Probably The Best Reason To Buy Vodafone Group plc Today

Long-term investors like its income, but there is another reason to buy Vodafone Group plc (LON:VOD) today, explains Roland Head.

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Few FTSE 100 stocks have attracted more intense discussion than Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) over the last few months — and for good reason.

Vodafone owns a 45% stake in the largest US mobile operator, Verizon Wireless. The other 55% of this firm is owned by Verizon Communications, which would dearly like to own the whole company.

I believe that a sale is increasingly likely, and that this might result in a major increase in Vodafone’s profitability and free cash flow.

No control

Vodafone receives income from Verizon Wireless in the form of an annual dividend. Last year, Vodafone received a £2.1bn dividend payment, which equates to an 8% annual return on Vodafone’s original investment in 2000 of £26bn.

That’s not bad, except that as a minority shareholder, Vodafone has no control over how Verizon Wireless is run, nor whether it pays a dividend — like all dividends, it’s optional, and is effectively under the control of Verizon’s management. Verizon Wireless didn’t pay a dividend for five years up until 2011.

Over the last couple of years, Vodafone has been pursuing a policy of selling of assets it doesn’t control, and Verizon Wireless is by far the biggest of these.

What could Vodafone do with $100bn?

Vodafone’s stake in Verizon Wireless is thought to be worth at least $100bn, and many analysts believe the price will need to be around $130bn for a deal to go through.

Company directors are generally reluctant to deliberately downsize their companies, so returning the cash to shareholders and paying down debt seems an unlikely option. More likely would be for the majority of the money to be used for one or more acquisitions.

Growth opportunity

Vodafone is far less burdened with debt than its European peer Telefonica, but it is suffering from a shortage of free cash flow, as is shown by the company’s current policy of maintaining (not increasing) current dividend levels.

I think that a one-off cash injection of this kind would provide Vodafone with a perfect opportunity to make one or two well-targeted long-term acquisitions outside the eurozone, and fund future capital expenditure without having to substantially increase its gearing.

By doing this, Vodafone should place itself in a strong position for medium-term growth and emerge as a robust, profitable and cash generative global business.

A share to retire on?

Vodafone currently offers a 5.4% yield, making it a strong favourite with retirement investors.

If you already own Vodafone shares and are looking for more good quality income stocks with growth potential, then I’d recommend you take a look at 5 Income Shares To Retire On“.

It’s a special report by the Motley Fool’s team of analysts, who have identified five FTSE 100 shares which they believe could be ideal income-generating retirement shares. The report is completely free, but availability is limited, so click here to download your copy now.

> Roland owns shares in Vodafone, but not in any of the other companies mentioned in this article. The Motley Fool has recommended Vodafone.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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