The Next Big Deal in UK Telecoms

Another major merger or acquisition seems just a matter of time

A question I’m regularly asked by clients is what’s next in mergers and acquisitions in the UK telecom market.

When O2 and Virgin Media decided to pal up earlier in 2020, I talked of a ripple effect as other providers scurried to reassess their position (see Urge to Merge at Virgin and O2). I’d bet that many frantic conversations took place in the days that followed the announcement, and possibly led to some early efforts to strike new deals too. The UK remains ripe for further consolidation, and I believe it’s only a matter of time before another major deal is announced. Beyond the fallout from the merger of O2 and Virgin Media, other factors are aligning to suggest things could move sooner rather than later.

With telecom operators more than proving their worth during the Covid-19 crisis, regulators could start to ease their recent tough stance on consolidation and adopt a more supportive framework, orientated more toward helping the sector make a return on investment. Also, a recent landmark court ruling annulled the 2016 decision by the European Commission to block Three’s acquisition of O2 in the UK. Although the annulment is being appealed, the move could bring new confidence to the sector to pursue fresh deals.

It has also been interesting to hear the candid opinions of the new CEO of Three UK, Robert Finnegan. He’s pulled no punches since taking the helm, quickly describing the UK market as “overcrowded” and “dysfunctional”. Mr Finnegan also leads Three’s operation in Ireland, where he has seen first-hand the impact of consolidation after Three acquired O2 in 2013. Clearly an advocate, he said that the deal spurred network investment in the market.

So what are the possibilities? With BT and EE having already joined forces, and O2 and Virgin Media now working through their merger, there are only so many combinations remaining. The mostly likely protagonists are Vodafone, Sky, TalkTalk and Three.

It seems clear that Three would be open to a deal, provided it was the right opportunity. The failure of the O2 merger was a huge blow to its aspirations to achieve greater scale, but it still harbours ambition.

A link-up between Three and Vodafone is worth exploring. Vodafone has taken more of a challenger role in recent times, shown by its launch of speed-tiered unlimited data tariffs and the decision to offer 5G at no extra cost. Three’s traditional focus is on market disruption and providing value for money, so their cultures may not now be too far apart. Furthermore, Vodafone and Three’s parent CK Hutchison have already united in Australia.

Of course, regulation would still be a massive hurdle. Such a deal would instantly create a new market leader in the mobile market with about 27 million retail customers, not to mention a vast trove of 5G spectrum. Some concessions would certainly be necessary. And don’t expect Ofcom to show any more leniency than the European Commission, post Brexit; if anything, the UK regulator was even more against the proposed tie-up between Three and O2.

Another drawback is that a deal between Three and Vodafone wouldn’t really address either side’s limited presence in the market for convergence. The UK has been slow to transition to bundled services, but the O2 and Virgin Media deal could finally be a catalyst, as we set out in our latest forecast for the UK telecom market. And with converged services a major pillar of Vodafone’s strategy, pairing with Three would appear contradictory.

Vodafone had toyed with a deal for Virgin Media for years, but it was interesting to hear group CEO Nick Read talk about an organic strategy for the UK on a recent call for analysts. It’s true that the operator continues to attract new broadband customers, but its market share in fixed-line connectivity is still dwarfed by those of BT, Virgin Media and Sky. The only way to become a scale player in this market now is to score a deal.

On that basis, a merger or acquisition for either Three or Vodafone with TalkTalk seems a more viable option. Coupling a mobile operator with a broadband provider would offer each side complementary assets and raise few concerns among regulators.

TalkTalk has more than 4 million fixed-line broadband customers, and according to reports rejected a takeover offer from its second-biggest shareholder in 2019. That bid came from UK-based investment fund Toscafund. As many telecom operators continue to endure depressed market valuations, asset managers and private equity companies could emerge as a major investor into the sector. In 2019, Australian investment bank Macquarie Group acquired Hull-based operator KCOM, adding it to a telecom portfolio that already includes UK infrastructure provider Arqiva and Danish operator TDC.

Earlier in 2020, reports also linked Macquarie to a deal for BT’s infrastructure unit Openreach. BT played down rumours, but that didn’t stop the company moving to shore up its defences in preparation for any future hostile bids, after its share price dipped to its lowest level in 10 years.

Another alternative is a deal between Sky and Vodafone or Three. Despite appearing reluctant to initially enter the mobile space, Sky’s mobile service is really well-crafted. It appears to be enjoying good momentum too, with more than 1.5 million customers according to our estimations. But its network partner O2 is now in bed with Virgin Media, which could strain the relationship. A merger or acquisition would give Sky Mobile greater scale and negate the need to pay wholesale access fees.

For Three or Vodafone, Sky would of course bring a large number of broadband customers and an extensive collection of premium content. There could also be the option to forge deals in other European markets where it competes.

These are my expectations for the UK’s biggest providers. But the next wave of acquisitions could involve smaller companies specializing in unified communications for the enterprise world. This is a fragmented market with potential for growth, and would probably be attractive to any network operator seeking to bolster its position in the business sector.

So, plenty of options are on the table, but which will be the next big deal? Each of my suggestions has sound logic but also challenges. And maybe there’s a wildcard out there that I haven’t even mentioned; Google or Amazon, anyone?

If I had to stick my neck out, I’d plump for Three buying TalkTalk. Three has a CEO clearly interested in a deal and a parent with a history of consolidating. Both companies have a similar challenger mentality, so the cultures would align nicely. I also don’t expect regulation would be a hurdle. Furthermore, a deal would give Three a beachhead in enterprise, a segment that its new boss appears keen to go after. And with TalkTalk’s market capitalization of less than £1 billion, Three wouldn’t have to dig too deep.

Most significantly, the combination would instantly create a presence in the home broadband and mobile markets. There may be some overlap in customers, but plenty of opportunity for cross-selling would remain. Crucially, with the UK market for converged services heavily focussed on the premium end, there’s a sizeable market to target with lower-priced bundles.

As ever, we’ll just have to wait and see what unfolds. There’ll be plenty of twists and turns ahead.

This is just one of the topics I’ll be talking about in my presentation during CCS Insight’s Predictions Week event. Be sure to register here and tune in on Wednesday 7 October 2020 to find out what lies ahead for telecom operators in 2021 and beyond.