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Did You Realise That Vodafone Group plc Is A Tech Play?

Technology shares have taken a hammering in 2014, whether the firms are listed in London (think ARM Holdings) or across the Atlantic (think Twitter).  

The mistaken assumption — especially when it comes to Internet stocks — is that every one of these companies will be a resounding success. They will not.

However, there will be a few big winners, along with a collection of duds. And I believe Vodafone (LSE: VOD) (NASDAQ: VOD.US) has the potential to be one of those winners, despite ongoing struggles in its key markets.

Yes, Vodafone, the British telecoms giant, is a tech play.

And unlike many technology companies — ones that haven’t got the long and illustrious history of a typical blue-chip — Vodafone pays a nice dividend (it’s currently yielding 5.6%).

Boom and bust?

VodafoneIndustry figures show that handset sales to contract and pay-as-you-go customers fell 10% year-on-year in December. The market has reached saturation point. But despite the smartphone boom being over, Vodafone is well placed to capitalise on new consumer trends.

Mobile users are consuming more data than ever — and it’s growing at a rate of 81% year-on-year. Vodafone now has 4.7m 4G customers across 14 countries, and the firm is presently engaged in a two-year investment plan to extend its coverage.

4G makes it easier to stream films, TV and music on the go, and given the popularity of services such as Spotify and Netflix, the revenue potential is obvious.

Changing winds

Vodafone anticipates that its investment programme will result in incremental free cash flow greater than £1bn from the 2019 financial year. During the investment phase, however, cash flow will be squeezed, which is something to consider if you’re an income-minded investor.

Free cash flow — that is, the cash profits available for shareholders — was £4.8bn in 2014. This is significantly below estimates from two years ago, which anticipated free cash flow in excess of £7bn, but the telecoms sector is evolving at a rapid pace, and Vodafone wants to lead the field.

What you’re investing in is a business, as we all know, not a ticker or any kind of label. Businesses breathe. Their qualities can alter. Vodafone may once have been a cozy fit for many an income portfolio, but the impetus is on potential investors to understand the present direction.

Margins are being squeezed by increasing competition, but there was a bright spot in 2014. In India, where Vodafone has 52m data customers, service revenue increased by 13%. Emerging markets are key for Vodafone — so we’re not just looking at a tech play, but also a macro one.

Margins

Vodafone isn’t a blue sky punt, then. Unlike, say, a more typical tech or internet stock (with triple digit P/E ratios, in some cases), Vodafone could benefit from the tech sector’s tail winds without the downside on valuation.

But can it drastically improve profit margins in the next five years? It won’t be easy, and if it doesn’t then the appreciation in the share price may be limited.

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Mark doesn't own shares in Vodafone.