May 7, 2020
Liberty Global and Telefónica have announced a merger of their UK operations that would value the two businesses at a combined £31.4 billion (US$38.9 billion) and create a fully "converged" operator to challenge incumbent BT in the market for mobile and fixed broadband services.
The 50:50 joint venture would unite Telefónica's O2, the UK's biggest mobile operator, with the Virgin Media cable business owned by Liberty Global, generating about £11 billion ($13.6 billion) in annual sales.
The companies had been under pressure from BT's growing emphasis on converged services that package fixed and mobile services into a single bill, promising convenience and lower prices for consumers as household budgets are squeezed by the COVID-19 pandemic.
The tie-up minimizes the risk that customers seeking a full range of communications services from a single provider would defect. While Virgin Media offered mobile services through a wholesale deal with BT, it served just 3.2 million customers at the end of last year, giving it about 4% of UK mobile connections. Lacking its own fixed-line infrastructure, O2 has had a negligible presence in the UK's broadband market, claiming just 29,000 customers in 2019.
However, the deal is mainly about financial engineering and cost savings as far as many analysts and market commentators are concerned. "Let's not forget the parents of both companies have been keen to offload these assets for a while," says Paolo Pescatore, an analyst with PP Foresight. "Telefónica needs cash to reduce its debt position."
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Under the terms of the deal announced this morning, which values O2 at £12.7 billion ($15.7 billion) and Virgin Media at £18.7 billion ($23.1 billion), Telefónica will receive a net cash payment of £5.7 billion ($7.1 billion), while Liberty Global will receive proceeds of about £1.4 billion ($1.7 billion). The joint venture will carry about £11.3 billion ($14 billion) in net debt.
The companies believe they can generate substantial cost savings and additional revenue, estimating these will be eventually be worth roughly £540 million ($668 million) per year, by combining operations and slashing wholesale payments to other UK operators.
Virgin Media had previously paid BT to function as a mobile virtual network operator (MVNO) on the incumbent's network, while O2 had stumped up fees for "backhaul" – the fixed-line connections that carry mobile traffic between basestations and the core network. Such backhaul connectivity looks set to become increasingly important with the shift to data-heavy 5G network services.
The tie-up could therefore put a small hole in BT's revenues and is also bad news for Vodafone, which was set to replace the incumbent as O2's wholesale partner starting next year. Both Vodafone and pay-TV giant Sky also now face the prospect of a much stronger UK rival.
"Vodafone UK appears the biggest loser as the deal lays bare its weak position in the market for converged services," said Kester Mann, the director of consumer and connectivity research for CCS Insight, an analyst firm, in emailed comments. "It also looks certain to scupper its virtual network partnership struck with Virgin Media in 2019."
"We think this deal will trigger a ripple effect on the UK market: Vodafone, Three, Sky and TalkTalk will all be assessing their positions and further deal-making can't be ruled out," he added.
News of the merger and talk of cost savings will inevitably stoke concern about job cuts when the operators finally merge, although the deal is not expected to be consummated until mid-2021.
It will need to secure the approval of competition authorities, which previously blocked a planned takeover of O2 by Three – the smallest of the UK's four mobile operators, owned by Hong Kong's CK Hutchison – due to concern it would reduce competition in the UK mobile market.
But regulators would have trouble justifying their opposition to this latest deal, having signed off BT's similar-looking takeover of mobile giant EE back in 2016. "It is more likely to appease regulators than two mobile operators coming together," Pescatore told Light Reading earlier this week.
The move could also appeal to UK authorities if the operators can demonstrate it will speed up investment in digital infrastructure over the next few years. Virgin Media has been working on a "Project Lightning" upgrade to its cable network that appears to have lagged original targets, while O2 is starting to build its new-generation 5G network. The operators have promised to invest a total of £10 billion ($12.4 billion) in the UK market over the next five years.
"We are creating a strong competitor with significant scale and financial strength to invest in UK digital infrastructure and give millions of consumer, business and public-sector customers more choice and value," said Jose Maria Alvarez-Pallete, Telefónica's CEO, in a statement.
— Iain Morris, International Editor, Light Reading
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