Vodafone, Three promise to invest £11B in UK after merger

The details had been trickling out for weeks after Vodafone and Three confirmed they were in talks about a merger of their UK networks, and there were no huge surprises in the statement issued today (June 14). Vodafone Group, as previously reported, would own 51% of the combined entity, with CK Hutchison, Three's Chinese owner (based in Hong Kong), taking the remainder. A deal will controversially shrink the number of UK mobile networks from four to three, establishing Vodafone-Three as the market leader. It has promised to invest £11 billion (US$14.9 billion) in the UK over the next ten years – but authorities could still block it.

Their chief concern will be that competition suffers and consumers end up worse off in a three-player market. "This will be a hard sale given that both companies have been outperforming the market for the last year or so," said Paolo Pescatore, an analyst with PP Foresight, in comments emailed to the press. "Let's see if the authorities have a change of heart. Both parties need to demonstrate that this is genuinely in the interest of UK plc, the economy and consumers for it to have a chance of getting over the line."

The big question, then, is whether anything has changed since 2016, when the European Commission (EC) blocked Three's attempt to buy O2, another UK mobile operator that subsequently merged with Virgin Media, a cable company. That obviously happened while the UK was still part of the EU, but the decision had the support of the UK's Competition and Markets Authority (CMA). Since then, however, the European Court of Justice has ruled the EC was mistaken. More importantly, the British government seems to agree with both Vodafone and Three that neither one today covers its cost of capital.

A merger would probably address that problem, allowing the companies to pool subscribers, consolidate their networks and slash costs. Worried about falling behind other parts of the world on the rollout of 5G networks, authorities could be swayed by the telcos' commitment to cover 99% of the population with a 5G "standalone" network by 2034.

Three better than four

Largely for those reasons, Kester Mann, another analyst with CCS Insight, believes the deal should be approved, although he is unsure this will happen. "It is better to have three strong providers than two that are dominant and two that are sub-scale," he wrote in his own email about the news. "Blocking it could thwart the long-term development of the UK's telecom infrastructure."

The CMA, of course, is supposed to be an independent body not influenced by government voices. It may already be concerned about the prospect of higher prices for consumers after both Vodafone and Three recently increased tariffs by up to 14.4%, as Mann notes. The other concern, although one unlikely to shape the CMA's thinking, is about the impact on jobs in a telco market that seems eager to shrink the workforce as quickly as possible.

Vodafone and Three have now said they aim to realize about £700 million ($885 million) of annual cost and capex "synergies" by the fifth full year after the deal's completion. Much of that will probably result from layoffs as the merging companies move to eliminate overlapping or duplicate roles. At the most senior level, Robert Finnegan, the current CEO of Three UK and Ireland, looks set to relinquish his UK post given the revelation that Ahmed Essam, Vodafone UK's boss, will take charge of the new entity. Meanwhile, Darren Purkis, Three UK's chief financial officer, would have that role in the combined company.

There could be some messy unwinding of supplier relationships and partner agreements. Vodafone currently shares network infrastructure with Virgin Media O2 through a joint venture known as Cornerstone, while Three does the same with BT in MBNL. A merged business would have a foot in either camp, to the possible disgruntlement of competition authorities.

Vodafone, moreover, had planned to shift from Huawei to Samsung and other suppliers in parts of the UK where Three either uses or would have intended to use Ericsson for its radio access network. Three also looks heavily reliant on Nokia's core network products, while Vodafone is developing a "converged" core with Ericsson instead. The new company will be forced to choose between various suppliers if it wants to save money.

Another likelihood is that it will have to give up some of its frequency licenses, according to Pescatore. "Concessions on spectrum will have to be made and the entity will have to provide solutions on areas like network sharing, rather than create another problem," he said.

None of this is likely to happen fast, with Vodafone and Three saying they expect to close the deal by the end of 2024. Shareholders pushing for juicier returns are unlikely to make a huge fuss, but satisfying the CMA will probably not be easy. If they can do that, the impact on the market will be closely watched throughout Europe.

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— Iain Morris, International Editor, Light Reading