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Vodafone shakes up European policy as it commits to Liberty assets

While we are fairly clear that the transaction announced this week for Vodafone to buy key parts of Liberty Global in Europe will go through, but to do so it means it has to avoid the scrutiny of the Bundeskartellamt, the German competition regulator.

That means the deal must be presided over by the European Commission, and not the Bundeskartellamt, usually referred to as the Cartel Office. And that will ruffle some traditional German feathers.

We firmly believe, as does Mike Fries, CEO of Liberty Global, that this is a deal where the regulators have already ironed out the “kind of terms” that would be acceptable – we can predict them here, but essentially some control over any exclusive content and some of the terms that Ziggo had placed on it, regarding no contractual clauses preventing content owners also placing their content on OTT systems.

We also expect this deal to be legally challenged either by the German Government, the Bundeskartellamt or Deutsche Telekom possibly with Telefonica and others in Germany. All of this will take time but achieve little. Let’s explain why.

The issues around Germany are that it has been treated as a special place within Europe, as a founder of the European Union, and the Ziggo merger in the Netherlands has changed the mindset in Europe and made deals like this more possible. This will result in a clash which will put the Bundeskartellamt dogma up against what the European Commission sees as progressiveness. We suspect that a compromise has already been found, as the two halves of this merger have been talking about it for years and have certainly had informal discussions with regulators.

Germany is the only fly in the ointment however and the other parts of the €18.4 billion ($21.8 billion) deal will bring little discussion – with the Czech Republic, Hungary and Romania all relatively competitive, with Romania in particular known for vicious price wars.

But Germany being a special case has raised eyebrows around Europe, and the European Commission has had to push harder and harder against regulator reluctance to “boss around” the mighty Deutsche Telekom. Broadband dominance based on Telco technology means that cable remains under-invested, financially weaker and anything that Germany can do to make Deutsche Telekom more efficient, such as introducing converged opposition, will benefit the average citizen.

Unbundling the local loop has been the European process for building competition in broadband, which has worked well in places like France and the UK and the Nordics – but not so far in Germany.

Vodafone was so frustrated with the lack of support from the competition authorities which means that the fixed line assets it purchased with Mannesmann, which brought it 2 million DSL lines, was fading as a force, which is why it bought Kabel Deutschland, as a fixed line counterbalance there and even that has not been enough.

Things like VULA access, whereby broadband vectoring crosstalk cancellation has to happen for each bundle of lines leaving an exchange on one single Deutsche Telekom owned server, was the beginning of a virtual monopoly in German broadband, with Cable being the only feasible rival to this. In the UK, OpenReach, the subsidiary of BT which looks after broadband infrastructure has gone down the route of it being threatened by the regulator to enforce a company split to combat this – one approach. But in the UK wholesaling and cable do form viable broadband competition, and that’s what this merger is all about. For Germany this is the answer, and we believe that Vodafone has already won this argument with regulators.

On multiple occasions, multiple companies, Deutsche Telekom included, have tried to bring together 4 out of the main 6 German cable firms, and this deal brings together that magic 4 operators – the two brought together under the tutelage of Liberty Global in Unity Media, plus Kabel BW and now Kabel Deutschland, acquired by Vodafone in 2013. There is just the Primacom-Tele Columbus grouping left outside, now known as PYUR with a few million subscribers, which were primarily in Eastern Germany and never part of original plans in the past to merge Germany’s cable providers.

Once upon a time (2000) Kabel Deutschland, the two components of Unity Media – Ish and Iesy (which were allowed to merge in 2005), and Kabel Baden-Württemberg were all owned by Deutsche Telekom, and the competition regulator, the Bundeskartellamt (German Cartel Office), forced it to break up. Attempts to bring them all together once again, both by Deutsche Telekom and Private Equity groups, were blocked by the Bundeskartellamt in 2004 and 2009.

There were even issues of ownership raised by the Bundeskartellamt over Unity Media acquiring Kabel Baden-Württemberg, which resulted in local rivals getting a payoff.

The strong arguments in favor of the deal – Deutsche Telekom needs an across the board rival – it has become far stronger in Broadband; OTT services such as Netflix have made great inroads in Germany, as have satellite operators like Sky, changing the pay TV landscape; and Telefonica is approaching the kind of strength where it can compete with both Deutsche Telekom and Vodafone there. And ISP United Internet, a shareholder in PYUR, has a stronger broadband presence, with over 4 million homes, creating at least one viable independent broadband rival.

