BLOG - The Vodafone Effect

Robert Davies, Fund Manager VT Maven Smart Dividend UK Fund

There are only nine companies on the London Stock Exchange that pay out more than two billion pounds in dividends. These nine account for 41% of the total income stream into UK equities*. So you might imagine that the disappearance of two billion pounds of this income would be viewed rather badly by investors. Any dividend cut of this order would create cries of anguish from all and sundry.

Instead the disposal by Vodafone of its stake in Verizon for £80 billion is being taken quite calmly. One reason for this is that £21 billion is being distributed to shareholders in cash and Verizon shares. The second reason is that after the transaction Vodafone will consolidate its shares on the basis of 6 new for every 11 old that will reduce the number of shares in issue from 48 billion to 29 billion. Even though the company says it will increase dividends per share to 11p the fact remains that the total normal annual payout will shrink from £5 billion to £3 billion.

Vodafone will end up as a substantially smaller company paying out a lot less in dividends.
The good news is that the new company will have a much better dividend cover than the old one so there will be a greater confidence that it can be maintained and even increased over time. The old payout regime was reliant on intermittent disbursements from Verizon which it did not control. The new one can declare and pay dividends from businesses it owns and manages. For that reason it is conceivable that investors will place a higher value on that cash flow. In other words they might rerate the shares upwards.

Even so, Vodafone will be contributing less to the total cash dividend income to the UK stock market than previously forecast. However, balancing that are the results and dividends now being declared by UK companies for 2013. February and March are the peak season for results from companies whose financial years coincide with calendar years. Overall these results have been good and provide a base for analysts to revise and improve forecasts for 2014 and 2015.

As a consequence, despite the Vodafone effect, consensus forecasts for total dividend income into the UK market in 2015 in aggregate has increased from £83.2 billion to £84.9 billion. The £2 billion shortfall from Vodafone has more than been made up by rising dividends from other constituents of the market.

Historically there is a good correlation between the levels of dividend income and the level of the market. In the last few years, since the emergency measures put in place after the crash of 2008, the market has been boosted by devaluation, low interest rates and money printing. Those stimulants are coming to an end. Indeed, the rising value of sterling is already hurting companies with earnings sourced overseas. The Vodafone contraction is another negative factor.

However, all these negative inputs are overruled by the seemingly irresistible tide of rising cash flow from the market as a whole. Whatever happens to valuations the important thing to remember about equity investing is that capital values are actually far less relevant to long term returns than dividends, growth in dividends and reinvested dividends. So while the Vodafone deal is significant its impact on the UK equity market will only be a minor blip over the long term.

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