* To spend more than expected, earlier than expected
* Suffers record drop in Q2 organic service revenue
* Hit by regulation, recession in Europe
* Vodafone shares up 0.6 pct, while telecoms index down
By Kate Holton
LONDON, Nov 12 (Reuters) - Britain's Vodafone willspend 7 billion pounds - more than expected and earlier thanexpected - to increase the speed and coverage of its networksand reverse a record fall in revenues resulting from itsstruggling European business.
The world's second-largest mobile operator, which is usingsome of the proceeds from the $130 billion sale of its U.S. armto upgrade its infrastructure, said it would spend 3 billionpounds in Europe, 1.5 billion in its emerging markets and therest on fixed-line assets, enterprise and its retail arm.
It will complete the programme by March 2016 - a billionpounds more than expected and a year earlier than forecast - tomeet the demand of consumers who want on-the-go internet accessvia smartphones and tablets.
"We expect that during the next three to five years, Europewill definitely improve," Chief Executive Vittorio Colao toldreporters. "Therefore, we prefer to have a stronger, moreperforming and more differentiated operation by then so that wecan come out at a higher speed than everybody else."
Shares in Vodafone were up 0.6 percent at 228.75 pence at1405 GMT, outperforming the European telecoms index,which was down 0.7 percent.
The group, which is seen as a possible bid candidate forU.S. giant AT&T, set out the details of its "ProjectSpring" spending programme as it reported first-half resultsshowing the pressures across the group.
Organic service revenue, which strips out items such ashandset sales, currency and acquisitions, was down a worse thanexpected 4.9 percent in the second quarter due toregulator-imposed price cuts and fierce competition in Italy,Spain, Germany, Turkey and Britain. Civil unrest in Egypt alsohit demand.
The 4.9 percent second quarter fall was worse than the 3.5percent drop recorded in the first quarter and well below thelast record fall of 4.2 percent in the fourth quarter.
In the three months to the end of September, organic servicerevenue was down 4.9 percent in northern and central Europe,down 15.5 percent in southern Europe and up 5.7 percent in itsemerging markets such as India and South Africa.
Credit rating agency Moody's said on Tuesday it expected afifth year of revenue decline in 2014, though operating marginswould stabilise, helped by cost cutting and the end ofregulatory cuts to mobile call termination fees.
"We view the decision to accelerate and expand ProjectSpring positively, given it brings forward the commercialbenefits and increases competitive pressure on Vodafone'sindebted and sub-scale rivals," Goldman Sachs said in a note.
Vodafone said the spending plans would take 0.6 billionpounds off its core earnings in the 2015 financial year. Itexpects the investment to result in incremental free cash flowof over 1 billion pounds in the 2019 financial year, and itotherwise reiterated its 2014 outlook.
Vodafone will now invest a total of 19 billion pounds overtwo years, when the Project Spring spending is added to regularinvestment of 12 billion pounds over that period. Colao said theexpected improvement in the European economy would combine withan expected increase in the usage of data-hungry smartphones,making the improved network a necessity.
"We are laying strong foundations for the future," Colaosaid. "The two years ahead will see the largest and fastestperiod of network investment in our 25-year history."
Colao said he expected Vodafone's strongest rivals, likelyto include Telefonica, Deutsche Telekom andOrange, to follow suit while smaller rivals wouldlikely struggle.
Moody's agreed: "Not many incumbent operators have thefinancial flexibility to match this, and the challengers ...have even less financial flexibility because of their highleverage."
Strong growth in data consumption by smartphones, tabletsand other devices means network quality is becoming moreimportant in the fight to win and keep customers.
With that in mind, Vodafone decided to plough some of theproceeds from the sale of its 45 percent in Verizon Wirelessinto infrastructure. But the bulk of the windfall from VerizonCommunications - $84 billion - will be handed toshareholders, and the rest used to cut debt.
Vodafone said its decision to invest had also been driven bya belief that it should see softer regulation from Brussels,which has spent years forcing down roaming and other call fees.
The group also recognised additional deferred tax assets of17.7 billion pounds in relation to the group's historical taxlosses. It said this would not have any impact on the tax itpays, but analysts said it could prove attractive to a possiblesuitor.
Bankers have told Reuters that AT&T is scouting for targetsin Europe, with Vodafone the leading candidate - a bold bid thatwould provide instant scale across the region - but Colaodeclined to comment on whether he expected a deal to take place.
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