Q&A: The secret of Vodafone's success

Mobile phone giant Vodafone has posted a £4bn profit, a result at the upper end of City expectations. However, the small print shows that the company actually made a loss of £8bn.

BBC News Online investigates whether Vodafone is a success story or in trouble.

A profit of £4bn? A loss of £8bn? Give me the real numbers!

Welcome to the mysterious world of corporate accounting.

Do you want to check out the potential of a company? Then you may want to look at its earnings excluding the costs of interest payments, tax, depreciation and amortisation. Corporate wonks call this EBITDA.

It makes most companies look good, regardless of their real profits. An official of the US stockmarket watchdog once called EBITDA the profits "before the bad stuff".

Ringing up Vodafone

EBITDA: £7bn
(+28%)

Pre-tax profit: £4.03bn
(+87%)

Loss after "exceptionals": £8.1bn
(-600%)

Turnover: £21.4bn
(+29%)

Proportionate customers: 83m
(+66%)

Customer total: 188m

Subsidiaries in more than 30 countries

Share price
2 June 2000: 335p

Share price
29 May 2001: 190p

On this count, Vodafone made a profit of £7.04bn ($10bn).

But this does not reflect the real costs of running Vodafone as a business. A better measure therefore will be "pre-tax profits", which show most of a company's income.

This figure sees Vodafone making a £4bn profit, and is probably the best measure of the group's performance.

Even this does not tell the whole story. Vodafone has been on a buying spree during the past few years, and shareholders are now being presented with the final bill.

The so-called "goodwill amortisation" on these purchases costs Vodafone close to £11.9bn.

The results is an annual loss of £8.1bn.

However, this are clearly one-off costs, so-called exceptionals, and while they hurt this year's bottom-line, they don't show the normal performance of the business.

To summarise: The secret of Vodafone's success was its rapid global expansion, thus gaining market share and revenue potential - and the company is now counting the costs.

Overall though, Vodafone is in a strong position for the future.

So Vodafone is doing well then?

Hmmm, the company is certainly doing better than many of its rivals.

Nobody else in the mobile phone market has such a wide international scope.

Vodafone also owns a majority stake in most of the phone networks it has invested in, which allows it to enforce a coherent corporate strategy.

The next bit of good news is that Vodafone managed to pay for most of its acquisitions with its own shares, which is much cheaper than asking the banks for money.

As a result, Vodafone has less than £7bn in debt - much less than its rivals.

And finally, Vodafone is a mobile phone "pure play". Analysts and many investors like this focus on one industry, as it allows the management to do one job really well.

That's the big picture. Looking at Tuesday's results, though, analysts are somewhat underwhelmed.

Investment bankers Goldman Sachs called the results "solidly in line"; Credit Lyonnais described them as "unexciting".

Despite this, nearly every broker rates Vodafone shares as a "buy" or better.

But there are risks. Vodafone has admitted that the roll-out of third-generation (3G) mobile phone networks will cost the company about £10bn during the next five years.

And nobody has yet figured out a fool-proof way to make money out of 3G services.

There is one consolation: Vodafone's chief executive, Chris Gent, has promised shareholders that the company will not have to go into debt to finance the 3G roll-out.

What are Vodafone's next steps?

Make more money. Seriously, though, this is exactly what the company is promising to do.

The days of rapid expansion are gone, says Mr Gent: "Acquisition activity should be less than it has been in the last two or three years".

The company will pass on opportunities to increase its stake in Cegetel of France or buy into MobilOne of Singapore.

Expansion plans for Latin America have been put on ice, following a big acquisition in Mexico earlier this year.

Mr Gent says that for now there are only two countries left to be targeted, Japan, where the company already has a substantial presence, and China.

The days of focusing on growing the customer base and market share are clearly over.

Vodafone now wants to improve its "margins", the money it can make from each customer.

There are several ways of doing this.

• Vodafone can become more efficient while charging the same.
• Customers can be enticed to pay for extra services, for example subscriptions to news and sports results.
• The company can also try and persuade customers to move from cheap but hardly profitable pre-pay schemes to more lucrative mobile phone contracts. The imminent roll-out of always-on GPRS phones - which promise users higher transmission speeds and better access to Wap and mobile internet services - could help with that.
• And if market conditions allow, Vodafone could also try to push up prices. But this is unlikely considering how competitive the market has become.

But if GPRS phones flop, then Vodafone will face some tough times until the roll-out of 3G services.

And what does it mean for Vodafone's shareholders?

As the results were announced, Vodafone's share price dipped slightly.

For the longer term, though, most brokers keep recommending the stock with "buy" or "strong buy" ratings.

But analysts also warn of a "vague outlook" for the company.

One problem is Vodafone's habit to pay with its own shares. Some analysts worry that the people who were paid in Vodafone shares might decide to get out of the business quick.

This could flood the market with Vodafone stock and depress the share price.

Another - more realistic - worry is that the mobile phone industry is actually experiencing shrinking profit margins.

And the telecoms sector continues to be out of favour with investors, which does not bode well for share prices.

And of course there is the big uncertainty of 3G.

All told, the whole telecoms sector is a gamble. But compared to its competitors, Vodafone clearly is one of the favourites to win the profits stakes.