Running Head: A financial statement analysis of Vodafone Group and China Mobile

A financial statement analysis of Vodafone Group and China Mobile

Toru Sekiguchi

May 16th, 2010

Table of Contents Title Page............ i Table of Contents.................. ii Abstract.................... iii I. Introduction. 1 II. Financial Ratio Analysis 3 III. Profitability Measures................................ 4 3.1 An overview of the profitability ratios ...................... 4 3.2 Profit Margin Ratio................ 4 3.3 EBITDA Margin Ratio................... 5 IV. Tests of Capital Utilization ................................... 7 4.1 An overview of the capital utilization ratios.......... 7 4.2 Current Ratio.................. 7 4.3 Debt Ratio.................. 9 V. Overall Financial Measures of Performance. 11 5.1 An overview of overall performance ratios.. 11 5.2 Return on Common Equity (ROE) Ratio............................. 11 5.3 Earnings per Share Ratio ................. 13 VI. Conclusions............... 15 VII. Bibliography... 18

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Abstract Vodafone Group and China Mobile are similarly the most influential companies in mobile telecommunications industry and have prominent advantages of economic scale but their strategic initiatives are very different. While Vodafone Group has implemented smart growth initiatives and not offered lower price than other competitors to attract new customers and retain existing customers around the world, China Mobile has relatively focused on driving growth and cost leadership initiatives in its domestic market. Their financial statements are analyzed by utilizing the profitability (profit margin ratio and EBITDA margin ratio), capital utilization (current ratio and debt ratio), and overall performance (return on common equity ratio and earnings per share ratio) ratios and compared to the industry norm to ensure how those different strategies have an impact on the different financial positions. Evidently, all these ratios of China Mobile have outperformed the industry norms for the three straight accounting periods but most of ratios of Vodafone Group have been reported relatively lower than the industry norm for the same accounting period. However, while those financial positions are very different, both operators have had better understanding of the positions, and formulated and implemented appropriate strategies.

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I. Introduction Vodafone Group Plc, which was established in 1982, is one of the worlds largest mobile operator managing ultra large-scale mobile networks in 25 countries and has a presence through partnerships in another 39 countries. Based on the registered customers of mobile telecommunications ventures in which it had ownership interests at that date, the Group had 333 million customers (Vodafone, 2010). While Vodafone Group has reinforced strong international presence and brand recognition, and controlled the interest in strong growth market such as Romania, Egypt, Turkey, and India, more than 70% of revenues still have been generated in European market where higher mobile penetration and fierce competition leave little room for growth than other regions. China Mobile Limited, which was incorporated in 1997, is the dominant market leader in China managing the largest domestic mobile network. China Mobile has a customer base of 522.283 million and enjoyed a market shares of approximately 70% in Mainland China (China Mobile, 2009, p. 3). China mobile has continued to expand its business in the tremendous potential market whose mobile penetration rate is approaching 50% although the rate in some European countries has increased to more than 100%. Vodafone Group and China Mobile are similarly the most influential companies in mobile telecommunications industry but their strategic initiatives are very different. Vodafone Group has implemented smart growth initiatives and not offered lower price than other competitors to attract new customers and retain existing customers. Vodafone Group has established their entities through the acquisition, joint-venture, and strategic alliance to expand their business globally. China Mobile has relatively focused on driving growth and cost leadership initiatives. China Mobile has not been globally diversified but pursued the domestic rural area market

development strategy of Lower ARPU, Lower MOU, and Lower cost (China Mobile, 2009, p.18) and spent huge amount of money on capital expenditures to construct mobile communications networks that enable China Mobile to meet the demands of stable growth in customer base. Vodafone Group and China Mobile have prominent advantages of economic scale despite different strategies. The objective of this paper is to analyze and compare their financial statements by utilizing the profitability, capital utilization, and overall performance ratios to ensure how those different strategies have an impact on the different financial positions.

II. Financial Ratio Analysis The financial statements dont provide a complete picture of an entitys performance because they report only past events, do not report market values, and are based on judgments and estimates (Breitner and Anthony, 2009, p. 156). The statements however provide important information and are usually analyzed by using ratios rather than absolute values which are directly derived from the financial statements in order to assess an entitys financial strength and weakness. Raito analysis involves comparing an entitys performance to that of other entities in the same industry and an entity with its own performance and trends in an entitys financial position over time. Different stakeholders have different levels of interest in an entitys performance and the ratio analysis is used to assess overall performance, profitability, capital utilization, and other aspects. For example, a creditor is concerned with an entitys short-term liquidity to decide whether to extend a short-term loan. On the other hand, another long-term creditor focuses on an entitys ability to continuously generate revenues and its operational efficiency. Shareholders are interested in the long-run profitability of an entity to expect appreciation in the market price of stocks and dividends. Managements are interested in every aspects of the financial analysis since they must identify how an entity is recognized by stakeholders. The financial statements of Vodafone Group and China Mobile are analyzed by using ratios from the viewpoint of profitability, capital utilization, and overall performance, and compared to the industry norm cited from the Hoovers, Strategy Analytics and Ycharts.

