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3 June 2021

Multi-network TV offering among Virgin Media O2 UK merger plans

A year after it was proposed, the £31.4 billion ($44 billion) merger between Telefónica’s O2 UK subsidiary, and Liberty Global’s Virgin Media – the UK’s largest cableco – has been approved by regulators. It is one of the UK’s largest ever telecoms deals, far higher than the £12.5 billion ($17.7 billion) price BT paid to acquire MNO EE in 2015. That is partly down to the strong job O2 UK has done in the past year to strengthen a business that often struggled in the 2010s, but has now leapt from third to first place in terms of subscribers.

The two parent firms have promised to invest £10 billion ($14.1 billion) in the UK over the next five years and create “a stronger fixed and mobile competitor in the UK market”. Their initial priorities are infrastructure-focused, to invest in accelerating expansion of fiber and 5G networks. But they are also expected to start to develop fixed/mobile services similar to BT’s Halo+, and a multi-network TV offering.

The deal finally gives Telefónica a co-investor in the challenging and competitive UK market, which the Spanish giant has sometimes sought to quit completely. In 2016, a proposal for O2 to be merged with the UK’s smallest MNO, Hutchison’s Three UK, was blocked by competition watchdogs on the grounds that it would reduce the number of mobile players from four to three, reducing competition and potentially driving up prices. In fact, a European Union review of that decision reversed the ruling in 2020, but the moment had passed, and by then, Telefónica was in talks with Liberty.

The blocking of the O2/Three merger was controversial because it came soon after the same regulators had allowed a far bigger merger, between BT and the UK’s then-largest MNO, EE, to go ahead. The rationale was that the BT deal did not reduce mobile competition, but the ruling reflected an old-school view of the telecoms and media markets that still persists among many antitrust bodies. It assumed fixed, mobile and TV/video services were still largely separate markets with their own competitive structures, whereas operators were increasingly gaining differentiation and growth if they could off multiplay bundles that combined all three types of services, often together with other offerings such as smart home or in-car applications.

The BT/EE merger created a dominant operator because it brought BT the country’s largest fixed and mobile networks, and the telco had already invested heavily in content and TV assets including sports. It is now backing away from some of those, in line with a general trend among operators to focus on infrastructure and networks rather than content (as AT&T and Verizon have demonstrated in recent painful divestments). And it is not as invincible as it seemed when it acquired EE. The regulator, Ofcom, has forced greater separation between BT’s retail activities and its wholesale fiber arm, Openreach. Several challengers have arisen in the fixed-line market it once dominated completely – increased build-out by Vodafone, and the emergence of several wholesale fiber providers such as CityFibre.

And now BT will have a full-blown challenger in Virgin/O2, a transaction that brings together nationwide mobile and cable networks, and significant content and TV deals. The two parent companies said the approval was “a watershed moment in the history of telecommunications in the UK”.

“We are reassured that competition amongst mobile communications providers will remain strong and it is therefore unlikely that the merger would lead to higher prices or lower quality services,” said Martin Coleman of the UK’s Competition and Markets Authority (CMA).

The deal values O2 at £12.7 billion and Virgin Media at £18.7 billion to give the new group a combined value of £31.4 billion including debt, and it is now expected to close by June 1. The 50:50 joint venture will be led by Virgin Media’s current CEO Lutz Schüler, and will have £11 billion of annual revenue at its inception. Ángel Vilá, Telefónica’s COO, said that the deal, combined with the sale of its Telxius tower division, would reduce its €36 billion net debt by €9 billion.

“We are now cleared to bring real choice where it hasn’t existed before, while investing in fiber and 5G that the UK needs to thrive,” Liberty Global CEO Mike Fries and his Telefónica counterpart José Maria Alvarez-Pallete said in a joint statement.

For Telefónica, this is part of a broader strategy to consolidate its activities in fewer, larger markets, rather than seeking wide coverage in Latin America and Europe. It sold its Irish subsidiary to Hutchison Three in 2015 and plans to exit many of its Latin American markets. It has backed away from wanting to quit the UK and German markets altogether but in both cases, has merged its subsidiary with another player’s to gain greater scale. In Germany, O2 merged with KPN’s E-plus unit.

The strategy is to consolidate its presence in four main markets – Spain, the UK, Germany and Brazil – in order to rationalize capex and opex costs and maximize market power. Its next big transaction is the acquisition of Oi in Brazil to increase its scale in that turbulent but large arena.

In fact, Telefónica has negotiated the Liberty merger from a position of greater strength than it had when it proposed the Three deal. Then, O2 was the third-largest MNO and Telefónica was known to be keen to exit the UK completely. Now, it has committed to the market and has become the largest MNO by subscriber numbers, with 36.6 million, overtaking EE and Vodafone.

Telefónica will also pay its 6,700 UK staff nearly £2,000 each as a cash bonus to reward them for a very strong first quarter performance ahead of the Liberty merger. The UK unit’s operating income before depreciation and amortization rose by almost 8% to €547 million in the first three months of the year, boosting Telefónica’s overall patchy performance. The growth was despite an 11% decline in revenue to €1.5 billion (O2 stores were closed because of the pandemic-related lockdown from mid-December until mid-April); and a 17% rise in capex to expand 5G.

Profits were boosted by lower churn, a one-off payment related to Cornerstone, O2’s UK towers joint venture with Vodafone, and lower commissions to reseller Carphone Warehouse after O2 stopped selling handsets and contracts through the retailer.

Mark Evans, outgoing CEO of O2 ,who will leave the company after the merger, said, “Not all operators are delivering that level of return. The health of this business bodes well for the future of the joint venture.”

O2 was originally known as Cellnex and was part of BT. Under its new brand, it was demerged in 2000 and then sold to Telefónica in 2005.

Virgin Media had previously planned to reach 15 million homes with FTTP services in 2021, and that target has now been upped by one million “within 12 months of the merger closing”. Virgin is second to BT in terms of fixed-line subscribers but has bigger reach than BT Openreach, which passes 4.5 million homes and supports several retail providers on a wholesale basis (BT and EE themselves plus Sky, TalkTalk and Plusnet). Openreach says it will reach 25 million homes by the end of 2026.