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25 April 2023

EU may soften stance on MNO mergers, as Vodafone seeks to rejig assets

The wave of mergers and acquisitions that swept over European mobile operators before the pandemic has abated somewhat since, but there are still deals in the offing, notably within the Vodafone Group. There could be a new string of mergers if the European Union softens its stance on consolidation in telecoms, which has long been at odds with large operators’ strategies.

There are signs that the EU will be encouraging consolidation, in a bid to accelerate investment and deployment of infrastructure in fiber and 5G. That could lead to a significant restructuring of the European market, if there are fewer restrictions on mergers between operators, particularly those that reduce mobile operators from four to three in a particular country.

In the past, the hostility of EU and member state competition regulators has blocked several would-be mergers, or imposed drastic conditions on others. A good example was in 2016 in the UK (then in the EU), when Telefonica O2 and Hutchison Three were blocked from merging their UK MNOs, as that would have reduced the total in the UK to three. Later, by apparent contrast, BT was allowed to acquire the largest MNO, EE, because this was a fixed-mobile consolidation that did not reduce mobile competition.

Of course, in fact, it enabled BT to inject significant new investment and scale into EE, making it a more dominant player, while the other three mobile players had to engage in price wars to increase their market share. That, in turn, they argue, reduced their ability to invest in advanced infrastructure.

Since then, Telefonica has placed O2 into a joint venture with cable provider Virgin Media, creating a credible fixed/mobile challenger to BT in the UK, but that has left Vodafone as a third player in its home market, with Three struggling in fourth place. The two companies’ parents propose to consolidate the two MNOs, arguing that they would be a more forceful challenger to BT and VMO2 when combined, and that the UK has significant consumer choice because of its large number of MVNOs (it is also the most competitive fiber-to-the-home market in Europe).

This time around, UK deals will not have to go through the full EU antitrust process, though implications for EU players will still be assessed. This is one reason why consolidation may succeed in the UK this time. But a recently published UK government policy document on wireless infrastructure, which calls for accelerated adoption of 5G Standalone and Open RAN, may influence the decision of the Competition and Markets Authority (CMA) on the proposed Vodafone/Three merger.

Vodafone has argued forcefully that implementing 5G SA on a nationwide basis is economically non-viable without either state financial support, or permission to consolidate and therefore boost investment scale while improving the business model.

The newly reorganized UK Department for Science, Innovation and Technology (DSIT) included a section entitled ‘Strengthening the investment environment’ in its wireless infrastructure policy, which sends clear signals that it believes Vodafone and Three need to be strengthened. It points out that neither MNO has been able to cover its cost of capital since 2018, based on figures from regulator Ofcom. That echoes the MNOs’ arguments that the market conditions make it impossible for them to achieve acceptable return on capital.

When Vodafone first confirmed the negotiations last October, it said in a statement that a combined operator would “challenge the two already consolidated players for all UK customers and bring benefits through competitively priced access to a third reliable, high-quality, and secure 5G network throughout the UK”. It also noted that as separate providers, both it and Three “lack the necessary scale to earn their cost of capital”.

DSIT insists it is entirely the CMA’s decision as to “whether the merger creates benefits to the relevant customers such as lower prices, higher quality, greater choice and greater innovation of goods and services.” If there are risks, the CMA can “suggest remedies,” DSIT added.

Such encouragement has led some analysts to predict that the merger will be finalized and approved in the coming month. The combined company would be worth €16.5bn (£14.6bn). It seems that the proposed transaction would see Vodafone take a 51% stake, and Three’s owner, CK Hutchison, owning the rest. There are also likely to be terms that enable Hutchison to exit the venture altogether in future, amid speculation that it will dial down on its European activities in markets where it cannot achieve scale (it has been allowed to merge with other MNOs in some other markets, including Italy, Austria and Ireland, though often with heavy conditions such as offloading spectrum to new entrants).

Vodafone UK currently serves 17.8 million mobile users and 1.1 million fixed broadband customers, while Three UK has 10.3 million customers across fixed and mobile, but remains mobile-centric.

Both parent firms are looking for deals or exits that would enable them to be large-scale players in their European markets of choice, or to offload their operations. Vodafone’s interim CEO Margherita Della Valle recently reiterated that consolidation remained a focus for the Group in four markets – Italy, Portugal, Spain and the UK.

In Portugal, there is a proposal to acquire Nowo Communications – the fourth largest operator, which recently acquired 5G spectrum – and merge it into Vodafone Portugal, though these talks are in early stages. Vodafone has not announced a specific plan for Italy, where there are no fewer than five MNOs, with a complex set of network sharing deals between them.

