If you are feeling depressed (or even thinking of investing) you should watch the webcast on the VOD investor relations website. It was Arun's / Andy's best performance I have seen yet.

Anyway a couple of points I think are really important.

1. Change in Shareholder Base

I can't profess to have even an inkling of constituents of the VOD shareholder base – they must be '000s of tracker funds for instance.

However, one thing is certain after today – VOD is no longer a growth share and therefore a whole new group of owners will be entering the register looking at things like dividend yield, eps, fcf, effective tax rates, ROCE, WACC, etc, etc.

As of today these indicators are much more important than Net Customer Additions, Inactive Ratios, ARPU & WiFi for VOD's future.

Welcome to the new world…

2. Real Reasons for "Underperformance"

i) Operating Profit

Given that VOD has changed from a “growth” company to a “cash-cow”, we should really be looking at underlying performance: operating profit is as good a measure as it gets.

VOD unfortunately doesn't make the comparison easy but I'll do the job for you:

            30-Sep-05 30-Sep-04   Diff			
                   £m        £m     £m
Mobile Ops:			
Germany           775      779      (4)
Italy             923      844      79
Japan             191      423    (232)
Spain             529      397     132
UK                320      396     (76)
Americas          772      738      34
Other mobile      793    1,196    (403)
Common functions  153      (25)    178
Total           4,456    4,748    (292)

Other ops:	
Germany            38       17      21
Other             (17)      (6)    (11)
Total           4,477    4,759    (282)

• Common Functions is basically a “tax avoidance” mechanism ie branding charges + partner revenues. So basically £175m has been charged to 5 countries or around £35m each ;-)
With this in mind we can probably say the problems areas are (in order of importance)
• Other Mobile ie Sweden!!!
• Japan
• UK
• Germany
• Italy
• Spain

First of all, Sweden not Japan, was the mega-problem with a £515m write-off. VOD have completely got away with this in the press / analysts. Also, VOD's explanation that the asset is better off with Telenor is rubbish. How can Tele2 have great margins in Sweden, when all they have in the other Scandinavian countries is a few dodgy MVNO's. All I say is their better be a bigger tie-up with Telenor coming soon.

Japan is a nightmare, but not exactly one that has not been pointed out before. Indeed, the cock-up was probably one of VOD's “global company” early-days. Thank god, VOD has now moved on to be a local/global company. Shareholders need a turn around in Japan. People forget that KDDI and VOD have achieved turnarounds in previous incarnations. Personally after today, I see Japan as a potential big upside to the VOD share-price!!!

The real worry to me is the UK, slowly but surely things are getting worse and worse year-by-year. VOD really have to sort out the mess in the UK – if they can't they will never be treated with respect anywhere in the world. The pathetic hope that o2 would be bought by T-Mobile and consolidation would happen and thereby the UK would return to decent margins has gone and it probably didn't exist anyway. Telefonica has real firepower (more than France Telecom or Deutsche Telekom), T-Mobile is investing £1.5bn into the UK. Yes, things are going to get more competitive in the UK and profits could go worse. The UK deserves a separate note which I will do later.

The big worry is that the virus which has spread from Sweden and is arguably currently in the UK will spread to another European subsid and therefore we will treated to another huge write-off and in another nightmare spread to Germany – aaaargh. The signs are that the MVNO's are moving into Germany heavily – lets see in the 2nd Half if profits fall in Germany or the UK can't recover or another European subsid catches the virus.

I don't think competition will affect either Italy or Spain soon.

I'm also a little confused about the States, I would have thought given the Verizon results, the profits increase would have been more like 20-25% not 5%, I will also have to check this out.

