Feature

Consolidation is the play, what next for the UK?

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Three UK and Vodafone – the last remaining domestic operators that have not yet embarked on consolidation – could be about to combine forces. Saf Malik analyses the likelihood of a merger between the pair

The UK telecoms landscape has shifted in recent years, with consolidation taking hold in the UK and Europe. Now, if the rumours are to be believed, the latest hot deal will involve the last two major players in the UK that have yet to consolidate: Three UK and Vodafone.

Reports and murmurs about their possible merger have populated news sites in the past few months. And the rumours were accentuated by a Financial Times report, published on May 12 that they are in active discussions. The deal, should it go ahead, would see the number of UK operators shrink from four to three, and create an entity that could compete with bigger players that have already converged, such as BT–EE and Virgin Media O2.

With several players becoming more active regarding consolidation, there are few big strategic moves left in the UK, according to Paolo Pescatore, TMT analyst at PP Foresight.

“Remaining players including TalkTalk, Three and Vodafone are all in a challenging position, given the growing importance of convergence,” he says.

While Vodafone has addressed this through several wholesale agreements in the fixed line market, it remains unclear whether a merger with Three UK is the “silver bullet” it needs, Pescatore says. But he is firm in his belief that a merger makes sense for Three UK, given its mobile-only position.

Vocal advocates

This is a view that is seems to be shared by senior executives at Three UK.

Earlier this year, Robert Finnegan, chief executive of Three UK, reiterated his vocal advocacy for consolidation in the UK market by labelling it “dysfunctional”.

Finnegan argued that the market needed “structural changes” in order to improve the overall quality of infrastructure in the UK. This, he believes, can be achieved if the UK market mimics European markets and reduces the number of its major operators from four to three.

Despite operating in a “dysfunctional” market, Three UK has recorded a strong year in terms of customer additions in 2021, with a 7% rise in its active contract base and a 4% rise in revenues to £2.44 billion. But despite this, Three UK has maintained its long-held stance that consolidation is healthy for the market.

In February, Nick Read, CEO of Vodafone, echoed Finnegan’s beliefs, and said the company is actively pursuing a range of live opportunities in a number of European markets.

Currently, the company is engaged in conversations within four of its European markets as it looks to revamp its asset portfolio. This comes after Etisalat Group (now known as “e&”) acquired a 9.8% stake in Vodafone for around US$4.4 billion, becoming the company’s largest shareholder. Vodafone is also under constant pressure from activist investor Cevian Capital to expand its offering through M&A activity.

Kester Mann, director for consumer and connectivity at CCS Insight, believes that the surprise move from e& could bring temporary relief to Vodafone amid the mounting influence from Cevian.

“Indeed, the presence of a new, wealthy shareholder could offer welcome financial support for Vodafone’s fixed and mobile investments across its broad footprint,” Mann says. “It could also bolster efforts to secure deals in competitive European markets such as the UK, Italy, Spain and Portugal – something Cevian is increasingly pushing for.”

Mann also notes that this investment reflects its intention to explore new avenues of growth, expand offering and forge new partnerships.

Challenger

In recent times, Mann thinks Vodafone has taken more of a “challenger role” in its home market, due to it stepping back from the “premium approach” it used in the past.

This happened through various offerings, such as the launch of speed-tiered unlimited data tariffs, as it sought to reinvigorate its brand after a few years Mann describes as “turbulent”.

Vodafone is continuing to be aggressive compared to some of its rivals with its pricing, which is a transition that brings it closer to Three UK, which historically focused on market disruption by providing value for money.

The fact that there seems to be some alignment between the two firms’ strategies may make a merger “more logical”, Mann adds.

“Regulation will be a tough hurdle to get over with this one. And it might be that we’ll need to see some concessions as well from both sides
Kester Mann, director of consumer and connectivity, CCS Insight

Pescatore says it is apparent that Three UK and Vodafone are seeking consolidation to become a mobile champion in an increasingly competitive market.

“In mobile there could be some scope to compete head-on with O2 and EE, especially in 5G,” he says. “Ultimately scale is key, and with this in mind a move to merge could make sense. But this’ll be subject to regulatory scrutiny and concessions will need to be made to get this over the line.”

The pairing would only be strengthened by a pre-existing relationship: in 2020 Three UK’s parent company CK Hutchison and Vodafone merged in Australia.

Obstacles

There are factors that could prevent a Three UK/Vodafone merger. One, Mann says, is that the merger would do little to address either side’s limited presence in the converged services market.

“Three UK has shown little appetite to combine home broadband with its mobile offers, but convergence is a major strategic goal for Vodafone,” he says. “The UK may have been slow to offer bundles. But the past 12 months have seen growing ambition as Virgin Media O2 introduced its first combined offer, Volt, just a few months after the joint venture officially launched.”

Even if a deal between Three UK and Vodafone was agreed, completing it would mean dealing with plenty of obstacles.

In 2016, CK Hutchison and Telefonica agreed to combine Three UK and O2 in a £10.25 billion deal. The merger would have created the largest mobile operator in the UK, with a market share of 40%. But the deal was blocked by the European Court of Justice (ECJ), which found that it would damage competition in the UK market. There were also further concerns that the merger would reduce incentives to invest in UK infrastructure, given that O2 and Vodafone and Three and EE, had shared network infrastructure agreements in place.

Despite the ECJ annulling this ruling in 2020, O2 merged with Virgin Media in June 2021, creating a UK telecom giant worth around £31 billion. Given that deal, and the BT Group/EE merger in 2016, could the Competition and Markets Authority (CMA) take issue with another merger on that scale?

“Regulation will be a tough hurdle to get over with this one. And it might be that we’ll need to see some concessions as well from both sides,” Mann says.

Also, UK regulators have also informed telco operators that it remains to be seen whether the UK market moving from four to three operators would benefit customers and the market as a whole.

Despite all that, Mann thinks a Three UK/Vodafone merger would find it easier to get over the line now than a few years ago.

“I think [UK regulators] are more open about the opportunities for M&A than they were six years ago,” he says.

While he believes that the CMA may still need some convincing, he thinks there is evidence of a “slight increase in leniency” from regulators, which is why talks between Three UK and Vodafone have escalated in recent times, as indicated by the frequent press reports on their potential merger.

Europe’s regulators are also becoming increasingly lenient, as several mergers and acquisitions continue to take place on the continent. Mann points to reports in March of a potential merger between Orange and Spain’s MasMovil. He believes that if that deal was given a green light, it could open floodgates to a host of other deals in the UK, Portugal and Italy.

Added players

Pescatore believes that if a Three UK/Vodafone deal was approved, other players would join in the mix.

“Considering a move to integrate TalkTalk could strengthen their overall position,” he says. “The company has a reasonable fixed line base and has now returned to offer TV services. Despite previous failed attempts, [Three UK and Vodafone] need to do more to sway customers to sign up to both mobile and fixed services.”

Pescatore also thinks that Vodafone will need to move quickly to avoid losing further ground in the UK, as it has in European markets.

Ultimately, a merging of Three UK and Vodafone makes sense given the rapidly converging landscape. But each firm caters to different a market segment. However, Mann says that if the two sides were unable to agree to a deal, both have several alternative options to pick from.

In the future, Pescatore says he expects to find Sky “sniffing around” any strategic deal in UK telecoms that could threaten the market leader BT, and a slew of corporate activity occurring among the altnets.

But before any of that will happen, analysts agree that Three UK and Vodafone will both have to make concessions before any deal between them could happen.

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