O2 realizes the future isn't mobile

Telefónica confirms it is in talks about a merger between its O2 business and Virgin Media that would bring an end to the mobile-only strategy.

Iain Morris, International Editor

May 4, 2020

5 Min Read
O2 realizes the future isn't mobile

Either O2 boss Mark Evans realized he was driving in the wrong direction, or someone higher up the Telefónica food chain told him.

In 2016 he was quoted by The Telegraph newspaper saying: "The future is mobile. The future isn't fixed." Less than two years later he told Telecoms.com, Light Reading's sister publication, that he wasn't convinced by the hype surrounding "convergence," the label that describes the sale of fixed and mobile services together.

Yet just last week, O2, the mobile business Evans runs, was rumored to have started talks about a $30 billion merger with Virgin Media, the UK's largest fixed-line operator after incumbent BT. Telefónica, O2's Spanish parent, today confirmed it was in a "negotiation phase" with Liberty Global, Virgin Media's owner, without disclosing further details. Outside the Hollywood movie car chase, handbrake turns are rarely so dramatic.

The tie-up would combine the UK's biggest mobile operator with its only near-nationwide provider of cable-based broadband and TV services. O2 finished 2019 with nearly 26 million mobile subscribers, pocketing about €7.1 billion (US$7.8 billion) in revenue and €2.1 billion ($2.3 billion) in operating income (before depreciation and amortization). Virgin Media serves roughly 5.3 million broadband subscribers and provides TV services to nearly 3.7 million homes. The largest of Liberty Global's European assets, it made operating free cash flow of $1.2 billion in 2019, on revenues of about $6.9 billion.

There is more to this deal than just convergence, says Paolo Pescatore, an analyst with PP Foresight. Lumbered with debt, Telefónica has been trying to marry off the UK business for some time. A proposed merger with Three, the UK's smallest mobile network operator, owned by Hong Kong's CK Hutchison, was blocked by regulators in 2016 on competition grounds. A tie-up with deal-making Liberty Global, which has already found mobile suitors for other European assets, stands more chance of success, says Pescatore. "For sure, it is more likely to appease regulators than two mobile operators coming together."

Yet each company may be increasingly worried about a glaring service gap in its portfolio. With its mobile-only focus, O2 had fewer than 29,000 broadband customers in December and no major fixed-line network of its own. The situation is reversed for Liberty Global. In a market of about 79 million handset connections, its 3.2 million mobile customers gave it just a 4% share last year. All are courtesy of a wholesale deal with BT, although Virgin Media was due to make a transition to Vodafone's network starting in 2021.

"Neither company is immune to the driving need for a converged network and services," says Pescatore. "This is the next battleground in the UK. Virgin Media was one of the pioneers in this area but has been let down without a mobile network, whereas O2's sole focus on mobile and championing consumers will run out of steam at some point."

The risks to an operator of lacking either a fixed or mobile network have been growing. Under CEO Philip Jansen, BT has become more evangelical about convergence, promoting bundles of broadband, TV and mobile services under its Halo brand. O2 and Virgin Media must worry their customers will be lured by the promise of discounts and single-bill convenience. As standalone players, neither has an answer.

In the new normal triggered by the COVID-19 pandemic, the threat to O2 is perhaps even greater. The virus has driven people indoors and restrictions on movement are unlikely to be entirely relaxed for at least several months. Suddenly, the residential broadband connection has become far more important than mobile data as the household budget is squeezed. To belt-tightening O2 customers, the appeal of a low-cost, all-in-one provider will be hard to resist.

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Still, not everyone has been a convert to convergence. "There is a portion of the market that is not looking for everything at once and that wants to pick and choose and not be tethered," said Ros Singleton, the former CEO of UK Broadband, a subsidiary of Three, during a previous interview. Three itself remains faithful to the mobile-only cause, although it is confident it can build a residential broadband business with mobile network technologies. It has continued to pick up subscribers in the handset market, but it is still far smaller than other network operators, and its sales and profits fell last year.

For critics of convergence, an earlier worry was that product bundling, and the discounts it entails, would put further downward pressure on pricing in what is already a competitive telecom market. Amid the COVID-19 pandemic, the danger that customers defect to lower-cost rivals will be a more pressing concern. That said, consumers worried about losing their jobs may not want to be "tethered" to an all-important, all-in-one provider.

Even if convergence is not for everyone, a deal could be an important defensive move by O2 and Virgin Media. But there is no guarantee of success. Pescatore is not convinced the new-look business will have the muscle to compete effectively against either BT or Sky, the UK's largest pay-TV provider, which uses O2's network to provide mobile services. Unraveling that deal and Virgin's new wholesale agreement with Vodafone will be tricky. The exact valuation of the deal could also be a "major sticking point," as far as Pescatore is concerned.

"Virgin Media remains the crown jewel in Liberty Global's portfolio, but also a problem child," he says. An investment in higher-speed broadband networks appears to have fallen behind original deployment targets, and Virgin Media has been losing TV subscribers, recording a decline of 77,600 in its recent October-to-December quarter. Liberty Global, though, has previously driven a hard bargain in negotiations about asset sales, says Pescatore. O2 must hope its latest maneuver does not stall.

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— Iain Morris, International Editor, Light Reading

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About the Author(s)

Iain Morris

International Editor, Light Reading

Iain Morris joined Light Reading as News Editor at the start of 2015 -- and we mean, right at the start. His friends and family were still singing Auld Lang Syne as Iain started sourcing New Year's Eve UK mobile network congestion statistics. Prior to boosting Light Reading's UK-based editorial team numbers (he is based in London, south of the river), Iain was a successful freelance writer and editor who had been covering the telecoms sector for the past 15 years. His work has appeared in publications including The Economist (classy!) and The Observer, besides a variety of trade and business journals. He was previously the lead telecoms analyst for the Economist Intelligence Unit, and before that worked as a features editor at Telecommunications magazine. Iain started out in telecoms as an editor at consulting and market-research company Analysys (now Analysys Mason).

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