As 2020 draws to a close, I am looking at potential UK companies to add to my portfolio. Vodafone (LSE: VOD) shares are on my radar but I am not convinced about investing in the stock. Here’s four reasons why I am not buying yet.
#1 – Mountain of debt
At time of writing, Vodafone has a market cap of £34bn. Recent results highlighted that its net debt amounts to €44bn (approximately £40bn), which exceeds the market value of the company.
As an investor, this does not make sense to me. I don’t like the idea of buying Vodafone shares when I know that huge mountain of debt will take so much time to pay down. The management team has implemented a cost cutting programme and is improving its customer focus to tackle the leverage on the balance sheet.
#2 – Vantage Towers
Vodafone is spinning off its Vantage Towers business through an initial public offering (IPO) in early 2021. The proceeds from this stock listing will be used to help pay down the debt position and possibly pay a bumper dividend to investors.
I am not getting sucked in Vodafone’s prospects of paying a special dividend. Vantage Towers is Vodafone’s European tower infrastructure business. It is a network of ground-based and roof-top towers across key locations. I believe the sale will mean that the company is losing an attractive asset, as Vantage Towers’s revenue is inflation-linked.
The requirement for data as well as the roll-out for 5G technology means that the growth potential for Vantage Towers is huge. While the FTSE 100 company will continue to be Vantage Tower’s tenant, the remaining business will be much smaller and debt laden. The remaining prospects for Vodafone shares do not sound appealing to me.
#3 – Liberty Global
In July 2019 the mobile operator completed its acquisition of Liberty Global’s assets in Germany and Central Eastern Europe. While the deal added to Vodafone’s debt burden, it was part of its convergence strategy, whereby it can sell multiple services to customers.
Germany is Vodafone’s largest market be revenue. By cross-selling mobile, broadband, and television services in this region, the customer retention will improve. But this does not prevent Vodafone’s competitors copying the strategy if it proves to be a winner.
While the convergence strategy makes sense to me, the benefits are likely to take time to manifest and is unlikely to reduce the debt in the short term.
#4 – Dividend payer
Vodafone has a history of paying large dividends that are not covered by earnings. In May 2019, it reduce its dividend by 40% in order to preserve cash and pay down debt.
The Vantage Towers IPO could result in a special dividend. But I think future dividend cuts could be in the pipeline especially when earnings do not cover the payment.
Despite Vodafone investing billions in the mobile spectrum, there is not much differentiating the company from its competitors. Customers typically just go with the cheapest deal, which could impact the telecom provider’s revenue and thus the security of its dividend.
In summary, the strategy and changes make sense to me but I am sceptical Vodafone shares can thrive from here.
Nadia Yaqub has no position in the shares mentioned. 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.