The industry gives its views to Mobile News on the impact the proposed deal between Hutchison and Telefonica would have on the UK market
Hutchison Whampoa’s acquisition spree looks set to continue after it confirmed “exclusive talks” with Telefonica over a proposed £9.25 billion deal for O2 have now begun.
The move, if agreed, would see Three parent Hutchison, which has annual revenues of above £42 billion, take its recent spending spree above £10 billion in the past six months, having purchased O2 Ireland in July. Its overseas spend in recent years stands at around £20 billion today.
It would also see a combined customer base of around 34 million (41 per cent of the market), making it the largest UK operator, above EE (27 million), and Vodafone (19 million).
Telefonica, which has debts of around £43 billion, has made little secret of its attempts to sell-off its UK operation.
Rumours over a potential O2 sale first appeared in December after BT confirmed it was in discussions with Telefonica about buying back its former mobile business. Days later talks with EE joint owners Orange and Deutsche Telecom were also confirmed.
On December 15, BT, as with Hutchison and Telefonica today, entered exclusive talks to buy EE for £13 billion, scuppering Telefonica plans. The following day, it was immediately linked with Hutchison Whampoa, who admitted it would be interested in acquiring whichever network BT turned down.
Safeguarding Three’s future
Reaction to the news from telecom market analysts has so far been largely positive, insisting the move “makes sense”.
Kantar Worldpanel ComTech consumer insight director Imran Choudhary told Mobile News he believes the deal is essential to safeguarding Three’s future in the UK.
“Three has grown over the years but growth has slowed and in the wake of the BT-EE deal, it seems inevitable that Hutchison need to make an acquisition in order to ensure Three doesn’t lose out in the future,” Choudhary said. “In the past it may have been just trying to make its mark but now its a case of guaranteeing its future survival.”
Ovum analyst Steven Hartley agreed, insisting the UK market has too many network operators, with three being the magic number.
“For years, there have been too many operators in the UK. The lack of scale that Three has been able to achieve shows that. The very crude economics of the mobile industry is that the more people you have per bay station, the better it is for you.
“It was always natural that it was going to settle down and three (operators) is almost the magic number we’ve been settling on, because it keeps you away from a duopoly or monopoly, but gives enough competition to keep the others on their toes. That level of competition won’t be as ridiculously high as it has been.”
He also expects Telefonica to keep some hold on the UK business, with rumours it had asked to retain a 20 per cent share, although this is not confirmed.
“What will be interesting is to see what form an acquisition takes,” Hartley told Mobile News. “When BT were in talks, the rumours were that Telefonica wanted to maintain some sort of stake, so it will be interesting to see if Hutchison make an outright buyout, which is what they’ve done in other acquisitions, or something more subtle. That wouldn’t surprise me.”
Following European trends
CCS Insight analyst Kester Mann backed these views stating it would mirror that of other European markets in recent years, reducing the number of players. The move may however struggle to gain regulatory approval, with Ofcom previously stating its preference was four operators in the UK. The press office refused to comment, when asked about the deal, with the final decision resting the European Commission.
Former Three CEO Kevin Russell, who left in June 2011, had also previously stated four UK operators was the ideal number based on the size of the market.
“If Hutchison made a move for O2, and we went down to three operators, it would get significant scrutiny from Ofcom and the EC,” said Mann. “If it was looked at and approved, I’d expect there to be significant concessions to MVNOs.
“Given what we’ve seen in Europe in the last year or two, there is a bit of a precedent set that could see this kind of deal approved in the UK. I’d expect it to undergo a lot more strategy than the proposed BT-EE deal.”
Whilst regulatory approval is required, the European Commission has shown in recent times a willingness to pass deals of this size – but only if significant concessions are made to retain a competitive market.
For example, in Germany, Telefonica purchased rival operator E-Plus in an £8.6 billion deal to make Telefonica Deutschland the largest operator in the country. To gain final clearance from the EC, Telefonica agreed to sell 20 per cent of the combined network’s capacity to German MVNO Drillisch, with a further 10 per cent available in the future.
