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Why Vodafone Group plc Investors Could Be Crying Next Year

The problem with a competitive market is that it’s competitive. I know that sounds like stating the bleeding obvious, but it’s true. If you’re running a business and you’re not competing, you’re falling behind. Some businesses fall so far behind they eventually wind up.

In addition, the market you’re competing in may take a turn down a path that you were trying to avoid, or perhaps a path you thought wouldn’t be fruitful. That’s precisely the position that Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) has found itself. That is, BT Group has led the charge down the bundled services path (fixed line, mobile, broadband, and TV services), and now Vodafone’s got some tough or uncomfortable decisions to make. So how is it all going to play out? Let’s find out.

You could do a lot worse than Vodafone

If you look at Vodafone as an isolated company it looks like a sound investment. Vodafone has produced income of £59.25 billion over the past 12 months. It’s also managed a net profit margin of around 26%. Given how flat the telco’s revenues are, the CFO deserves a pat on the back for that achievement. The management accountants also deserve a round of beers given the company’s return on assets — sitting at just under 9%. Given the stability of the stock price, longer-term investors might also be attracted to Vodafone’s dividend. It’s a little over 11p, pulling in a yield of around 4.8%.

Here’s the thing, though: while to date the company’s performance has been sound, shares in the telecommunications firm are down 2.5% over the year. That suggests a lack of confidence in the value of the firm’s future cash flows (or its value). Why is that? It may have something to do with the direction the company is taking, or at least thinking of taking.

Its current offer

It’s all about 4G at the moment. Vodafone has been using content offers to encourage customers to take its premium 4G offering — the idea being that customers use additional data as part of their contracts. Its main competitor, BT, on the other hand, has bundled TV with broadband and mobile services. Its TV offering provides on-demand content, 20 extra entertainment channels, 9 extra children’s channels, 11 Movie channels, and 3 live sports channels. Vodafone simply doesn’t compare. So does Vodafone step up, or does it cut costs (and drop prices) in order to compete with the many other high-tech mobile providers out there?

Vodafone’s game plan

The mobile provider looks like it’s going to step up. Vodafone says it’s planning to launch its own broadband and TV services in spring next year. The telco already offers Sky Sports channels on mobile devices as part of its 4G bundles. It also recently introduced the Sky-owned Now TV as an option for 4G customers, granting access to Sky Movies. So now, rather than leapfrogging BT — which is a mammoth task — the most sensible option looks to be a full-scale partnership with Sky, allowing both companies to offer a complete range of broadband, fixed line, mobile and pay-TV services. The end result would effectively be BT versus Sky and Vodafone.

Naturally BT has responded by saying it’ll likely re-enter the mobile market around the same time that Vodafone is expected to move into broadband. The competition’s therefore now become neck and neck.

The risks

This all makes sense to me accept for the fact that Vodafone is essentially going ‘kicking and screaming’ into this new digital revolution. Vodafone’s chief executive actually said he had doubts that in the long run this content will really create a lot of value for the platform. He said he thought it would just create lots of value for the owner/customer. No offense taken, Mr Colao!

Realistically Vodafone needs to embark on this project to stay in the mobile and TV space. It can’t do it on its own, nor does it want to do it on its own… so it’ll likely partner up with Sky. Partnerships are meant to create synergies, but I can’t see this new partnership generating much love. It’s essentially an arranged marriage. If Vodafone can learn to love broadband and TV, however, you’ve got yourself quite a partnership.

Any kind of worthwhile stock analysis should be both quantitative and qualitative. Fortunately the Fools are great mathematicians, so that's covered, but you also need to know how to analyse a company's strategy and its management. Take the case above for example. Knowing why companies do what they do is important.

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David Taylor has no position in any shares mentioned. The Motley Fool UK has recommended Sky. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.