III. Profitability Measures 3.1 An overview of the profitability ratios A primary goal of an entity is to earn a profit. Profitability ratios indicate the results of a number of operating decisions and financing policies and provide useful clues to improve its operational effectiveness. They also show the combined effects of liquidity, asset management, and debt management policies on operating results (Park, 2010, p.49)

3.2 Profit Margin Ratio The profit margin ratio shows how efficiency an entity is using its resources in its operational process and a high profit margin indicates that an entity can earn a reasonable profit on sales as long as it maintains overhead costs in control. The profit margin is calculated by dividing net income by sales revenue. Profit Margin = Net income Sales Revenue

Vodafone Group Account Revenue Net income Profit Margin China Mobile Account Revenue Net income Profit Margin 31 December 2009 RMB 452,103m RMB 115,465m 24.7% 31 December 2008 RMB 411,810m RMB 112,395m 27.3% 31 December 2007 RMB 356,959m RMB 87,179m 24.4% Hoovers N/A N/A 15.8% 31 March 2009 41,017m 3,080m 7.5% 31 March 2008 35,478m 6,756m 19.0% 31 March 2007 31,104m (5,222m) -16.7% Hoovers N/A N/A 15.8%

Both Vodafone Group and China Mobile have increased sales revenues every year along with an increase in the number of their mobile subscribers. The profit margin ratio of China Mobile are continuously reported much higher than the industry norm, and China Mobile can subsequently afford to focus on driving growth and cost leadership initiatives. On the contrary, the profit margin ratio of Vodafone Group is not always reported higher than the industry norm because the goodwill in relation to Vodafone Groups operations and mobile joint-ventures in Spain, Turkey Ghana, Germany, and Italy, is impaired by 5,900m and 11,600m for the year ended March 31, 2009 and 2007 respectively in line with its international expansion strategy to establish their entities through the acquisition, joint-venture, and strategic alliance. No impairment losses are reported for the year ended March 31, 2008 and therefore the profit margin for the year ended March 31, 2008 are relatively higher than for the years ended 2009 and 2007. To improve its bottom-line performance, Vodafone Group has implemented its strategic initiative, One Vodafone program, which transforms 16 operating companies into a united operation to achieve streamlined cost effective and efficiency group.

3.3 EBITDA Margin Ratio The EBITDA, Earnings before Interest, Taxes, Depreciation and Amortization, to sales ratio is a measure of cash flows from the entitys operations. The EBITDA margin is calculated by dividing EBITDA by sales revenue. EBITDA Margin = EBITDA Sales Revenue

Vodafone Group Account Revenue EBITDA EBITDA Margin China Mobile Account Revenue EBITDA EBITDA Margin 31 December 2009 31 December 2008 RMB 452,103m RMB 229,023m 50.7% RMB 411,810m RMB 216,267m 52.5% 31 December 2007 RMB 356,959m RMB 194,003m 54.3% Strategy Analytics N/A N/A 41.0% 31 March 2009 41,017m 14,490m 35.5% 31 March 2008 35,478m 13,178m 37.1% 31 March 2007 31,104m 11,960m 38.5% Strategy Analytics N/A N/A 41.0%

A robust network infrastructure is a source of competitive advantages for mobile operators but they generally report large losses due to hugely spending capital expenditures to construct the infrastructure. EBITDA enables operators to analyze their profitability of core business operations while deducting the huge amount of interest, taxes, and capital expenses. The EBITDA margin ratio of China Mobile is stable at more than 50% and higher than the industry norm. China Mobile has continuously maintained a relatively high level of profitability due to its solid capital structure and its solid financial strength is the foundations of cost leadership initiatives. The EBITDA margin ratio of Vodafone Group are also stable but lower than the industry norm due to the impact of acquisitions and disposals and foreign exchange that are associated with its international expansion strategy.

IV. Test of Capital Utilization 4.1 An overview of the capital utilization ratios An entity needs capital to purchase new inventories, reinforce facilities, execute mergers and acquisitions, make major investments, or achieve other business objectives. The capital utilization ratios indicate how efficiently capital is used to generate revenues.