I think for a VOD investor the key operating questions are:
1. Do you think Japan can recover?
2. Will another small European operator catch the Swedish bug?
3. How low can the UK go?
4. Can our Spanish amigo's & Italian amico's continue to bring home the jamón?


ii) Free Cash Flow

                                  Six months to 30 September
2005 £m
                                                    2005    2004      %
                                                      £m      £m change
Net cash inflow from operating activities          6,084   5,827    4.4
Add: Taxation                                        667     417
Net Capex                                         (2,570) (2,515)   2.2
Purchase of intangible fixed assets                 (252)   (329) (23.4)
Purchase of property, plant and equipment         (2,328) (2,204)   5.6
Disposal of property, plant and equipment             10      18  (44.4)


Operating free cash flow                           4,181   3,729   12.1


Taxation                                            (667)   (417)  60.0
Dividends received from associated undertakings      375     947  (60.4)
Dividends paid to minority interests in subsidiary   (21)    (18)  16.7
Net interest paid                                   (173)   (222) (22.1)
Dividends received from investments                   41      18  127.8
Interest received                                    135     194  (30.4)
Interest paid                                       (345)   (430) (19.8)
Interest element of finance leases                    (4)     (4)     –


Free cash flow                                     3,695   4,019   (8.1)

What I gather from the above is:
a. Despite the woes in several subsides, operating cashflow from the just keeps getting better & better;
b. the big drop in dividends received is almost completely down to Verizion Wireless stopping paying dividends and is not necessarily a bad thing. If they paid, it would only go straight out of the door to shareholders in dividends & buybacks ;-)
c. Financing Charges are more or less even – expect these to go up in the future as the balance sheet is re-leveraged. For instance net debt was £11bn at Mar 2005 and is forecast to increase to £17bn at March 2006.
d. cash taxation charges are going up and up. This is the nuclear bomb lying in the balance sheet - £5bn of potential deferred tax charges payable over the next 3 years There is some serious negotiations going on with the various taxation authorities across Europe. Although if they had to pay the lot it would not do any damage to the P&L – it would however wipe out cash flow for a year!! At least with the figure being £5bn the new CFO can afford some serious bomb disposal experts. Mind you those deficits in the governments of Italy and Germany are quite large and need attention ;-(

Bear in mind - with all the doom and gloom that will undoubtedly be in the press tomorrow – VOD is still a business that generated £3.6bn in cash in 6 months.

With the market cap down to £83.3bn and net debt of £14bn ie Enterprise Value of £97.3bn, the 1st 6 months FCF yield is 7.6% which is pretty cheap.

iii) Dividends / Earning per Share shenanigans

Vod proudly claimed today
Adjusted basic earnings per share increased by 8.5% to 5.37 pence.
This is absolutely rubbish as it deducted the Swedish Bug costing £515m and an Egyptian Put costing £151m – must also find out about that one.

The real truth is:

                                                                                  Six months     Year ended
                                                               September 2005 September 2004     March 2005
Weighted average number of shares for basic EPS (millions)             63,694         66,915         66,196
Basic earnings per share                                                4.36p          5.40p          9.68p
Adjusted basic earnings per share                                       5.37p          4.95p          9.62p

ie a real drop of 19.3%!!!

The only real reason I point this out (apart from the fact I like to point out “accounting cheats”) is the effect that the buy-back on EPS ultimately affects dividends. The shares in issue were reduced by 4.8% y-o-y

For what it is worth with the Free Cash Flow of £3,695m and the shares in issue, this equates to 5.8p of cash flow per share. With the new declared policy of dividends at 50% of EPS and the rest in buy backs – it implies an additional pay-back beyond the 2.2p dividend of 3.6p in buy-backs.

In reality it is going to be bigger this year with the overall £6.5bn buy-back programme. It is really difficuly to work out the average per share because of timing issue in the purchase affecting the weighted shares. But if we use the 63,694 shares as a benchmark:

Share buy back = approx. 10.2p /share
Interim Dividend =        2.2p /share
Final Dividend = guess.   2.5p /share (based upon 15% increase in final)

In other words           14.9p /share return to shareholders

Unbelievable?