But equally the equation in Germany has changed little and the Cartel office has always worried that Deutsche Telekom would be at a disadvantage and would not countenance a cable merger. That now is apparently dogma and no longer acceptable thinking. The key is broadband competition, as long as content is protected.

In broadband the combined cable firms reach into almost 20 million homes, and where they can install DOCSIS 3.0 and 3.1, thought to be a superior broadband technology to DSL and G.fast.

In pay TV, Germany is a “value market” because of the strength of broadcaster content and also there are many OTT services, each relatively successful, all queued up behind Netflix, in pure subscriber numbers. Some even believe that Amazon Prime is almost as strong. And in cellular telephony, Vodafone is just behind Deutsche Telecom’s T-Mobile, with Telefonica bringing up the rear – it is one of those markets which has already reduced to 3 major cellular players. It will now reduce to two rival fixed line players.

When Ziggo in the Netherlands was formed it sent a ripple through Europe but achieving the same in Germany will send a tidal wave through conservative Telco ownership and drive a new wave of consolidation in the 2019 time frame, when this deal will finally get its okay – one way or another.

The thing to consider here is what happens next. Liberty Global can go two or three ways – it can spend the spare cash from this deal on more content, it has a holding in ITV in the UK for instance and has flirted with content on multiple occasions. It might chase holdings in a number of content players in France, and Germany to go with that and build out OTT services. The other way it can go is to build cellular assets for a converged play in the markets where it continues to have cable and DTH pay TV assets. Or it could re-invest the money in Latin America. The big problem for investors in Liberty Global has been the changing currency markets – especially the Brexit influenced UK pound in Virgin revenue, which it continues to hold. One plan would be to put all the cash into spectrum and RAN network assets in the major markets of Western Europe – the Netherlands, Switzerland, Belgium and the UK – and then perhaps exit Europe finally down the road, by selling all of this to Vodafone, in an unholy merger that would create a gargantuan converged player.

Our feeling is that Liberty Global will eventually exit saturated European markets for the high growth, but volatile Latin American and Caribbean markets, but not for a while yet. And the timing will be dictated by purely financial outcomes.

This deal has been initiated by the changing of the guard at the European Commission – the new thinkers around the anti-trust argument in the Commission – Margrethe Vestager, and before her Joaquín Almunia, have taken an updated line against broadband investment somewhat different from Neelie Kroes and Mario Monti before them, who were staunchly hyper-aware of the dangers of anti-trust. But perhaps they came from an era when governments protected their own Telcos with golden shares.

Jean-Claude Juncker as President of the European Commission has surrounded himself with a new breed of Commissioner not known for blocking any kind of merger – keen to embrace larger European Institutions. The queue of players wanting similar converged plays may lead to future disasters, with incumbent telcos crashing hen compared against their cable driven opposition. The creation of Ziggo in the Netherlands brought together 65% of the Pay TV market and 50% of broadband customers into a single company, which merged with Vodafone in 2016.

Vodafone claimed it will become the leading next generation network in Europe, with 54 million cable and fiber homes and in reach of 110 million homes.

Already the war of words has begun between the Vodafone CEO Vittorio Colao and Timotheus Höttges, with the Höttges complaining that the merger should be blocked because it will distort competition, and Colao countering that these are weasel words designed to maintain Deutsche’s cushy control of Germany – Vodafone’s chief continued to note Deutsche Telekom currently has a presence in 70% of German homes – higher than other Telcos across Europe.

He also pointed out that in Central European and Eastern (CEE) markets, Vodafone’s combined businesses will reach 6.4 million homes (39% of total households) and will serve 15.8 million mobile, 1.8 million broadband and 2.1 million TV customers.

Vodafone said there would be cost and capex synergies of €535 million ($636 million) a year before integration costs by the fifth year post completion.

The deal values the acquired operations at 12.5 times its forecast 2019 cashflow and it will be paid for using existing cash, some new debt facilities and around €3 billion of mandatory convertible bonds.

Although the main antagonist in this deal is Deutsche – both inside and outside Germany with operations in each of Romania, the Czech Republic, and Hungary, but back in Germany it puts question marks over Telefonica viability which will need to seek out fixed line associations – perhaps it can approach PYUR and United Internet – and it will have to consider its position in the rest of Europe.

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