Vodafone: A difficult call to make And while a large dividend payment from its US joint venture with Verizon Communications is on the horizon - perhaps as soon as next month - the question of what Vodafone should do strategically across the Atlantic remains high on the agenda. As Colao unveils Vodafone's results for the six months to September on Tuesday, on the back of a series of bearish research notes from a number of investment banks, the question as to what he will do to revive the sleeping giant of the FTSE 100 is more pertinent than ever. Southern Europe and deteriorating economies are as much of a headache as ever. In late June, conscious of the problem, Colao split Europe into two regions, establishing a northern and central European division, comprising strongholds such as Germany, the UK, the Netherlands and Ireland, and southern Europe, including Portugal, Italy, Greece and Spain, as well as Albania and Malta. Paolo Bertoluzzo, head of Vodafone Italy, was promoted to run the region. The reason behind the division was clear less than a month later, when Vodafone published its results for the three months to June, showing a 10pc fall in service revenue growth in Spain, and a 7.7pc fall in Italy. Colao spoke of "difficult market conditions" in the region. The reason this is important to Vodafone is the percentage of revenue both Italy and Spain traditionally provide. In the three months to June 2011, Italy and Spain accounted for 31pc of that quarter's £8bn revenue in Europe, almost 70pc of the group's total. In the three months to June 2012, Italy and Spain accounted for 28.5pc of that quarter's £7.4bn revenue in Europe, some 68pc of the group's total. Both countries are important parts of the Vodafone map, and the drop in revenue, despite higher take-ups of smartphones and increased data usage, affects Vodafone's financial health. Investors spoken to by The Sunday Telegraph are clearly concerned. One top 15 investor questioned whether the situation will have worsened since the quarterly numbers in July, while another, smaller investor said he did not think Colao was doing enough to rectify the problems. Spain is a good case study of the issues Colao is facing. "Vodafone had hoped that Spanish trends would have bottomed out mid-2012 - however, the macro [economic] backdrop has worsened," says Emmet Kelly, telecoms analyst at Bank of America Merrill Lynch. As customers trade down to cheaper tariffs and deals, Orange is said to be winning market share, while Telefonica, which owns O2 in the UK, is attracting customers with its recently launched quad-play - fixed line, mobile, television and broadband - offering. Local reports suggest Vodafone lost more than 600,000 customers in the country in the three months to the end of July, after stopping subsidising smartphones. Although those subsidies have now been reintroduced, the impact of that loss of customers is expected to be felt in the first-half results. Company insiders say that Vodafone's challenges should not be over-exaggerated. One source, who spoke anonymously, said that "the challenges facing Vittorio are less than the heads of other major telecoms businesses." Most of Vodafone's rivals have severe balance sheet strain and have cut dividends. It's no secret that the southern Europe telecoms market is horrible," the source went on. "The big issue is negative growth in western/southern Europe," says another trade source. Colao has taken some measures to deal with it, such as asking Bertoluzzo to focus exclusively on slower markets, but I reckon the situation will have got worse over the last few months. The conundrum of what to do with Vodafone's 45pc stake in Verizon Wireless - the American mobile-phone giant it owns in partnership with 55pc-owner Verizon Communications - is another issue thought to be weighing heavily on Colao's mind. Although the relationship is a profitable one - Vodafone is expected to receive a $4.5bn (£2.83bn) dividend in January, followed by a further $5.85bn in 2014 - it also starkly highlights the slower pace of growth in the different parts of its business. One source suggests that as recently as this year, Colao went to Lowell McAdam, his opposite number at Verizon Communications, to suggest a merger. McAdam flatly dismissed the idea, questioning why he would want to lumber his shareholders with a slow-growth European-focused business. Vodafone sources indicate, however, that such a move is unlikely. "Vittorio is an arch negotiator," says one source. He's unlikely to do anything quite so crass as that. His priority with Verizon has been to put relations on a solid footing so as to ensure the dividend stream flows. While the truth is probably somewhere in the middle - it is thought likely a merger has been discussed at some point, albeit perhaps not recently - it highlights the issues at the heart of the relationship. Robin Bienenstock, senior analyst at Bernstein Research, argues that with Verizon at a record valuation, and Vodafone in need of what he terms "major strategic change," now could be the time to act. He sees two possible outcomes: a straight merger or a sale of part of Vodafone's Verizon stake. He does not believe Verizon Communications could afford to buy all of the 45pc stake and suggests perhaps that it could buy three-fifths of it. However, the Verizon stake shows just how difficult large parts of the Vodafone empire are finding the present situation. As Nick Delfas, analyst at Morgan Stanley, points out, the "controlled versus non-controlled gap widens." Controlled means the businesses Vodafone has control over; non-controlled those in which it owns a stake, including Verizon Wireless. "The problem with this trend of core declines but Verizon Wireless earnings surprises is that although Vodafone's guidance appears very solid, declining Ebitda [earnings before interest, tax, depreciation and amortisation] puts significant pressure on free cash flow," argues Goldman Sachs telecoms analyst, Tim Boddy. Reduced free cash flow will in turn affect the amount Vodafone can pay out to its own shareholders. Although the $4.5bn payment from Verizon in January will be welcomed, how much of it will be seen by shareholders remains to be seen. In May 2010, the Vodafone board, now chaired by Gerard Kleisterlee, ex-Philips chief executive, agreed to what some saw as an aggressive dividend policy, targeting annual growth of no less than 7pc for the subsequent three years. Currently trading with a dividend yield of 5.68pc, Vodafone shares - with a market capitalisation of £82.4bn, it remains among the largest five companies in the FTSE 100 by value - remain particularly attractive to income-led investors. Were the dividend to be cut, its share price would probably drift southwards. In a research note aimed at examining this, Barclays" Maurice Patrick says that operating free cash flow has fallen by 14pc - or £1.1bn - in three years, meaning that the ordinary dividend is barely covered once the issue of payments for 4G and other spectrum are considered. Patrick argues that the board has two options. One: to reduce ordinary dividends per share to improve the number of times it is covered. Or two: maintain the level of dividend but use the money from Verizon to pay for future spectrum auctions, acquisitions or share buy-backs to reduce future dividend commitments. The decision will be made in the light of several rivals cutting their dividends. France Telecom, part-owner of Everything Everywhere, has said it will cut its dividend for 2012 and 2013 by more than 40pc. Although Colao is unlikely to go into any great detail on the future of dividend policy on the analysts" call, which follows the release of Tuesday's interim results - when analysts are expecting a 7pc fall in group revenue to £21.82bn compared with the same period last year and a 10pc fall in adjusted operating profit to £5.9bn - it will remain a subject of interest. With Verizon expected to announce details of the actual Verizon Wireless dividend payment next month, the issues around future payouts to investors will come front and centre at the turn of the year. But any concerns have to be kept in perspective. "Vodafone is the least worst off of the majors," says one source close to the company. At least it can continue to invest in its network, unlike its rivals. I would say that's not such a bad place to be. For Colao's sake, let's hope investors share that sentiment.