Vodafone LGI German merger – over Bundeskartellamt’s dead body

There is an idea expressed by Liberty Global CEO Mike Fries, about Netflix a few years back, which is coming back to haunt him. “I’d rather have our business model than theirs,” he said. But today Fries is flailing about trying to rid himself of assets which are not working for him and adjust the Liberty Global Inc (LGI) business model so that it can be more like Netflix. For a cable company it’s a tough ask.

We have pointed out on multiple occasions that running a company which reports in US dollars but does most of its business in Euros and British Pounds, is tough in a period of currency fluctuation and Brexit is the trigger for the current round of such fluctuation – in the past it was the southern Eurozone which played havoc with the value of the Euro – and it is set to last 3 more years.

Despite this, by using the euphemism, “Rebased” and applying it to revenues and profits, to show how performance “would have been” if not for currency and other issues beyond Liberty’s control, Fries has pulled the wool over most people’s eyes for some time. The impression has been that LGI has been doing well, although Faultline has never thought so.

But this week, Vodafone’s 80-word press release about the fact that it is in talks with Liberty Global about a “potential transaction” suggests that one more of the Liberty global businesses is up for grabs and everyone has immediately plumbed for it being Germany and Unitymedia.

It was proposed on two occasions that Kabel Deutschland merged with the component parts of Unity Media some years ago, when both had different owners. On both occasions the Bundeskartellamt or Cartel Office squashed the deal, once in 2004 and again in 2009.

In fact Deutsche Telekom once owned nearly all the cable companies in Germany and it was the Bundeskartellamt, which forced it to sell them off separately in 2001, in a deal where it planned to sell off 6 cable firms to what today has become Liberty Global. The Bundeskartellamt blocked that deal and they all had to be sold separately. So that makes 3 occasions.

And after Vodafone had taken ownership of Kabel Deutschland, and tried to buy the much smaller Tele Columbus, in 2013, once again the Bundeskartellamt blocked a similar type of deal.

So why is it that the current management of Vodafone and the (same) management of Liberty Global, think it can slip a deal past the local anti-trust regulator now?

And even now the deal cut in 2011, for Unity Media to acquire Kabel Baden-Württemberg (Kabel BW), which at the time was the third largest German cable operator, remains a thorny issue, with the Bundeskartellamt approving the deal in 2011, the courts removing that approval in 2013, and in 2016 Liberty Global paying some, but not all of the dissenting cable firms off with €300 million. The remaining German cable firms under the cable operator association FRK is still holding out for some cash for it to remove its blocking court action. But then again the FRK, an association of mostly campus wide cable firms in Germany, still thinks that charging Facebook and Google €1 a month for access to each of its customers, is viable and not against European Net Neutrality rulings.

There is so much history around the mergers to date, that surely no-one can assume that merging Vodafone’s Kabel Deutschland and Liberty Global’s Unity Media, will be trouble free.

So let’s look at the statement Vodafone made and the requirements of the two companies.

The statement says very specifically, that Vodafone confirms it is in early stage discussions with Liberty Global regarding the potential acquisition of “certain overlapping continental European assets owned by Liberty Global.” And it makes the point that it is NOT in discussions to buy all of Liberty global.

That word “Continental,” makes it clear that it does not mean the in UK, and why would it, as Virgin media is one of Liberty Global’s best performing subsidiaries. Well it should mean this, because the UK is where Vodafone has two issues to cover – firstly that it has no video service there, and so cannot offer a quad play – despite two attempts throughout 2016/7 to launch one. Secondly it has the weakest fixed line infrastructure of any of its big markets – Germany, Spain, Italy and the UK, even though it bought the network of the first “duopoly” player in the UK which went up against British Telecom, from Cable and Wireless, where it was once branded as BT rival, Mercury Communications.

That deal netted Vodafone unbundled local loop equipment sitting inside some 500 telephone exchanges, which are in reach of VDSL and connections and another 900 exchanges which can offer basic ADSL. It’s a drop in the ocean compared to the 5,500 exchanges that British Telecom operates. So buying Virgin Media would be high on its agenda, but low on Liberty Global’s.

The statement says specifically “overlapping” countries. On the continent, Liberty Global has operations in Austria, Belgium, Switzerland, Poland, and Slovakia where Vodafone does not have a network, so they can be eliminated, and that leaves Romania, Hungary, Ireland, the Czech Republic and Germany which we have discussed, where there is an overlap. These are all between 371,000 internet lines and 1.1 million with the exception of Germany which is 3.4 million internet subscribers and 6.7 million TV subs – by far the largest operation.

For guidance, a deal to sell LGI Austria has anyway been agreed with T-Mobile. Austria was losing pay TV subs and gaining broadband rather slowly. Of the candidate operations, the closest fit to that is not Germany which is gaining plenty of internet subscribers, although losing pay TV customers; nor Romania and the Czech Republic, where, like the UK, both numbers are going up. Which leaves us with Poland or Hungary. So logically this is where the discussion should be centered.

Of course these conversations are much smaller than the one to be had about Germany and so it seems likely that the first conversation the two would complete is in face Germany. It could come back to those other market later. The issue in Germany is multi-layered. Can Vodafone and Liberty Global get the European Commission to take on the approval of such a deal, bypassing the less sympathetic and rigid Bundeskartellamt? This is what it managed in the Netherlands, and there remain rumblings about the deal not being in the consumer’s best interest. Those deals could still be reversed.

Or can it argue that the video market has changed substantially since the deal was last rejected in 2011, due to the widespread introduction of multiple OTT video services such as Netflix? And does the existence of the two Netherlands mergers involving these two companies change the precedent in merger law – there were two operations Liberty Global and Ziggo which had 65% of pay TV, and 50% of broadband between them, and they merged, and they then merged with Vodafone which had just under 50% of the MNO market as well.

That deal was a blot on the track record of the European Commission, which overruled the local regulator about who was the better skilled to take approval on. The Commission has previously managed to keep competition on track throughout Europe with a very clear and repeatable policy. The new breed of Eurocrat at the Commission threw away 30 years of precedent when it agreed these two deals in a volte-face so stunning as to appear to be policy change similar in magnitude to the US position on AT&T buying Time Warner in a market vertical deal.

There are many countries where all cable franchises have ended up in a single ownership, but in no cases has it involved anything above a 40% market share. Armed with the Netherlands deal as a precedent, it looks like Vodafone may be about to test the law once again, in a merger that may bring similar numbers to Germany 65% or more of pay TV and around 33% of broadband, tacked, onto the number two in cellular with well over 35% market share. We don’t think it is going to happen if the Bundeskartellamt has anything to do with the decision – but perhaps this is the one time that it won’t. It would be the first time the Commission has pulled rank over the German regulator and we would not bet on it sitting still and laying quietly, as the Netherlands regulator did, while it happened.