Hutchison’s €780 million (£600 million) deal for O2 Ireland last year, saw it forced to reserve valuable for the creation of two new MVNOs – one owned by Carphone Warehouse and the other from Liberty Global TV and broadband provider UPC .
IDC analyst John Delaney believes this trend for consolidation will help Hutchison gain regulatory approval, but warns that price competition could be negatively impacted.
“Years ago, I don’t think Ofcom would have gone for that but four operators is increasingly rare in Europe,” he said. “We’re also seeing an increasingly friendly attitude on behalf of the EU towards mergers happening in markets that have four mobile operators.”
“It has become fairly clear that Three’s acquisition of Orange in Austria (2012, for $1.7bn) has led to much less vigorous price competition in that market and even increases in some of the post-paid packages. It’s not a rule of thumb but a paper from the OECD said that the impact and effect of consolidation from four to three in european countries has been over time, if not increase prices, then at least to lessen the tendency towards cut throat price wars, like in Austria or Denmark.
“Then again, the UK is one of the most vigorously competitive mobile markets in Europe so even if that vigorousness is reduced, it would still remain a very competitive market.”
If Three completed the purchase, it would go from being the smallest provider with 9.7 million customers according to its last financial results, to a combined 34 million.
Ovum’s Hartley compared the acquisition to a “mouse eating an elephant”, and warned that the integration of the two telecoms operators could face problems.
“If Three does take it on, it would be like the mouse eating the elephant and the risk of indigestion is quite high,” Hartley said. “Three in the UK has never had to be that big, and the scale of it is huge. The legacy systems are quite old as well – Three is twelve years old but O2 (or Cellnet) is over twenty years, meaning that integration would be complicated.”
Rival operator EE faced similar problems when it was formed from the merger of Orange and T-Mobile in 2010. Owners of the joint venture Deutsche Telekom and Orange expected £600 million to £800 million to be spent integrating the two companies, while confusion over branding and use of legacy systems has impacted EE.
O2 brand axe likely
O2 is the older brand, having existed in its current form since BT Cellnet was relaunched as O2 in 2002. Hutchison launched Three in the UK on March 3 2003, with its 2G network running on O2 until 2006, when it switched to Orange.
Hutchison has so far opted to retain the O2 brand in Ireland – although recent decision to rebrand the O2 Arena in Ireland to the Three Arena, and replace the O2 logo with Three’s on the Irish national Rugby shirts, suggest its days are numbered.
With the O2 brand still present in other Telefonica markets, such as Germany, it seems unlikely Hutchison would want to retain it, something they admits would be a “shame” given the impact the O2 brand has had in the UK since entering (under the O2 brand) in 2002.
Hartley said: “More people know O2 as it has a good reputation for marketing and has invested a huge amount in naming rights for music venues across the country.For the short-term the two brands would continue but if you had to plump for one or the other, it would probably be O2.”
Mann added: “Branding is interesting,” the CCS Insight analyst said. “If Hutchison bought O2, you’d expect it to want to maintain the Three brand, which is a prominent brand for it in Europe.
“If it ditched the O2 brand – and its unclear if it would be allowed to maintain it – it would be a shame, because the O2 brand is well understood and well known by consumers. It has a good name and good reputation in the UK.”
Impact on Telefonica
The UK is Telefonica’s second biggest market in terms of revenue (behind Spain), with revenues of £1.433 billion between July and September 2014. With reports in Spain suggesting that Telefonica has also held preliminary discussions with Sky and TalkTalk, and reported interest from Liberty Global as well, O2 being bought seems a real possibility. (see boxout)
Telefonica has debts of €45 billion according to its latest financial results, which gives some indication as to why it is willing to sell one of its most profitable operations to a rival. This has doubled in the last decade, according to Bloomberg.
This has put pressure on cash strapped Telefonica to streamline its assets and put more focus on less markets, according to IDC associate VP of european mobility John Delaney.
