Urge to Merge at Virgin and O2

Deal will ripple through the UK’s telecom landscape

On 7 May, Liberty Global and Telefonica announced they would combine their UK operations in a 50:50 joint venture. The deal values O2 in the UK at £12.7 billion and Virgin Media at £18.7 billion. Our full analysis of the move is available to CCS Insight clients here.

In my view, a combination of O2 and Virgin Media is a natural fit. Each side gains crucial assets it severely lacks: a mobile network for Virgin and a fixed-line arm for O2. More importantly, the deal will transform the UK telecom landscape.

The merger requires regulatory approval, but as the new venture wouldn’t create a significantly stronger player in the fixed-line or mobile markets, it’s an unlikely barrier. I think the greatest challenges will arise after the deal completes. Integrating two established providers is a complex undertaking, and difficult decisions about the entity’s branding and personnel will have to be taken. In addition, the new entity will come under greater regulatory scrutiny than the two companies operating independently.

The merger has considerable implications for the UK’s other telecom players. In my view, Vodafone emerges as the biggest loser. The combined strength of the joint venture exposes Vodafone’s weak position in the market for converged services. The deal also scuppers its agreement to provide Virgin Media with the network for its mobile virtual network operator (MVNO) business. Losing out to O2 may push Vodafone to strengthen ties with CityFibre. In 2017, the two companies forged a strategic agreement to bring full-fibre connections to 5 million UK homes and businesses by 2025.

Providers such as Three, TalkTalk and Sky will be scurrying to consider their options as the telecom landscape is reshaped. A merger between Three and Vodafone to create a leading provider focussed just on the mobile market is possible, but it would face a major hurdle trying to appease regulators. Alternatively, Three, under new CEO Robert Finnegan, may look to accelerate its 5G fixed wireless strategy in response.

Competition from the new provider will also turn the heat up on BT and Sky, possibly pushing them to offer richer and more competitive bundles in response. And Sky may encounter tougher negotiations with MVNO partner O2, which will instantly become a direct competitor.

The choice of which brand or brands to retain will be a major decision for the new management team. In the long run, we believe the O2 brand should prevail at the expense of Virgin. Both have a strong presence, but O2’s respected customer service, highly loyal customers and sponsorship of the O2 Arena in London make it impossible to drop. However, cross-selling fixed-line services to mobile customers could be challenging, given that O2 has almost no heritage in home broadband.

As well as having a major position in consumer markets, the new company will provide fresh competition in the enterprise space. The combination of Virgin Media Business and O2 Business will offer services in fast-growing areas such as cloud services, big data, the Internet of things and cybersecurity, targeted at small, medium and large business segments.

The UK market has remained ripe for further consolidation since BT’s acquisition of EE in 2016. Although the timing of the announcement — during a global pandemic — was unexpected, CCS Insight has consistently argued that further mergers and acquisitions were inevitable. The UK’s laggard position in convergence is a surprising anomaly compared with the rest of Europe, but this deal could finally be the spur to make up lost ground.