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Why I Swapped Vodafone Group plc For British Sky Broadcasting Group plc

Vodafone

Like many private investors, I’ve had a good run with shares in Vodafone (LSE: VOD) (NASDAQ: VOD.US). I sold a chunk after the Verizon Wireless distribution, but held onto some shares to see what the new Vodafone would do.

Recently, I sold the last of my holding and bought British Sky Broadcasting (LSE: BSY) instead. It’s not that Vodafone is a bad share but, on a side-by-side comparison, I think Sky has better upside potential and lower downside risk.

The two companies represent opposite ends of a converging industry that is in a state of flux. Vodafone is the largest mobile phone company in Europe, steering towards offering ‘quad play’ mobile, broadband, fixed line and pay-TV services through its ‘Project Spring’ transformation strategy. It recently acquired cable TV companies in Germany and Spain. Sky is the biggest pay-TV operator in Europe. Content-driven, it offers just triple-play (without mobile) but is the most innovative in delivering content on mobiles and tablets.

The downside

I’ve been skewing my portfolio to be more defensive, in anticipation of what could be a bumpy road ahead for markets. Both companies have defensive characteristics: mobiles and TV have become consumer staples.

But Vodafone has greater market risk. It’s trading on a high prospective P/E (29.6 against Sky’s market-average 13.0). The shares are supported by the fat dividend, which the company can comfortably pay whilst it builds a new business to replace the income stream it lost when it sold Verizon Wireless. But that makes Vodafone something of a story stock: any negative news in a febrile market could see the shares punished. I don’t see the same degree of downside risk with Sky.

The upside

On the other hand, Sky is positioning itself nicely to capitalise on the evolving shape of the sector. Its recent purchase of fellow associates Sky Deutschland and Sky Italia offers several advantages. There should be cost savings from rationalising operations; there’s the potential for technology transfer from more advanced to less advanced countries; and it creates a large-scale customer base to spread the cost of investment in original programming and content acquisition.

The icing on the cake is that whilst the chances of a buyer knocking on Vodafone’s door have withered, Sky’s strong market position in a fast-changing sector, coupled with its digestible size, makes it a potential target – indeed possibly for Vodafone itself.

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Tony Reading owns shares in British Sky Broadcasting. The Motley Fool has recommended British Sky Broadcasting. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.