Does Vodafone’s merger with Three make the stock a buy?

Is news of a merger with Three UK the start of a turnaround for the Vodafone share price? Stephen Wright looks at what investors need to know.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Young Asian man drinking coffee at home and looking at his phone

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Vodafone (LSE:VOD) and Three UK, the UK’s third- and fourth-largest mobile operators have announced a merger agreement. Could this be the start of a turnaround for the embattled income stock?

Vodafone’s problems

As a business, Vodafone has had a number of issues. Some of those are specific to the company, but I’d argue its biggest issues are to do with the environment in which it operates.

First, telecoms is a capital-intensive business. Operators are constantly faced with high fixed costs and a need to invest more cash in their assets.

Second, the industry is somewhat commoditised. In the UK, for example, Vodafone competes with EE, O2, and Three with little to differentiate it from a customer perspective.

This means the most important issue for customers is price. And a third problem is its competitors appear determined to win at all costs, reducing returns for everyone.

In a market like this, what Vodafone needs is a competitive advantage. Until now, this has been conspicuously lacking, but news of the merger might be about to change that.

A solution

According to reports, Vodafone has agreed a deal to combine its UK operations with Three UK, currently owned by CK Hutchison. Doing so would create the UK’s largest mobile network. 

The deal hasn’t been approved by regulators yet and there’s a chance it might not be. But if it goes through, it could be a significant boost for the company.

From Vodafone’s perspective, there are two main benefits. First, it would remove a major competitor, reducing the intensity around price competition.

Second, it would give the combined company greater scale than either has individually. This might help it reduce its own costs, giving it the kind of advantage it has been lacking.

It’s therefore understandable that Vodafone’s shareholders might view this positively. But it raises some other issues for investors to consider.

Investment thesis

I think there are two potential downsides for shareholders to consider. The first is that joining with Three might reduce the chances of the company being acquired itself.

Some of Vodafone’s major shareholders are other telecoms companies. And this has had stock market participants speculating a takeover offer might be coming.

Joining with Three probably makes this less likely. So investors hoping to be bought out at a premium might have to rethink their thesis.

There’s also a question of what the proposed arrangement means for the dividend. The 10% yield has seemed unsustainable to me and more shareholders on board makes this even more likely.

A stock to buy?

I think the announcement is positive news for Vodafone as a company and increases the intrinsic value of its shares. But there’s too much uncertainty for me to invest right now.

Will the deal go through? Will it give the company enough of a competitive edge? Does the merger make an acquisition less likely? What does the future of the dividend look like?

To me, these are all key questions. So I’ll wish Vodafone shareholders the best of luck with their investment, but I’ll be cheering them on from the sidelines for the time being.

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.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Illustration of flames over a black background
Investing Articles

Just released: October’s higher-risk, high-reward stock recommendation [PREMIUM PICKS]

Fire ideas will tend to be more adventurous and are designed for investors who can stomach a bit more volatility.

Read more »

A Black father and daughter having breakfast at hotel restaurant
Investing Articles

2 household names quietly thrashing the FTSE 100

Paul Summers takes a closer look at two FTSE 100 stocks that have soared despite recent economic headwinds. Will they…

Read more »

Investing Articles

A FTSE 250 share and an ETF I’d buy for a second income

I'm looking for ways to make a healthy passive income and I think this stock and this exchange-traded fund (ETF)…

Read more »

Frustrated young white male looking disconsolate while sat on his sofa holding a beer
Investing Articles

3 reasons why I’m avoiding Rolls-Royce shares like the plague!

Rolls-Royce shares trade on a meaty price-to-earnings (P/E) ratio of 30 times. Royston Wild thinks this leaves them in danger…

Read more »

Investing Articles

After crashing another 15% today is this FTSE blue-chip now the best share to buy today?

Harvey Jones has been watching FTSE 100 gambling stock Entain for months and is now wondering whether it's the best…

Read more »

Chalkboard representation of risk versus reward on a pair of scales
Investing Articles

Here’s what Warren Buffett says is ‘the best way to minimise risk’ (it’s not buying the S&P 500)

What should investors do to try and avoid losing money? Warren Buffett has an answer that doesn’t involve buying an…

Read more »

Young Black woman looking concerned while in front of her laptop
Investing Articles

2 cheap shares I wouldn’t touch with a bargepole in today’s stock market

These FTSE 100 and small-cap stocks are on sale right now. But Royston Wild believes these cheap UK shares may…

Read more »

Investing Articles

Here’s the growth forecast for Greggs shares through to 2027!

City analysts expect the UK's leading food-on-the-go retailer to continue growing. But would this writer buy Greggs shares today?

Read more »