Fixing Vodafone

There was a time when the news that Vodafone Group was eyeing a takeover of Cable & Wireless Worldwide (CWW) would have come as a big surprise. The UK-based operator once seemed determined to be thought of as a mobile-only player, shunning investments in the fixed-line infrastructure that is CWW’s speciality. But when Vodafone last week confirmed its interest in exactly such a deal, few were taken aback. Buying CWW would simply mark the continuation of a strategy that Vodafone started to implement several years ago.

Indeed, Vodafone has diversified into fixed-line services in many parts of Europe, either through leasing or by acquiring assets, and fixed-line revenues now account for about a tenth of its total European turnover. Its biggest investment is in Germany, where it owns Arcor, a sizeable broadband operator using DSL technology (a way to boost speeds over traditional copper links). Often, it has seen offering fixed and mobile services together, usually in discounted bundles, as a means of growing its market share. Its fixed-line acquisitions mean it can better compete with Europe’s other big operators, including France Telecom, Deutsche Telekom, Telecom Italia and TeliaSonera, each of which now has fixed and mobile infrastructure. A takeover of CWW would make Vodafone an even stronger rival.

With CWW’s network assets, Vodafone would also be a lot less reliant on leasing capacity from fixed-line players to help it carry growing volumes of mobile-data traffic. Moreover, CWW claims to have the largest fibre network in the UK dedicated to business users (with more than 20,000km of lines), supported by an impressive list of large business customers that includes 70 FTSE 100 companies. The takeover would also help Vodafone to sell corporations services like data connectivity and cloud computing, besides basic connectivity. Fixed-line operators are typically perceived to have greater proficiency in these areas.

Not as easy as it sounds

But merging two big businesses, with very different backgrounds, is not going to be easy. And while CWW has an impressive customer list and attractive network assets, it is performing poorly. Since its March 2010 demerger from Cable & Wireless Communications (which has operations in the Caribbean, Panama and Macau), CWW has announced a string of profit warnings. In the six months to September 31st last year, it also posted a net loss of £433m (US$687m, at today’s exchange rate). Competitive pressures, along with a slowdown in public-sector spending—the UK government is one of CWW’s biggest customers—have badly affected the company.

Bad management decisions have not helped matters, either. Under John Pluthero, its former chief executive, CWW overpaid for Energis and Thus, two smaller rivals, by some measure. Asset writedowns on these acquisitions total £423m. Mr Pluthero stepped down from his post last November, when there was little sign that CWW’s financial performance was improving. His replacement, Gavin Darby, previously worked at Vodafone.

Following asset sales in France, Poland, Japan and China, Vodafone certainly has enough cash to make an attractive offer for CWW. It may also benefit from a substantial annual dividend from Verizon Wireless, the US mobile operator in which it holds a 45% stake. Last year, Vodafone received its first dividend from Verizon Wireless, which totalled US$4.5bn. The bulk (£2bn) went to Vodafone shareholders, but future payments of similar amounts (if sanctioned by Verizon Communications, the parent company of Verizon Wireless) would put Vodafone in an even stronger cash position.

The dramatic fall in CWW’s share price will also help Vodafone. Twelve months ago, CWW shares were trading at £0.75, but they had fallen to just £0.13 by the time Mr Pluthero resigned in November. Although they have risen slightly since Mr Darby’s appointment, and rallied to more than £0.27 on news of Vodafone’s interest, CWW shareholders are still a lot worse off than a year ago.

The question that Vodafone’s managers must ask is whether they can turn the CWW business around. When Mr Pluthero took the CWW helm in 2006, he famously told company employees they were working for an “underperforming business in a crappy industry”. Executives from both companies will need to be a lot more upbeat if a deal is to come off.

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