3. Industry Prospects

It is a bit boring (although vital now) to do the number crunching so just a few thoughts on the key industry challenges (as opposed to VOD)

i) Regulation

I really did think things were looking brighter on the regulation front after the nightmare of the UK termination rate cuts spreading across Europe. The Dutch regulator had just allowed a purchase by KPN which took it over 50% market share. Ofcom were looking more telco friendly. The Germans were looking after Deutsche Telekom, the Spanish looking after Telefonica. All was looking good on the political front – or at least better, but a week is a long time in politics :-(

However, todays other news that the EU competition authority were going to do a 4 four month investigation into a single transaction in the small Austrian market which has 5 competitors and MVNOs (ie T-mobile purchase of tele.ring) is really, really bad news.

I only fear things can get much worse…

ii) Fixed Mobile Convergence

A lot of devices are about to be launched soon with GSM & WiFi capabilities, I think I am alone (apart from the fixed line PTT's and a few fellow wierdo's) in thinking these will be extremely successful and a big challenge to the pure mobile plays and certainly for their claim of grabbing more fixed minutes – it could work in reverse!!!

Everyone took the proverbial p#ss out of the BT for the Bluephone project, but they really do have a momentum starting to build with more and more PTTs signing on and more and more equipment makers signing on. Be prepared for phase 2 which is WiFi based.

Worst of all for VOD, there are compelling reasons for users to switch: price, improved coverage and convenience. If the industry can get this technology to work it will be a bigger threat to VOD than WiMax and all the rest of acronyms combined.

iii) Competition

How can VOD aide the consolidation process ? I know it sounds cruel but in the UK it is time a MVNO went bankrupt, Virgin disappeared and someone put Carphone Warehouse back where they belong! It would also be nice if H3G gave up, but I doubt that as well.

4. Inorganic Growth

Looking at the results, a cynic might say that the recent overseas M &A spurt in the developing world are because the board new that the current portfolio wouldn't deliver any growth. This is a bit harsh to me, even though I'd been a massive critic about the pace of acquisitions and missed opportunities.

If someone said to me what are the M&A priorities 5 years ago, I would have said:
• Increase ownership %'s in current subsid's
• Expand foot print in Europe
• Expand into Russia / CIS
• Expand into “new” Asian markets
• Expand into South / Latin America

All within the constraints of cash generated within the business, businesses being available at the right price and the VOD balance sheet.

Personally, I think VOD has done quite well on the first two. A lot missed opportunities have passed in Asia, but VOD is trying to fix it in India and I think watch this space. The strategy in Africa has been spot-on, but they could have been in Nigeria earlier, but who would have guessed the legal quagmire there? The announcement today of the “partnership” with Americas Movil is a great start in Latin America. Obviously Russia/CIA is missing, but again I feel watch this space.

The big constraint going into the future is the move from growth share to utility share – it will mean a far more disciplined company, which is not necessarily bad apart from in intermittent periods of land-grab (like today)

5. Outlook

VOd has been crucified on the outlook and deservedly so. Just to re-iterate for 06/07

• Slightly lower organic proportionate mobile revenue growth due to progressively
higher levels of mobile penetration and a greater impact from changes in
termination rates
• Small reduction in organic proportionate mobile EBITDA margin outside Japan
• Further investment in customers leading to significant reduction in mobile
EBITDA margin in Japan
• Slightly higher capitalised fixed asset additions than FY 05/06
• Significant increase in cash tax payments, with similar increase in effective tax
rate to that expected for FY 05/06
• Resulting in lower free cash flow compared to FY 05/06

It really was a horrific forecast… but could have been less horrific if VOD had provided ranges…

6. Summary

Things aren't as bad, nor are they as good as they seem on the surface.

VOD can gain market share and improve its' performance, but nothing is certain. It can also crash and burn.

More than ever:
- the country managers have to perform in market share
- Geitner's team have to produce a few differentiated products (It sounds like he is)
- the wheelers and dealers have to buy a few decent assets at a decent price
- the regulators have to be sympathetic
- the taxman has to be lenient

3 out 5 would be great :-)