The merger of Vodafone Group PLC’s (LSE:VOD) UK mobile telecoms arm with Three UK will be tough to get past regulators on competition grounds, according to analysts, though the current third and fourth largest networks in the country argue the deal will “level the competitive playing field”.
A deal was unveiled late on Wednesday morning, with Vodafone owning 51% of the proposed merged business, into which it will offload £4.3bn of debt with a “broadly neutral impact” on its ratio of debt to earnings but expected benefits to cash flow from four years onwards.
Merging two of the UK’s four largest mobile networks will create a new market leader.
Based on the precedence set following 2016’s failed merger between Three and O2, analyst Paolo Pescatore at PP Foresight said the merger “will be a hard sale”.
Analyst Dan Ridsdale at Edison said the Vodafone statement gives a clear indication that it is already concerned about the competition issue, with a statement that “reads like an overt pitch to convince a broader set of interest groups”.
“Management will have a good level of insight into the opinions of key investors regarding the deal, whereas regulators play their cards much closer to their chest,” he said.
Recent actions by the UK’s Competition & Markets Authority have shown how tough it can be to push through big deals, said Matt Britzman, equity analyst at Hargreaves Lansdown.
“But there might be some hope,” he said, “given how challenging and expensive the 5G rollout is, and there’s a good argument that the economics of the industry need to improve for the benefit of both providers and consumers.”
The statement from Vodafone, which has also created a new website especially to promote the benefits of the deal, argues the merger “will level the competitive playing field, increasing competition to the two largest converged operators,” referring to BT’s EE and the newly merged Virgin Media O2.
According to industry figures from GSMA, Vodafone UK and Three UK respectively have market shares of 20% and 10% of mobile market subscribers, which the statement called “sub-scale”.
The pair noted that regulator Ofcom’s future approach to mobile markets and spectrum review found that Vodafone and Three’s returns are lower than EE and O2’s, meaning they have not been able to recover their cost of capital and, the statement added, “limits their ability to continue to invest”.
“After completion, MergeCo will have the necessary scale and a great platform to invest, grow and compete,” it said.
Ofcom is one thing, but the CMA recently blocked Microsoft’s takeover of Activision Blizzard, not to mention deciding that Broadcom’s swoop for VMWare would also hurt competition.
Guess it comes down to do you break the tacit 4 MNO rule to create three vertically integrated carriers with scale to do 5G, or do you think prices will be affected too much? CMA has a chequered history on this sort of thing #VOD
— Neil Wilson (@marketsneil) June 14, 2023
Pescatotre said: “Let’s see if the authorities have a change of heart. Both parties need to demonstrate that this is genuinely in the interest of UK plc, the economy, and consumers for it to have a chance of getting over the line.”
Indeed, for the CMA, Ridsdale says the equation is “likely to come down to how much they take into account the consumer benefits from the promised acceleration to the roll out of 5G, gained through economies of scale versus the competitive risks from concentrating market power.”
“They will almost certainly consult Ofcom as part of the process who have already highlighted that Vodafone and Three’s poor return on capital under the current market structure presented a risk to future investment in the UK’s networks.”
A “marriage of convenience” makes some sense for the wider market, says Pescatore, as having sufficient scale is “key” to helping lower costs and improve margins, as the Ofcom report suggested.
Alex Tofts, at comparison site Broadband Genie, said while the deal would “create a power couple and a real force to be reckoned with in the mobiles market”, the combined group would “still be at a disadvantage” with the likes of BT and VMO2, where mergers combined fixed-line broadband with mobile specialists, and the CMA “tend to be wary of mobile-only mergers”.
On national security, with Three’s owner CK Hutchison based in Hong Kong, Vodafone’s majority ownership of the merged business should allay concerns, says Pescatore.
“I expect the Hutchison share to reduce over time,” he adds.
“Hutchison already has an extensive presence in the UK, but this should be seen as a gradual exit from the telco market. Having the current Vodafone UK CEO heading up the new operation is a testament to this belief. His considered approach will resonate with key stakeholders and improve any chance of getting the deal over the line.”