Vodafone and Liberty look to avoid being left behind

Companies enter into asset swap talks as analysts warn market consolidation could put the telecommunications giant in a “perilous” position

The proposed consolidation in the UK market has forced Vodafone to enter into discussions with Liberty Global about an exchange of assets or risk finding itself in a “perilous” position.

That was the view of some of the industry’s leading analysts, following the Vodafone announcement earlier this month – which they both insist is not a potential merger. Specific details of the ‘exchange of assets’ has yet to be officially confirmed as Mobile News went to press.

Ovum analyst Steven Hartley

Ovum analyst Steven Hartley, speaking immediately after the announcement, says he believes BT’s proposed £12.5 billion acquisition of EE, and Three-owner Hutchison Whampoa’s £10.25 billion deal to buy O2 had left Vodafone in a “sticky situation” which, if completed, would see its market status plummet to an all-time low.

“Assuming all combinations proposed go ahead, Vodafone would become the smallest mobile player in the UK,” Hartley explained.

“It isn’t big enough to compete on mobile only, but it isn’t competing directly with BT/EE. Whenever Vodafone has been challenged on this before, it has always pointed to Cable and Wireless’ reach in however many exchanges nationwide, but Virgin Media offers content as well, so the talk of exchanging assets makes a lot of sense.”

Quad play
Vodafone bought telecoms firm Cable and Wireless in 2012 in a deal worth just over £1 billion and began the rollout of its consumer broadband proposition, Vodafone Connect, over the last few weeks. Connect will use a combination of C&W infrastructure and BT OpenReach.

Liberty Global already offers a fixed line service in the UK through Virgin Media, which it bought for £15 billion in a stock and cash merger in June 2013.

IDC associate vice president of mobility John Delaney agreed with Hartley, in that Vodafone would be under threat by a combined BT/EE rival which could begin offering converged bundles – known as quad-play – consisting of mobile, fixed line, broadband and TV.

“Vodafone has been painted into a corner by the two pending mergers in the UK for a number of reasons,” Delaney explained.

“It is pretty clear that BT is planning something major in the area of quad-play once it has acquired EE, and Vodafone has no way to respond to that because it doesn’t have a TV offering. So it needs to do something about that. A merger with Liberty Global would achieve that.”

Vodafone, as mentioned, has ruled out a full merger between the two companies and said current negotiations surround swapping some key assets, although reports in the national media have since claimed that Liberty Global CEO John Malone would prefer a full tie-up.

Indeed a month ago Malone described the prospect of a Vodafone merger as a “great fit” for his company, prompting shares at Vodafone to jump 3.5 per cent.

Vodafone chief executive Vittorio Colao

Vodafone chief executive Vittorio Colao had also made it clear that Vodafone would be interested in a deal with Liberty at the “right price”.

Vodafone, according to the markets, is valued at around £60 billion while Liberty Global is valued at £29 billion.

Speculation has been rife about a tie-up between Vodafone and Liberty for months following a spate of mergers and acquisitions in the global telecommunications industry.

Delaney went on to add that a full merger between the two companies might not even be possible due to the intense regulatory scrutiny in countries where both operate more than one service, such as Germany.

He added: “The merger, although attractive strategically, has problems, so an asset swap seems like a much better idea in principal because it allows both companies to solve specific problems each has without creating new problems.

“One attractive proposition for Vodafone is for Virgin Media to be swapped to it. The question is then what would Vodafone give to Liberty. There are endless  permutations for speculation on that.”

Organic growth
As Mobile News went to press, neither Vodafone nor Liberty Global had disclosed what assets were being discussed, but nearly all of the analysts we spoke to agreed that acquiring Virgin Media would be of great benefit to Vodafone.

Virgin runs an MVNO in the UK (Virgin Mobile) on EE’s network, with around three million customers, but it is its fibre-optic network and TV offering, which serves around five million people, that would benefit Vodafone most strategically.