4.2 Current Ratio Current assets normally are comprised of cash, accounts receivable, inventories, and marketable securities. Current liabilities include accounts payable, short-term notes payable, current portion of long-term debt, accrued taxes, wage, and other accrued expenses. The current ratio indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future (Brigham and Houston, 2009, p. 88). The current ratio is calculated by dividing current assets by current liabilities. Current Ratio = Current assets Current liabilities

Vodafone Group Account Current assets Current liabilities Current Ratio China Mobile Account Current assets Current liabilities 31 December 2009 RMB 287,355m RMB 209,805m 31 December 2008 RMB 240,170m RMB 183,559m 31 December 2007 RMB 207,635m RMB 157,719m Hoovers N/A N/A 31 March 2009 13,029m 27,947m 0.47 31 March 2008 8,724m 21,973m 0.40 31 March 2007 12,813m 18,946m 0.68 Hoovers N/A N/A 0.89

Current Ratio

1.37

1.31

1.32

0.89

The current ratios of China Mobile are stable and much higher than the industry norm. A total of cash and cash equivalents, and deposits with banks for the year ended December 31, 2009, 2008 and 2007, are reported at RMB 264,507m, RMB 218,259m, and RMB 188,544, and account for 92.0%, 90.9%, and 90.8% of total current assets respectively. Excessively high current ratio indicates that an entity may have used an excessive amount of inventory or account receivables but a total of account receivables and inventory have captured only less than 10% of current assets, relatively lower than a total of cash and cash equivalents and deposits with banks. In addition, 82.5% of accounts receivable for the year ended December 31 are due for payment within 60 days. Consequently, impairment losses on accounts receivable can be expected to be relatively low. The amount of inventories, RMB 3,847m, only captures 1.3% of total current assets for the year ended December 31, 2009 and potential inventory obsolesce will not have a huge impact on current assets. China Mobile manages short-term liquidity by maintaining sufficient cash balances and its strong financial position subsequently enables to pursue driving growth and cost leadership initiatives while spending a huge amount of money to construct mobile communications networks which are a source of its competitive advantages. On the other hand, the current ratios of Vodafone Group have been reported much lower than the industry norm. Cash and cash equivalents, which are comprised of cash at bank and in hand, money market funds, purchase agreement, and commercial paper, only capture 37.4% and 19.4% of total current assets for the year ended March 31, 2009 and 2008 respectively. Vodafone Group stated The Groups key sources of liquidity in the foreseeable future are likely to be cash generated from operations and borrowing through long term and short term issuances in the capital markets as well as committed bank facilities (Vodafone, 2009, p. 38). While net cash 8

flows from operating activities for the year ended March 31, 2009 have increased by 14.2% in comparison to the previous period, short term borrowings have increased by 52.9%. While current assets have increased by annually 33%, current liabilities have also increased annually 25% for the year ended March 31, 2009. Current assets are rising faster than current liabilities and therefore Vodafone Group has slowly improved the short-term liquidity.

4.3 Debt Ratio The debt ratio measures the percentage of funds provided by noncurrent liabilities and equity. Non current liabilities are debt capital, and non current liabilities plus equity is the total permanent capital. Ehrhardt and Brigham (2009) argued that creditors prefer low debt ratios because the lower the ratio, the greater the cushion against creditors losses in the event of liquidation, and stockholders, on the other hand, may want more leverage because it magnifies expected earnings (p. 123). Debt Ratio = Noncurrent liabilities Noncurrent liabilities + Equity

Vodafone Group Account Noncurrent liabilities Noncurrent liabilities + Equity Debt Ratio China Mobile Account Noncurrent 31 December 2009 RMB 33,929m 31 December 2008 RMB 34,217m 9 31 December 2007 RMB 34,301m Ycharts N/A 31 March 2009 39,875m 124,752m 32.0% 31 March 2008 28,826m 105,297m 27.4% 31 March 2007 23,378m 90,671m 25.8% Ycharts N/A N/A 17.2%

liabilities Noncurrent liabilities + Equity Debt Ratio RMB 541,563m RMB 474,868m RMB 406,450m N/A

6.2%

7.2%

8.4%

17.2%

The debt ratio of China Mobile has decreased gradually due to an increase in total equity, mainly from the retained earnings, while maintaining the amount of noncurrent liabilities. China Mobile also manages long-term liquidity and credit risks by maintaining the retained earnings at a high level and its strong financial position helps China Mobile spend a huge amount of money when needed to pursue driving growth and cost leadership initiatives. On the contrary, the debt ratio of Vodafone Group has increased on a year-on-year basis as the impact of business acquisitions and disposals, and of foreign exchange rates since more than 50% of net debt has been denominated in euro that are associated with Vodafone Groups international expansion strategies and Vodafones statement on its key sources of liquidity in the foreseeable future. Vodafone Group stated The Groups key sources of liquidity in the foreseeable future are likely to be cash generated from operations and borrowing through long term and short term issuances in the capital markets as well as committed bank facilities (Vodafone, 2009, p. 38).

