Vodafone's plan to boost investment in broadband and superfast mobile networks after its $130 billion deal with Verizon could force its European competitors to increase their own spending and even prompt further deal-making.
Under its "Project Spring", Vodafone (Newbury, UK) plans to raise its capital expenditures by 6 billion pounds ($9 billion) over three financial years to improve network quality for customers in Europe and emerging markets such as India and South Africa.
Strong growth in data consumption by smartphones, tablets and other devices means network quality is becoming more important in the fight to win and keep customers.
With that in mind, Vodafone decided to plough some of the proceeds from the sale of its 45 percent in Verizon Wireless (New York City, NY, USA) into infrastructure. But the bulk of the windfall - $84 billion - will be handed to shareholders with the rest to pay down debt.
The move is also a sign that Chief Executive Vittorio Colao is betting the sector will benefit from softer regulation from the European Commission after it spent years forcing down roaming and other types of mobile call fees.
EU telecoms chief Neelie Kroes is expected to unveil a plan on September 11 to create a single market for telecom services as part an effort to boost competitiveness and help Europe catch up with the United States and Asia in mobile and broadband.
"The commission is getting clearly more pro-investment and understands that some of its past decisions were not helpful," Colao said on a call with analysts on Tuesday.
Promising to provide more details of the financial returns from Project Spring in November, Colao said the group's big competitors were also likely to increase network investments.
"With the advent of 4G mobile, there is a window for number one or two players in each market to spring ahead and put more space between us and smaller players," he said.
"The operators with bigger shoulders will follow us, while the smaller ones, or the ones who are more financially constrained, may not be able to."
The pressure from a stronger Vodafone is likely to be toughest for Telefonica (Madrid, Spain) in Spain, Germany, and Britain and Telecom Italia (Rome, Italy) in Italy.
Both groups have high levels of debt that they have been trying to pay down.
Germany, in particular, is likely to be a battlefield. Vodafone and Deutsche Telekom (Bonn, Germany) each have about 34 percent of mobile service revenue, and fourth-placed Telefonica has agreed to buy third-placed KPN (The Hague, Netherlands).
Niek Jan van Damme, head of Deutsche Telekom's German operations, told Reuters on Tuesday that he expected Vodafone to plough more money into Germany, although it remained to be seen how profitable that would be.
"We will have to decide whether we have to do something," he said, adding that he sees further consolidation in Europe ahead.
A sector banker predicted that Project Spring would pressure other telcos to raise investments and spur them to consolidate, provided European antitrust regulators permit such deals.
Regulators are now examining consolidation deals, which risk hitting consumers with higher prices by reducing the number of operators, proposed by Hutchison Whampoa (Hong Kong) in Ireland and Telefonica in Germany.
The Vodafone deal and its ramped up network investments have "significant ramifications for the sector that have not been fully understood yet," said the banker.
"The ripple effect is really marking the start of the next big round of consolidation."
Vodafone said roughly half the money from Project Spring would go to mobile networks in Europe and elsewhere. It aims to expand 4G coverage to more than 90 percent of the population by 2017 in its five main European markets - Germany, Britain, Italy, Spain and the Netherlands.
Up to a quarter of the cash will be spent on investing in services for businesses, such as cloud computing, improving its stores, both bricks and mortar and online, and on modernizing its customer support systems, the company said.
The remainder of the money will be spent on improving high speed broadband, the latest sign of how Vodafone has redirected its focus from mobile to fixed-line services.
In June, Vodafone agreed to buy Germany's largest cable operator, Kabel Deutschland (Unterfoehring, Germany), for 7.7 billion euros to help defend itself against mounting competition in its most important market.
Colao said Vodafone would continue to take a market-by-market approach on whether to buy fixed-line assets, build them alone or with partners, or keep renting capacity from competitors.
Bankers have said Vodafone could spend heavily on further acquisitions with the proceeds from the Verizon sale, such as Italy's Fastweb (Milan), which is owned by Swisscom (Worblaufen, Switzerland), and Spanish cable operator Ono (Madrid).
Colao played down such talk. "We have no intention to throw money away so we will be disciplined. The decision is not an emotional one - if buying assets is too expensive then we will build them."
Vodafone spent 6.3 billion pounds on network investment in its last fiscal year, so the three-year uptick does represent a significant new effort for the group. But according to Bernstein Research, Vodafone's capital expenditure-to-sales ratio, the industry metric used to compare investment levels, has slightly trailed the average of European telecom operators since 2007.
With Project Spring, Vodafone's network investments will be higher than those of rivals. Bernstein analysts said some is catch-up spending for the last two years when the British group had a 13 percent capex-to-sales ratio versus an industry average of 15-16 percent.
Vodafone shares were down 4.5 percent at 1330 GMT, while the European telecoms index was down 1.1 percent.
A Vodafone investor who declined to be named said the share weakness stemmed in part from concerns over whether the extra capital spending would pay off for Vodafone.
"It is difficult to evaluate Spring at this stage", the investor said, because the project's impact on Vodafone's free cash flow targets is unknown. "People don't fully understand what kind of returns they should hope to achieve from this investment of 6 billion pounds."
($1 = 0.6425 British pounds)
(Reporting by Leila Abboud, Paul Sandle, Sinead Cruise, Anjuli Davies, and Nadine Schimroszik; Editing by Rhys Jones and Giles Elgood)