Hartley added: “It would be logical for Vodafone to want Virgin Media in the UK. I can’t see the competition authorities in Germany approving a merging of assets, but the Netherlands could be up for it, with Vodafone’s operations there going to Liberty.

“That won’t be enough of a counterweight for Virgin so there may be others, such as the Czech Republic, some of Vodafone’s smaller operations and maybe some cash thrown in as well. Out of it, Vodafone will probably come away with Virgin Media.”

CCS Insight’s director of multiplay Paolo Pescatore says the prospect of Vodafone becoming the smallest operator in its home market “just isn’t good enough” for a company of its size, but warned the operator against trying to grow a broadband base organically.

Pescatore used rival mobile provider EE as an example. At the end of 2014, EE had 834,000 fixed broadband customers and launched EE TV, but Pescatore said the operator had struggled to gain any traction organically.

“Vodafone has been making acquisitions for a while, just not in the UK, but now it has suddenly found itself about to become the third provider in its home market.” he said.

“If they have any aspirations to compete in broadband, they need to acquire some assets, rather than trying to grow organically. We’ve seen that with EE’s broadband numbers, even though they’ve done a reasonably good job of net-adds, they need to be able to compete head-on in a market usually dominated by three or four players.”

Liberty Global CEO John Malone

Liberty Global CEO John Malone has previously called Vodafone a “great fit” for his company, but the mobile operator has consistently refused to discuss a potential deal.

“We’ve looked at that from our side and there would be very substantial synergies if we could find a way to work together or combine the companies with respect to western Europe,” said Malone.

“Is there a great fit in Germany? Absolutely. Is there a great fit in the UK? Absolutely. Is there a great fit in Holland? Absolutely. There’s the promise of creating enormous shareholder value if we could work it out.”

“Flirting”
Hartley said that all of the “flirting” between the two companies had ramped up pressure on Vodafone to make a statement to the markets
about whether it was interested in any kind of deal.

His view was echoed by Pescatore, who speculated that Malone-owned firm Charter Communications’ $80 billion agreement to buy US-based cable provider Time Warner could have sparked the American billionaire to reassess his European options.

The CCS analyst explained: “There has been a series of events that have caused Vodafone to make this announcement. Malone’s bid for Time Warner Cable has led him to consider his best options and perhaps look at leaving Europe.

“They need funds and acquisitions may not have worked out as well when it comes to attracting new households. It is a tough, competitive landscape. At the same time, telcos need to strengthen their assets.”

Market consolidation
An exchange of assets could also prevent Vodafone and Liberty from undergoing too much regulatory scrutiny. BT’s acquisition of EE and Hutchison’s purchase of O2 will both require regulatory approval, the former from the Competitions and Markets Authority in the UK, and the latter from Europe.

Vodafone has already expressed concerns about the potential consolidation in the market, but is unlikely to ease off its criticism of those deals in the foreseeable future, according to Hartley.

He said: “Vodafone has the most to lose by all the other consolidation going on and so it will kick up a big fuss. That could help slow that process down. If this comes off, would Vodafone ease off? I wouldn’t. I’d make a big noise to try to slow down the other deals, and ease off later on.

“The regulatory obstacles could help slow down the other consolidation and that would benefit Vodafone.

“Given everything else going on, there is unlikely to be regulatory issues at a higher level. It is difficult  to judge what is going to happen as there are several competition authorities looking at the different  convergence.

“If BT/EE is approved then it gives Vodafone a strong message to say it is competing on a converged level.

If O2/Three is approved, then that makes a dominant mobile-only player. So from a logical perspective there aren’t a lot of issues.” Choudhary felt regulators may  find concerns about less competition  in the market if Vodafone teams up with Liberty.

He said: “Consumers can expect to see intense competition in the early stages post consolidation, as these new giants look to capture as much market share as possible in the short term by offering compelling propositions.

“In the long-term however, with less competitors in  the market, there will be less pressure to keep prices low as possible. That will be a concern to regulators.”