The Motley Fool

Will the Vodafone share price ever make a successful comeback?

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.

Image source: Getty Images

The Vodafone Group (LSE: VOD) share price is trading at levels not seen since the financial crisis, 10 years ago. Is this a clear signal to buy, or a sign of possible distress?

The big risk for investors is the firm’s rising level of debt. I’ve previously been bullish about this stock, but new developments last week have prompted me to take a fresh look. Here’s what I think.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

Between a rock and a hard place?

If a profitable company needs cash to fund an acquisition, the first choice is usually debt. But if the company already has too much debt, then sometimes it will choose to raise the cash by issuing new shares.

Vodafone is in this situation at the moment. It needs to come up with €10.8bn in cash to finance last year’s €18.4bn deal to buy European cable operator Liberty Global.

Unfortunately, the group’s net debt is already high, at €32bn. That represents roughly 2.2 times the group’s earnings before interest, tax, depreciation and amortisation (EBITDA). As a general rule, I prefer to see debt below 2x EBITDA.

Should VOD issue new shares?

One option for chief executive Nick Read would be to issue new shares to raise cash. This would help to manage the group’s debt levels and protect its investment-grade credit rating. Losing this rating would be bad news, as Vodafone’s borrowing costs would rise sharply.

However, there are two problems with issuing new shares.

The first is that with the stock at a 10-year low of c.136p, Vodafone shares aren’t a very valuable currency. I estimate that to raise a given amount of cash, the firm would need to issue 45% more shares today than it would have done one year ago, when the stock traded over 200p. This would increase the level of dilution suffered by shareholders.

The second problem with issuing new shares is that it would increase the annual cost of paying the dividend. This would make a dividend cut almost certain — something Mr Read is trying to avoid.

A cunning plan

The solution chosen by Mr Read is to issue £3.4bn of mandatory convertible bonds. These are basically bonds that are repaid with new shares, instead of cash. The company hopes that because no cash is due to be repaid, these bonds won’t affect its credit rating.

If you’re thinking that this is just a delayed way to issue new shares, you’re right. But Mr Read has a cunning plan. When these bonds mature in 2021 and 2022, he plans to buy back the new shares he’ll have to issue. To fund this buyback, Vodafone plans to issue more debt.

Should I buy, sell or hold?

My view is that Vodafone’s new bonds should provide some breathing room and allow the dividend to be maintained for another year or two.

However, I can see no plans to reduce borrowing. It turns out that this is deliberate — Mr Read believes that his plans for the firm will enable it to support higher debt levels on a permanent basis.

He may be correct, in which case the shares could perform strongly. But this seems a risky strategy to me.

I wouldn’t buy the shares at their current levels, and am thinking about selling my own stock.

“This Stock Could Be Like Buying Amazon in 1997”

I'm sure you'll agree that's quite the statement from Motley Fool Co-Founder Tom Gardner.

But since our US analyst team first recommended shares in this unique tech stock back in 2016, the value has soared.

What's more, we firmly believe there's still plenty of upside in its future. In fact, even throughout the current coronavirus crisis, its performance has been beating Wall St expectations.

And right now, we're giving you a chance to discover exactly what has got our analysts all fired up about this niche industry phenomenon, in our FREE special report, A Top US Share From The Motley Fool.

Click here to claim your copy now — and we’ll tell you the name of this Top US Share… free of charge!

Roland Head owns shares of Vodafone. The Motley Fool UK has no position in any of the shares mentioned. 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.

Our 6 'Best Buys Now' Shares

Renowned stock-picker Mark Rogers and his analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply click below to discover how you can take advantage of this.