholders. It achieves the lasting benefit of decreasing the number of shares in issue, which in turn makes Vodafone’s regular dividend payments more sustainable. Either the company can pay the same dividend per share to a smaller number of shares, meaning it has more cash to spend on other things, or it can spend the same amount of cash paying dividends to the smaller number of shares, meaning the dividend per share can grow more than it might have done otherwise.

While the rest of Europe’s struggling telecoms sector is being forced into rights issues and dividend cuts, the retention of some of this latest Verizon distribution by not using it all for the buyback will strengthen Vodafone’s balance sheet. Like some sort of spoilt child, the market might want it all – and want it all now – but given the challenges many of its peers are facing it is tough to paint Vodafone’s windfall and ensuing buyback programme as a disappointment or bad news.

 

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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