It has been little over a year since mobile operator O2 tied-up with cable broadband provider Virgin Media to create a new telecom giant ‘Virgin Media O2’. Unlike Three’s proposed takeover of O2, which was blocked by the regulators back in 2016 due to competition concerns, this merger was approved as it involved two service providers with complementary businesses creating a new entity to accelerate investments in 5G and fibre networks.
Recently, it has being reported that Vodafone and Three are in talks about a potential merger. The main rationale for coming together in this case seems to be to drive scale and reduce costs in the mobile sector, as opposed to convergence in the case of the O2 and Virgin Media merger.
UK telecom landscape
How likely is the Vodafone and Three merger to be approved?
Operators’ perspective: The UK is a competitive market, with operators providing unlimited data plans as well as a wide array of MVNOs offering discounted services. Vodafone, the current third largest operator, has been under pressure from its investors to improve returns, whereas Three, the UK’s number four operator, has reported flat revenue growth for last few quarters and has been vocal on the need for structural changes to the UK telecoms market. Therefore, the main reason behind the Vodafone and Three merger is to increase subscriber share (the merger would create a market leading entity) and lower operating costs.
Another rationale could be RAN sharing and cost reduction, as the two operators have a similar set of frequencies in the sub-6 GHz range. The two operators combined can create a more sustainable and stronger player with increased ability to network investments and benefit from economies of scale.
5G Spectrum Portfolio of Vodafone and Three UK
Regulator’s perspective: The primary concern around this deal would be the reduction of the number of players from four to three. Some studies show that such reduced competition can lead to increased prices and negatively impact service levels. In addition, regulators are wary of mergers creating a dominant player in the market. As a result, this merger may collapse for similar reasons as Three’s takeover bid of O2.
However, while the Vodafone and Three merger would create a market leading entity, the resultant approximate 30% subscriber market share would be similar to its competitors. In addition, regulators are suspected to be a little more sympathetic towards mergers these days than in the pre-pandemic times.
What has changed post-pandemic?
Connectivity services played a very important role throughout the pandemic, emerging as a lifeline for consumers. Many businesses and some aspects of life are now fully dependent on telecom services. Therefore, if a merger promises increased network investments to improve connectivity and quality of service, regulatory authorities are expected to be more flexible and take a softer stance than in the past.
M&A activity in other competitive markets of Europe
- Spain: Orange (the second largest operator) and Masmovil (the fourth largest operator) recently signed an agreement worth €18.6 billion ($19 billion) to combine their operations and form a 50-50 joint venture. The new entity will become the country’s largest operator with more than 40% subscriber market share.
- Italy: At the beginning of 2022, Vodafone and Iliad were in talks to merge their units amid cut-throat competition in the Italian market. However, Vodafone rejected Iliad’s preliminary offer of €11.25 billion ($12.92 billion) citing a lack of value-add for its shareholders. The operator is still ready to evaluate other opportunities.
Additionally, Telecom Italia (TIM) hopes to get the right valuation for its fixed-line assets, which the operator plans to sell and raise cash to cut its debt.
These developments indicate there is increasing consolidation occurring in both the mobile and fixed telecom space. Additionally, many operators have spun-off their tower business or launched joint ventures in order to raise money for network investments or reduce debts. For instance, Deutsche Telekom (DT) has recently announced the sale of 51% of its tower business, GD Towers, to a consortium for €17.5 billion ($17.5 billion). The transaction will help the operator with much needed cash to cut debt and proceed with its target of acquiring a majority stake of 50.1% in T-Mobile US (an increase from its current stake of 48.4%).
Viewpoint
The UK’s telecom market is characterised by fierce competition, and it is difficult for the operators to grow organically. Key factors that influence operators’ ROI include weakened bargaining power in the procurement of 5G network equipment (in view of the ban on Chinese vendors Huawei and ZTE), competition from other ecosystem players in the enterprise segment (particularly private networks) and increasing cost pressures. Mergers in such an environment help achieve economies of scale through an increased number of subscribers, pooling of resources and lower operating costs. It is likely that the Vodafone – Three merger will be approved and thus improve the overall quality of infrastructure, but only after close scrutiny from regulatory bodies.
Interestingly, Virgin Media O2, Vodafone and Sky are also rumoured to be interested in acquiring broadband service provider TalkTalk. Going by the recent trends it looks to be only a matter of time before we see the next mega-merger in the UK market. There is a high likelihood of the market evolving to a smaller number of integrated telecom operators offering fixed-mobile convergence services and diversifying the way they engage with consumers. One can see such positive impacts from the Virgin Media O2 case, as the new operator recently reported on its first anniversary that there is a growing adoption of converged services, with 45% of its broadband customers also taking a mobile contract.
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©Counterpoint Research; Source: Digital Mobile Spectrum Ltd.