VMO2 - comment - Q3 26

We expect some modest relief in bond prices following the Q3 results, with EBITDA ahead of expectations and the announcement of a significant strategic reset. However, without the full accounts and a detailed cash flow reconciliation, it is difficult to draw any major conclusions from the headline numbers. More important will be commentary on the Liberty Global call at 2 pm, particularly whether the shareholders are prepared to pause or reduce distributions to prioritise deleveraging. We would like to know more about the outflow from vendor financing, which declined by approximately £150m during the quarter. 

VMO2 is prioritising cash generation and cost reduction over further network investment, targeting £800m of annualised savings by 2029 (£400m in 2027 and £600m in 2028), including £300m from organisational restructuring. This involves £250m of restructuring costs, with management expecting payback within one year. More importantly, VMO2 is halting further fibre upgrades beyond existing commitments, arguing that the economics do not support three overlapping fibre networks. The company is also exploring wholesale arrangements to extend its reach beyond its existing footprint. This represents a clear shift from network expansion towards sweating existing assets, simplifying the business and improving operating cash flow.

The operating KPIs remain challenging. VMO2 lost 23,300 fixed-line customers in Q3, taking the base to 5.5m, although this was an improvement on the 32,700 losses a year earlier. Broadband losses were 22,100. Mobile contract additions of 31,700 were entirely driven by wholesale, which added 59,000 connections, while consumer and business contract customers continued to decline. Fixed-line ARPU fell 5.0% to £45.83, reflecting continued pricing pressure, while consumer mobile ARPU increased 2.0% to £18.12. Consumer fixed service revenue declined 6.4%, with mobile down 1.7% and business down 5.3%, partly offset by 1.8% growth in wholesale.

Q3 service revenue was £2.04bn, down 3.5%, while adjusted EBITDA of £995m was 2.6% lower year-on-year but £177m ahead of our expectations. Excluding £35m of favourable legal and commission-related items, underlying EBITDA was still £142m ahead of our forecast, demonstrating encouraging cost control. However, this failed to translate into cash generation. Capex was broadly in line with our expectations on a phasing basis, with the cash shortfall instead concentrated below EBITDA and particularly in vendor financing. VMO2 now needs to generate approximately £634m of adjusted FCF in Q4 to meet its £200m FY guidance. The EBITDA beat is encouraging, but the cash conversion is disappointing, and the required Q4 recovery is substantial.