Vodafone and Three U.K. confirm merger talks

After months of speculation, mobile network operator Vodafone UK has confirmed that they are officially in “discussions” with Three UK about the possibility of creating a joint venture merger. This will be a 51%-49% split and will make it the U.K.'s largest Operator with 27 million subscribers.

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In a press release, Vodafone offered 5G investments as their rationale for the deal. “The UK Government rightly sees 5G as transformational for the economy and society and critical to the UK becoming more competitive in an increasingly digital world.”

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Vodafone is playing to the tune of the regulator by tying its rationale to 5G investments to create a digital 5G leader. All the right notes to appease the regulator. However, there is certainly more to this M&A story. It has been well documented that Vodafone has been under pressure in recent years to improve its performance. It has watched its share price drop 54% in the last five years. And its net debt – as reported at the end of March – exceeds its current market value by about ￡7.4 billion ($8.5 billion). M&A has been shared as a cornerstone strategy to drive this turnaround. And as recently as February, Nick Read, the chief executive of Vodafone, said he had entered M&A talks in its biggest markets to strike deals with “speed and resolve”. With the argument that the European telecoms industry must consolidate to create more profitable businesses that are more attractive to investors.

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At the same time, Hutch has been seeking a transaction that will help the business to achieve scale and increased profitability. Such as in 2016, when Hutchison-owned Three was courting Telefónica's O2 business and the UK was still part of the European Union (EU). However, at the time this deal was blocked by regulators.

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See our previous post on State of the UK Mobile Market to see specifically the challenges both Three and Vodafone have faced. The biggest being languishing profits, no true fixed broadband play and NPS scores that trail the other MNOs.

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Vodafone claims that the merged businesses would challenge the two already consolidated players (BT EE and Virgin O2) for all UK customers. And would bring “benefits through competitively priced access to a third reliable, high quality, and secure 5G network throughout the UK”.

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However, the benefits of such a merger aren’t quite as clear-cut as they were in the case of BT and EE or O2 and Virgin Media. Both of which predominantly reflected combining a fixed-line business on one side, and mobile businesses on the other. By comparison, Three UK doesn’t have a fixed line business and Vodafone has some of its business fibre. But their consumer base largely reflects partnerships with Openreach and City Fibre.

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The merger would be subject to an in-depth investigation by the CMA which will likely focus on several key areas. The new entirety would hold large quantities of the spectrum – as much as 49% of all licensed bands, according to Ofcom. It would also eliminate a competitor, turning the UK from a four- to a three-player mobile market. This would potentially present a risk of increased prices at a time of rising inflation and further squeeze household budgets.

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Additionally, a combined entity will mean one less place for MVNOs to go for a hosting deal. Vodafone and Three have also had quite opposing views towards MVNOs in the past. Three has been known to openly embrace the MVNO model, whereas Vodafone has been known to be less supportive over recent years. In previous mergers, there have been remedies involving MVNOs, including divesting MVNO sub-brands or allowing preferential network access to MVNOs to create a meaningful competitor. Divestment of an MVNO does not look possible in this case. Neither Vodafone’s Voxi nor Three’s Smarty brand possesses enough scale to be considered a significant market player for competition purposes. So perhaps a remedy will focus on offering network access. I’d suggest that the combined entity would also be required to give up some of its spectrum. Although the challenge here will be that giving up a meaningful amount of spectrum will go against the principles of the combined entity creating a 5G powerhouse.

The consolidation movement continues with gusto in the U.K. I, for one, will be most interested to see how the CMA approaches the competition question. Particularly as it pertains to the wholesale market.