Recent press reports that Vodafone and Three are in talks to merge their UK operations come as no surprise.
Three’s CEO, Robert Finnegan, has promoted the need for consolidation in the UK from the day he took the role, regularly lambasting a “dysfunctional” market structure he says has held back network investment and hindered quality of service.
Vodafone Group CEO Nick Read is also on the hunt for deals. Last November, he called for consolidation in some of Europe’s most competitive markets, adding that a potential tie-up with Three in the UK should be something looked upon favourably by regulators.
More recently, the arrival of activist investor Cevian Capital has put pressure on the company to engage in mergers or acquisitions. Yet this year it’s missed out to rival Orange on an opportunity to merge in Spain and rejected a takeover bid from Iliad in Italy. The CEO says Vodafone’s having “many active conversations”, but its options are dwindling.
Not so long ago, a tie-up between Vodafone and Three would have felt like an unnatural pairing. But in recent times, Vodafone has taken on more of a challenger role in its home market — notably through the launch of speed-tiered unlimited data tariffs — as it sought to reinvigorate the brand after a turbulent few years. Three’s traditional focus is on market disruption and providing value for money, so their strategies may no longer be too far apart. Furthermore, Three’s parent, CK Hutchison, and Vodafone have forged a deal before, combining their operations in Australia in 2020.
One drawback of a merger between Vodafone and Three is that it does little to address either side’s limited presence in the converged services market. Although Three has shown little appetite to combine home broadband with its mobile offers, convergence is a major strategic goal for Vodafone. The UK may have been slow to offer bundles, but the past 12 months have seen growing ambition: Virgin Media O2 introduced its first combined offer, Volt, just a few months after the joint venture officially launched, and BT’s recent decision to adopt EE as its flagship consumer brand aims to create a springboard for a more assertive push into this market (see Instant Insight: BT Announces Consumer Branding Shift).
In my view, the leading motivation for Vodafone and Three to join forces is scale. In telecommunications, the most successful companies tend to be the largest; bulking up would offer synergies and cost-saving opportunities in areas spanning procurement, research and development, customer service and marketing. Under the status quo, it’s hard to see either operator growing enough organically to get close to challenging BT and Virgin Media O2 for size in the UK.
The other major benefit is that moving from four operators to three would cool the competitive intensity of the market. However, this is where the thorny subject of regulation takes over.
The new entity would instantly become the number-one player in mobile, with nearly 27 million retail customers and a trove of 4G and 5G spectrum. It’d be up to the competition authorities to decide whether reducing the number of players is for the overall good of the market. Advocates will argue it encourages investment; dissenters will claim it’s a reason to push up prices.
Of course, this debate is no different to when Three tried and failed to buy O2 in 2016. But there’s a sense now that regulator sentiment toward deals could finally be shifting. Many in the industry are pinning hopes on a more sympathetic stance after operators more than proved their worth in the pandemic. With telecom networks now considered a critical part of national infrastructure, could we start to see a greater focus on encouraging network investment and less on offering low prices for consumers?
The sector will also have taken heart from a European court’s decision last year to uphold an appeal against the annulment of the Three and O2 deal. This could have encouraged Orange and MasMovil in Spain to announce their plans to merge a couple of months ago.
Many in the industry feel that authorities are now less wedded to having at least four mobile operators in each market. The Orange–MasMovil deal will test this hypothesis — if it gets the green light, it could open the floodgates for deals elsewhere.
Intriguingly, UK regulator Ofcom recently clarified its position on mergers, saying it would review any deal on its individual merits, rather than the potential for reducing the number of competitors. This set tongues wagging about potential mergers; but as ever the devil was in the detail. Ofcom added that it sees no evidence that service quality or investment increases when markets get more concentrated.
Still, although Ofcom has indicated it may be prepared to think differently, it’s the Competition and Markets Authority that would have final say. With UK customers enjoying some of Europe’s most attractive mobile tariffs, it could prove a harder body to win over. Whichever way you look at it, Vodafone and Three would still face massive scrutiny. Should they announce a deal, I’m sure it would need some concessions to get over the line.
Of course, Vodafone pairing with Three is just one potential tie-up. I’ve long argued that Three and TalkTalk is a logical combination; it could find success by targeting the vacant mass-market for converged services and would encounter few regulatory hurdles (seeThe Next Big Deal in UK Telecoms).
In recent weeks, Vodafone and Sky have also been linked with a deal for TalkTalk. But Vodafone’s CEO appeared to rule out a move on the recent full-year earnings call, stressing his preference for mobile mergers (see Instant Insight: Vodafone Results, Fiscal 4Q21/22).
Another option is a deal for Sky with either Vodafone or Three. This would give it a huge leg-up in convergence by expanding its fast-growing mobile virtual service that recently passed 2.75 million customers.
It’s clear to me that the next major deal in the UK is only a matter of time.
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