“Telefonica is clearly willing to get rid of O2, as they were planning to do that with BT,” Delaney said. “What Telefonica really needs is more cash because, apart from Telecom Italia, it is the most indebted European telco as a percentage of income or revenue. They’ve made reasonable headway reducing debt within the last couple of years but its still massive. Telefonica has clearly decided they could do with a large amount of cash and selling O2 UK is one way of raising that.
“It has already done the opposite in Germany, so it seems to be a strategy of bulking up there, staying in its home market in Spain and moving out of the UK.
“When Telefonica bought O2 UK it had aspirations for a much larger presence in Western Europe. It bought operators in Germany, Czech Republic and the UK but its proven not to be viable for them or a lot of other operators – even Vodafone has moved out of some markets. In the ten years since it bought O2, the strategy has changed and it is now balancing between a presence in countries where it can bulk up and have a large presence and countries where it can’t make enough headway.”
Another reason for exiting the UK market is the potential threat of quad-play, in which O2 has so far resisted plans to enter, unlike its nearest rivals EE and Vodafone. In 2013, O2 sold its fixed line and broadband business to Sky for £200 million but BT’s interest in buying a mobile operator indicates an interest in offering converged services – something which is likely to have a significant impact in the market.
Quad-play – the ability to offer fixed-line, broadband, TV and mobile in one bundle – has become increasingly popular in other European markets such as Spain and BT, EE, Virgin and Vodafone have all announced differing plans to provide all four services in some form.
According to Hartley the threat of quad-play will leave mobile-only operators in jeopardy, unless they are big enough to be able to offer a strong mobile-only alternative.
“If BT buys EE and Vodafone are also playing in quad-play, then that leaves two operators in quad-play and two not offering it,” Hartley explained. “When it comes to quad-play, I do think you can get away with being mobile only if you’ve got a very efficient and disruptive mobile offering, because you can use that to break the bundle.
“The weakest element of any quad-play bundle is mobile, as its easier to offer a separate mobile plan. But you need to be big enough on a mobile scale in order to survive.”
Reach for the Sky
If BT and EE do merge and Hutchison acquires Three, it could force more consolidation as other players look to compete with the merged companies. Though Vodafone is cash rich following the £84 billion sale of Verizon in 2013, it will have around 19 million UK customers – unthinkably the smallest operator in the market.
Analysts speculated this will force Vodafone to make a stronger move in quad-play or risk a much more difficult position in the market.
Mann believes this may push Sky and Vodafone even closer together.
“In the case of Sky, Germany has strongly hinted that it is looking at a mobile arm, and with BT looking at quad-play, mobile is the only arm that Sky doesn’t have. Sky and Vodafone has come closer together over the last year but its unlikely Sky will buy, bearing in mind that it has made investments in the rest of Europe and it may not have the financial clout to make a large buyout.
“Vodafone has already reacted to moves from BT and EE by announcing its quad-play offering later this year. Perhaps Vodafone could come in and buy Sky, as they have the cash following the Verizon withdrawal. You can’t rule Vodafone out of acting.”
Hartley agreed, saying: “As the rest of the market moves towards quad-play, Vodafone might have to act. You can probably have one mobile only operator but you can’t have two, and Vodafone would be the smaller one if O2 and Three merged. Vodafone does need to sort out its UK strategy and, if it wasn’t a British company, you’d begin to question whether it was really committed to the UK.
“Vodafone has acquired fixed assets in Germany and Spain and is being linked with purchases in other countries, but in the UK it doesn’t seem to be doing as much. Strategically, Vodafone doesn’t look strong in the UK, although performance doesn’t look too shabby. As things have been swirling around in the UK market, you’d hope Vodafone’s UK board was coming up with an appropriate response.”
Though none of the major parties have confirmed that talks have taken place, it is clear that Telefonica would be interested should a buyer come in for O2, and any such move would shake up the UK telecoms industry.