By Kate Holton and Paul Sandle
LONDON (Reuters) - Vodafone will reinvest a $3.2 billion dividend from its healthy U.S. arm to counter weakness in southern Europe that contributed to the largest ever quarterly fall in the group's main revenue measure.
The British firm is trying to decide whether to sell Verizon Wireless, its profitable U.S. unit in what could be the world's third largest deal to support its struggling core operations.
Majority owner Verizon Communications wants to buy Vodafone's 45 percent stake but Chief Executive Vittorio Colao once again refused to discuss the possibility, saying that he had nothing new to add.
"Verizon is performing well, it's an excellent investment," Colao told reporters on Tuesday as the company reported its results. "If there were anything to announce we would announce it."
The contribution from Verizon and cost cuts elsewhere helped Vodafone, the world's second largest mobile operator, to offset the increasing economic and regulatory pressures in Europe, to post profits slightly ahead of forecasts.
It was also affected by the timing of a leap year last year.
But Vodafone posted a 4.2 percent quarterly fall in organic service revenue, in line with forecasts, but worse than the 2.6 percent it recorded in the third quarter and the largest quarterly drop since the company started using the measurement in 2003.
The steepest falls came from southern Europe, where operators are cutting prices to win business from struggling consumers. In Italy service revenue fell 12.8 percent, while in Spain it was down 11.5 percent.
The group also took a 1.8 billion pounds impairment charge on its business in Italy, taking the total writedowns for Spain and Italy for the year to 7.7 billion pounds.
Vodafone is the second largest mobile operator in both those markets but it has lost share to cheaper rivals, as cash-strapped customers switched to low-cost operators or ditched their phones altogether.
In response it is trying to broaden its appeal by offering new services such as superfast broadband and pay-TV to better compete with rivals.
"We continue to face stiff headwinds from regulation, competition and the tough economic environment, particularly in Europe," Colao said. "In Italy there is a pretty aggressive price war taking place.
"However, we are well positioned with very broad geographic exposure, which includes attractive growth markets in India, Africa and the U.S."
Overall the group posted its first fall in full-year sales since 2005, down 4.2 percent to 44.4 billion pounds ($67.6 billion), while core earnings fell 3.1 percent.
Full year margins on core earnings were down 0.5 percentage points on an organic basis to 29.9 percent, from 33.1 percent just three years ago. Margins at the U.S. business were at 50 percent, reflecting the market-leading position in the U.S. where it is adding customers at a rapid rate.
Having completed a three-year dividend program that guaranteed a highly attractive 7 percent growth per year, Vodafone scaled back its ambitions, pledging instead to maintain the ordinary dividend at least at current levels.
The increasing pressures on the core business, which serves 403 million customers from Europe to Asia, Australasia and Africa, meant the group decided to keep hold of its 2.1 billion pound dividend payment that will come from Verizon in June, rather than returning it to shareholders as normal.
"The situation in southern Europe remains one of disappointment, where a service revenue decline was compounded by a writedown in both Spain and Italy," said Richard Hunter, head of Equities at Hargreaves Lansdown Stockbrokers.
"The question of the Verizon stake remains at the top of the agenda for investors, although Vodafone's decision hitherto to stay put continues to reap measurable rewards, quite apart from the value of its stake appreciating by the year."
Shares in the group were flat in early trading on Tuesday, following a 28 percent rise since the beginning of the year to highs not seen since the dot com boom in 2001, on speculation that Vodafone could finally do a deal with Verizon.
Two people familiar with the matter have told Reuters that Verizon Communications is working on a possible $100 billion bid to take full control of Verizon Wireless, in a 50:50 cash and stock bid.
At $100 billion, a deal would be the third-largest acquisition ever, according to Thomson Reuters data, for a group that boasts 95.9 million retail connections.
Investors and analysts say conditions for a deal have never been better, with Verizon's high valuation, low interest rates and currency movements all in favor. Although a figure of $100 billion would be too low and is more likely an opening gambit.
($1 = 0.6570 British pounds)
(Editing by Anna Willard)