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V. Overall Financial Measures of Performance 5.1 An overview of overall performance ratios The overall performance ratios are commonly used to analyze the overall performance and efficiency of the optimal use of the available resources. Return on common equity, earnings per share, price-earnings ratio, and return on permanent capital are included in the overall performance ratios that are used widely by investors and an entitys management.

5.2 Return on Common Equity (ROE) Ratio ROE is the most important bottom-line accounting ratio. Net income is, however, an accrualbased accounting measure of profits during the accounting period and may fundamentally differ from the actual return earned by stockholders and the net cash flows during the period. DuPont system is used to conduct a deeper analysis of the ROE ratios, and highlight the influence of the profit margin, total assets turnover, and financial leverage called the equity multiplier on an entitys overall performance.

Return on common equity

= Profit Margin = Net income Sales revenue

X Total Assets Turnover X Equity Multiplier X Sale revenue Total assets X Total assets Equity

Vodafone Group Account Revenue Net income Profit Margin Total Assets Total Assets 31 March 2009 41,017m 3,080m 7.5% 152,699m 0.26 11 31 March 2008 35,478m 6,756m 19.0% 127,270m 0.27 31 March 2007 31,104m (5,222m) -16.7% 109,617m 0.28 Hoovers N/A N/A 15.8% N/A 0.3

Turnover Total Equity Equity Multiplier ROE 84,777m 1.8 3.5% 76,471m 1.7 8.7% 67,293m 1.6 -7.5% N/A N/A 10.8%

China Mobile Account Revenue Net income Profit Margin Total Assets Total Assets Turnover Total Equity Equity Multiplier ROE 31 December 2009 RMB 452,103m RMB 115,465m 24.7% RMB 751,368m 0.60 RMB 507,634m 1.5 22.2% 31 December 2008 31 December 2007 RMB 411,810m RMB 356,959m RMB 112,395m 27.3% RMB 658,427m 0.63 RMB 440,651m 1.5 25.8% RMB 87,179m 24.4% RMB 563,493m 0.63 RMB 372,149m 1.5 23.0% Hoovers N/A N/A 15.8% N/A 0.3 N/A N/A 10.8%

The ROE ratio of Vodafone has been reported slightly lower mainly due to lower profit margin than the industry norm. The lower profit margin percentages for the year ended March 31, 2009 and 2007 have come from the huge amount of the goodwill associated with Vodafone Groups operations and mobile joint-ventures around the globe impaired by 5,900m and 11,600m respectively. While continuously implementing its international expansion strategies, it also has formulated and implemented One Vodafone program to improve the bottom-line performance. The ROE of China Mobile has been relatively reported much higher due to higher profit margin percentages and total asset turnover than the industry norm. Its higher profit margin reflects its stable growth on significant financial strength. Total assets turnover indicates that an 12

entitys effectiveness of use of its total asset base. An excessively higher assets turnover than the industry norm may imply that an entity has used obsolete or fully depreciated assets that does not generate high sales volumes. However, 77.6% and 78.3% of current assets are the property, plan and equipment that are depreciated, and the accumulated depreciations for them are reported at RMB 350,192 million and 302,793 million and the net book values are RMB 306,075 million and 327,783 million at December 31, 2009 and 2008 and consequently those property, plant and equipment are not obsolete and fully depreciated.

5.3 Earnings per Share Ratio The earnings per share ratio is one of the most important indicators of an entitys performance for common stockholders to assess the return on investment and risk of an entity. Nikolai, Bazley, and Jones (2009) argued that the amount of earnings per share, the change in earnings per share from the previous period, and the trend in earnings per share are all important indicators of a corporations success (p. 840). The earnings per share ratio is calculated by dividing net income by numbers of shares of common stock outstanding. Net income Number of shares of common stock outstanding

Earnings per share

Vodafone Group Account Net income Number of shares of common stock outstanding Earnings per share 31 March 2009 3,080m 52,737m 31 March 2008 31 March 2007 6,756m 53,019m (5,222m) 55,144m Ycharts N/A N/A

0.17

0.13

-0.09

-0.03

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China Mobile Account Net income Number of shares of common stock outstanding Earnings per share 31 December 2009 RMB 115,465m 20,057,674,088 31 December 2008 RMB 112,395m 31 December 2007 RMB 87,179m Ycharts N/A N/A

