Ahead of its merger with Three, is Vodafone’s share price worth a punt?

The Vodafone (LSE:VOD) share price has fallen over the last decade as the company has struggled to earn a decent return on heavy capital investments. But things seem to be moving in the right direction.

With approval to merge its UK operations with Three and the sale of its Italian business complete, Vodafone looks to be in a stronger position. So should investors consider buying the stock while it’s down?

Scale

Vodafone’s business faces two big structural issues. The first is that it operates in an industry where capital requirements for building and maintaining infrastructure are high.

The company has to find ways to earn a return on its investments, but it faces an additional challenge in trying to do this. The problem is that customers are mostly influenced by price.

Combined with low switching costs, this means Vodafone can’t just increase prices to customers to boost its income. And this puts the business in a difficult position.

If it can’t generate more cash by raising prices, the only strategy is to bring down its costs. And that’s what the company is trying to do with some recent restructuring moves. 

Ins and outs

Vodafone has recently completed the sale of its operations in Italy. In doing so, it raised around £6.6bn in cash, which it plans to use for debt reduction and shareholder returns.

The cash returned to investors should total around 7.5% of the current market cap. More importantly, the sale should remove the firm’s need to invest in a market where it has struggled to earn a decent return.

In the UK, Vodafone’s bid to merge with Three has been approved by the regulators. This should boost its customer base significantly, allowing it to earn a better return on its existing infrastructure.

Both moves look positive for the company over the long term. But there are a few things I think investors considering buying the stock should be wary of going forward.

Ongoing issues

Despite the recent progress, I think the market is still right to be unconvinced by Vodafone shares. There are still some ongoing issues that make me sceptical about the stock as an opportunity.

Arguably, the company’s biggest problem is in Germany. Increasing prices is – unsurprisingly – leading to lower customer numbers and revenues are declining in the region as a result. 

Around a third of Vodafone’s sales come from Germany, compared to less than 20% from the UK. So I’m doubtful that higher returns following the Three merger can offset lower sales elsewhere.

Lastly, the firm is committed to some significant capital investments in the UK’s 5G network as part of its deal to merge with Three. So it might be a while before investors see the returns.

Time to buy?

Arguably, there has never been a better time to buy Vodafone shares in the last 10 years. But I’m still not drawn to the stock from an investment perspective.

While there are encouraging signs – and I think these are genuine positives – there are still big ongoing challenges. So I think there are better opportunities for investors to look at elsewhere.

The post Ahead of its merger with Three, is Vodafone’s share price worth a punt? appeared first on The Motley Fool UK.

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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Vodafone Group Public. 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.

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