The Portuguese Competition Authority (AdC) kicked off its in-depth investigation of the potential Nowo deal this month, and has so far seemed negative. In a statement, AdC said the merger could lead to “unilateral effects and coordinated effects, with adverse impacts for telecommunications customers in Portugal”.

It fears a merger would disrupt the current competitive balance, raise barriers to entry and expansion, and reduce the number of operators. In particular, it said that Vodafone would acquire Nowo spectrum, which was designated for new entrants, and that, while Nowo is small, it “exerts a not insignificant competitive constraint in the market”.

In Spain, Vodafone has made various failed attempts (some official, some just reported) to acquire smaller players, notably MasMovil, which it lost to Orange Spain. Now it may look to offload some activities rather than scale up, or even exit the market altogether.

Recently there were reports that Vodafone would sell its fixed-line unit, but last week, Bloomberg sources said the whole Spanish business was in the sights of acquirers, with a valuation of up to $4bn. The suitors seem likely to be private equity players, which are highly active in the telecoms market in the current economic climate, though there could be interest from other operator groups, especially if the EU is softening its line on consolidation between established telcos.

There is no scope for in-market consolidation unless the Orange/Masmovil merger is blocked (but that would send a very negative signal for any alternative transaction). However, telecom investment groups such as Xavier Niel’s vehicle could be interested, or even Liberty Global.

Vodafone has come under intense pressure from activist investors in the past year, to streamline its operations and take drastic action in underperforming operating companies. It has struggled in Spain recently and has now moved the unit into its ‘Other Europe’ group, placing it with the smaller Vodafone businesses rather than as a flagship operation like Germany. Vodafone has already sold one of its ‘Other Europe’ businesses, Vodafone Hungary, to the country’s government, though it gained a stake in local MNO Yettel in return.

However, it would be a bigger strategic decision to offload Spain, which has been a core business unit for many years. And the future competitive landscape is uncertain since the Orange/Masmovil deal still has to gain regulatory approval.

Earlier this year, Spanish business paper El Economista reported that infrastructure investors Maquarie and Ardian were both preparing bids for Vodafone’s fixed network, placing a value of around €4bn on that part of the business alone.

All these reports and negotiations are taking place against a context of intensified lobbying for the EU to allow more consolidation, in order to boost the leading players’ ability to invest in infrastructure. Of the two, the consolidation side is where the EU can more easily make changes.

The big European players, such as Vodafone, Orange and Deutsche Telekom, argue that there is too much competition in most countries in the bloc, especially as markets saturate and ARPUs fall. They argue that, only if they are allowed to consolidate will they have the scale and revenues to invest fully in infrastructure and in upgrades such as 5G Standalone, which are essential to meet EU and national government objectives such as industrial transformation.

That is also presented, by the large operators, as the only alternative to their demand that the EU compel major Internet players to contribute to the infrastructure from which they profit so much. The ‘fair contribution’ debate and the calls to enable consolidation are both linked to the telco argument that they can no longer carry the whole burden of fiber and 5G investment because of their limited opportunities to grow revenue or market share.

According to Telecoms.com, the European Commission, the EU’s governing body, is revisiting the old idea of a single European telecoms market, and that would be supported rather than hindered by consolidation.

Internal Market Commissioner Thierry Breton also indicated, in a recent speech in Finland, that consolidation was being viewed favorably. He said: “The current fragmentation in Europe with sub-optimized business models based on national markets and high costs for national spectrum licenses is holding back our collective potential compared to other continents.”

Breton continued: “I believe that creating a true Single Market for telecommunications services also requires a reflection on encouraging cross-border consolidation, all while preserving fair and necessary competition for the benefit of our consumers.”

The main focus here is on cross-border consolidation to strengthen the major telecom groups, but EC officials who spoke to Telecoms.com indicated this would affect stances on in-market mergers too, with the EU already less wedded than before to barring four-to-three MNO deals.

The EC will publish its public consultation into the future of European connectivity and infrastructure this month, and is expected to address some of the issues surrounding a single market and fair contribution.

“The investments which will be required to achieve our ambitions will be enormous and we need to ensure that they are matched by the availability of sufficient funding. The burden of this financing should not be only on the shoulders of the Member States or the EU budget,” Breton said. “At a time when technology companies are using most bandwidth and telco operators are seeing their return-on-investment drop, this also raises the question of who pays for the next generation of connectivity infrastructure.”

The consultation will cover two fundamental questions, he explained. Essentially, it will look at what infrastructure Europe needs to spend money on in order to lead the digital transformation, and how those investments should take place.

Technology vendors should be rejoicing at these new sales opportunities, but ‘fair contribution’ may well poison that well, if MNOs prove happy to seek financial compensation rather than technological fixes.