20,043,933,958 20,005,123,269

RMB 5.76

RMB 5.61

RMB 4.36

RMB -0.4

The earnings per share ratio of Vodafone Group has increased by 37.4% to 17.17 pence due to a favorable foreign exchange environment and a one-off tax benefit. Excluding those factors, adjusted earnings per share ratio has increased around 3%. The trend in earnings per share reflects that Vodafone Groups has made further progress in implementing the drive operational performance strategy. The main objective of the strategy is value enhancement and cost reduction while launching new products in a number of markets, which offer customers more value in return for increased commitment and accelerate 1 billion cost reduction program. Dividends per share ratios have also increased by 3.5% to 7.77 pence due to the underlying earnings and cash performance of Vodafone Group. The earnings per share ratio of China Mobile has been continuously reported much higher than the industry norm and gradually increased on a year-on-year basis. The amount of net income for the year ended December 31, 2009 and 2008 has increased by 2.6% and 22.4% respectively while numbers of shares of common stock outstanding slightly increased by 0.06% and 0.19% respectively. The results can help China Mobile collect money from investors when needed to focus on driving growth and cost leadership initiatives.

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VI. Conclusions A following table shows the results of the financial statement analysis of Vodafone Group and China Mobile by using the financial ratios from the viewpoint of profitability, capital utilization, and overall performance. Evidently, all six ratios, which are used to analyze the profitability, capital utilization, and overall performance of China Mobile, have outperformed the industry norms for the three straight accounting periods. With regard to the profitability, China Mobile has been significantly stable and continuously maintained its solid capital structure and a high level of the profitability due to a larger market share in the emerging domestic market and therefore it can afford to make huge investments in a robust network infrastructure to gain and maintain competitive advantages. China Mobile has also performed well from the viewpoint of the capital utilization due to very strong cash position and managed both short-term and longterm liquidity risks effectively. Consequently, the results of financial statements analysis indicate its outstanding overall performance that enables China Mobile to focus on driving growth and cost leadership initiatives. On the contrary, most of financial ratios of Vodafone Group analyzed in this research are lower than the industry norm. Its profitability ratios are reported relatively lower than the industry norm but the results are derived from the impact of acquisitions and disposals and foreign exchange that are associated with its international expansion strategies. In addition, Vodafone Group has already implemented its strategic initiative, One Vodafone program to achieve streamlined cost effectiveness and efficiency in order to improve its bottom-line performance. An increase in short-term borrowings has been relatively higher than an increase in the cash flows from operating activities, and its long-term debt ratio has increased on a year-onyear as the impact of business acquisitions and disposal, and foreign exchange rates. Vodafone

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Group has acknowledged its short-term and long-term liquidity risks that are associated with its international expansion strategies and subsequently implemented One Vodafone program to significantly reduce its costs. Vodafone Group, however, may need further challenges in taking higher priority in investing in existing businesses to improve the average revenues per users from existing customer basis, generating cash from its existing assets, and expanding its business to new countries where Vodafone Group can expect immediate turnaround rather than huge and long-term investments in new areas to pursue high returns. Generally, its overall performance is reported relatively lower than the industry norm due to its international expansion strategies. The sizes of business in both Vodafone Group and China Mobile are significantly large enough to capture prominent advantages of economic scale but China Mobile is in the much stronger financial position than Vodafone Group. While those financial positions are very different, both operators have had better understanding of the positions, and formulated and implemented appropriate strategies.

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Categories

Ratios

The Industry Norm 2009

Vodafone Group 2009 Comparison with the industry norm Inferior Inferior Inferior Inferior Inferior

China Mobile 2009 Comparison with the industry norm Superior Superior Superior Superior Superior

Profitability

Profit Margin EBITDA Margin Current Ratio Debt Ratio Return on common equity Earnings per share

15.8% 41.0% 0.89 17.2% 10.8%

7.5% 35.5% 0.47 32% 3.5%

24.7% 50.7% 1.37 6.2% 22.2%

Capital Utilization

Overall Performance

-0.03 (RMB -0.4)

0.17

Superior

RMB 5.76

Superior

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VII.

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Nikolai, L. A., Bazley, J. D., & Jones, J. P. (2009). Intermediate Accounting. Florence, KY: Cengage Learning.

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Park, C. S. (2010). Contemporary Engineering Economics. New York, NY: Prentice Hall.

Strategy Analytics. (2009). Wireless Operator Performance Benchmarking Q3 2009. Santa Fe, NM: Strategy Analytics.

Vodafone. (2010). About Vodafone. Retrieved May-13, 2010 from http://www.vodafone.com/start/about_vodafone/who_we_are.html

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