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QEV: how Vodafone’s capital return will shape markets

QEV: how Vodafone’s capital return will shape markets

On 4 March Vodafone will distribute £52 billion to its shareholders, following their approval of the disposal of Verizon Wireless, a deluge of cash even sober market watchers have likened to quantitative easing (QE).

The headline amount – comprised of a £15 billion cash dividend and Verizon shares worth around £37 billion, a great deal of which will be sold immediately given the tax treatment of US shares – is an amount greater than the market capitalisation of giants like AstraZeneca, Rio Tinto, and Barclays. A £52 billion company would be among the 10 largest in the FTSE 100. The cash portion alone is more than the market capitalisation of BAE Systems, Legal & General, and Reed Elsevier.

Stephen Bailey of Liontrust’s macro-thematic team expects the flow of cash to have a significant effect on markets. ‘You could argue it is like having another dose of QE. The effect on the index is quite dramatic. For example, an index fund will have to purchase every other stock in the FTSE 100 to rebalance portfolios,’ he said.

While that process should buoy large-caps in general, it also stands to boost several sectors in particular. ‘The interesting side will be the re-investment from non-passive investors,’ explained Bailey.

‘You could argue that most holders of Vodafone do so because of an income bias. Therefore, if you hold Vodafone and you have a pot of cash coming back to you, where else can you invest for an above-average level of income? I think large oil and pharma will benefit.’

Citywire A-rated Michael Clark, manager of the £722 million Fidelity MoneyBuilder Dividend fund, also believes income seekers will plump for the ‘oil twins’ and healthcare titans. ‘There isn’t a shortage of alternative opportunities. It’s not going to be difficult to replace the income.’ Chris Kitchenham, a director at Walker Crips, agrees that those two sectors will attract a good deal of the money.

He and Clark moot HSBC as a possible destination too, especially for value-minded investors. ‘HSBC is the one because it already pays a dividend,’ Clark remarked of the banking sector. ‘For the others it’s more hope over experience.’ George Godber, manager of the Miton UK Value Opportunities fund, suggests Royal Mail as another probable home given its ‘fantastic dividend potential’.

Those interested in a like-for-like replacement telecoms stock have more limited options, although Godber cites BT as a ‘natural home’ for the Vodafone proceeds. Europe offers more obvious equivalents, with Godber having bought into Deutsche Telekom for example.

It too boasts an American asset – T-Mobile USA – that Godber believes is ‘under-reflected in the current share price’. However, he is sceptical of the broader European telecoms industry as they have ‘slightly scary capital structures and will probably needs rights issues’.

A more tangential winner from the Vodafone redeployment could be consumer discretionary names, Godber contends. An investor with £1,000 in Vodafone should receive around £500, which Godber compares to the cheques many received from PPI mis-selling. He notes that that ‘really manifested in the new car market’, and supposes that the Vodafone cash could similarly be spent on a new TV (particularly with the World Cup approaching) or a holiday, in which case stocks to back could be Dixons or Thomas Cook. But Clark points out that such options won’t match Vodafone for yield.

Others are more circumspect in their expectations. Paul Kavanagh, a partner at Killik, observes that Vodafone is well owned by global investors. ‘It would be wrong to suggest that all of it comes back into the UK.

I suspect the cash will be spread across international markets. While the headline sums look attractive, once you strip it all out I don’t think you will see a noticeable effect.’ Kitchenham predicts that the impact will be felt slowly, as the proceeds are reallocated gradually rather than instantly. ‘Some will feel the cash is burning a hole in their pocket and some will be more relaxed.’

As for Vodafone itself, few are excited by the prospects for what remains of the business. Citywire AAA-rated Richard Colwell, manager of the £2.5 billion Threadneedle UK Equity Income fund, is not tempted by the firm.

‘In terms of the core business and the fact they have indicated they need to invest more capital expenditure and they appear to be quite keen to buy fixed-lined assets in Europe, I think that vindicates some of the operational concerns that I had over Vodafone – that their core cash flows were not as stable as a lot of people thought.’

Whether Vodafone opts for a series of bolt-on acquisitions or a transformative deal such as a merger with BSkyB, Kavanagh acknowledges that ‘you have some deal risk here’. Godber concurs that ‘there is going to be an enormous amount of corporate activity in this market’.

Optimists can instead highlight Vodafone’s exposure to Europe, says Kavanagh, and particularly the south of the continent. ‘Savvy investors will appreciate that European markets are recovering,’ Kitchenham commented. Clark is doubtful, due to the pressure on telecom margins in Europe. ‘It’s not evident that a general recovery there will benefit Vodafone.’

Kitchenham is nonetheless reassured by the fact that ‘we’ve had a fair indication Vodafone is going to be a progressive dividend payer’.

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