1) The deal structure was largely as expected
Vodafone and Three have yesterday announced their long-anticipated merger, alongside the tag line that a tie-up would be “great for customers, the country and competition.”
As expected, Vodafone will own 51% of the combined business (Mergeco) with Three’s parent company CK Hutchinson owning the remaining 49%. No cash consideration will be paid, instead the two parties will contribute differential debt amounts at completion to achieve the desired shareholding.
Mergeco will have a six-person board with three directors appointed by Vodafone and three directors by CK Hutchison. The new organisation, the CEO role will be filled by Vodafone UK boss Ahmed Essam, while Three’s CFO Darren Purkis will continue in his role at Mergeco.
Vodafone will have a casting vote in relation to Mergeco’s business plan and budget.
The transaction is expected to close before the end of 2024, subject to regulatory and shareholder approvals.
2) National security concerns shouldn’t hold up the deal
Good for customers, country, competition, and China? Apparently not, according to Three UK and Ireland and Vodafone UK CEO’s Robert Finnegan and Ahmed Essam.
Concerns have been raised that national security concerns could hold up the deal as the UK government becomes more averse to working with companies that have links to China.
“The state, with the national security and investment act, actually has the power to intervene and reject a deal.” Erhan Gurses, equity research analyst at Bloomberg Intelligence told Capacity.
When asked by Capacity about the potential impact this could have on the deal, Finnegan was keen to point out that Hutchinson would be reducing their stake by merging with Vodafone, compared to its ownership of Three UK.
Essam agreed that the UK has strong compliance principles in place around national security approvals for mergers and acquisitions and spoke to Vodafone’s own data privacy protocols that protected customer data.
“Hutchison already has an extensive presence in the UK, but [the merger] should be seen as a gradual exit from the telco market. There should not be any security concerns as the joint venture should be majority owned by Vodafone. I expect the Hutchison share to reduce over time,” Paolo Pescatore, technology, media & telecoms analyst at PP Foresight told Capacity.
On the exit mechanics of the deal, Vodafone outlined the parties have agreed a put/call framework in order to enable Vodafone to acquire 100% of Mergeco, which would come into play three years after the completion of the transaction.
The consideration will be based on fair market value which must reach an enterprise value of £16.5 billion and be determined through an independent third-party valuation process.
3) Convincing the CMA is Key
As previously reported by Capacity, approval of the deal by UK M&A regulator Competition and Markets Authority (CMA) will be subject to whether the increased investment in Mergeco’s network outweighs the consolidation of market power. The CMA will be inclined to review this from a consumer perspective.
Reading the statements coming from both companies, it appears that Vodafone and Three are both conscious that regulatory approval poses a greater threat to their plans than approval from shareholders.
Commentators have pointed to the failed 02/Three merger in 2016 as cause for concern. “The release reads like an overt pitch to convince a broader set of interest groups (e.g., CMA, Ofcom, press etc) leading with the benefits for customers, country and competition, before looking at deal synergies,” said Dan Ridsdale, director of TMT at Edison Group.
Canning Fok, group co-managing director of CK Hutchison was keen to point out, “Three UK and Vodafone UK currently lack the necessary scale on their own to earn their cost of capital. This has long been a challenge for Three UK’s ability to invest and compete. Together, we will have the scale needed to deliver a best-in-class 5G network for the UK, transforming mobile services for our customers and opening up new opportunities for businesses across the length and breadth of the UK.”
Core to Mergeco’s argument is that failing to fix “unsustainable sub-scale economics” in the UK market could lead to the market essentially functioning a duopoly between EE and VM02. As such, a merger would actually boost competition and drive additional investment in the UK’s networks to allow Mergeco to deliver on its promises (more on those later).
The CMA will no doubt consult with the UK telecoms regulator, Ofcom, which already appears sympathetic to the sub-scale operators’ plights. In a paper published in December 2022, Ofcom found that both companies have Returns on capital executed (ROCE) of 1-2%. Considering their smaller market share both companies are unable to recover their cost of capital, Vodafone said in its statement.
“Ofcom recognises the challenges of the UK mobile market and the need for scale. Convincing the CMA will be the real test. Current investment levels are not sustainable in the longer term.” Pescatore said.
Convincing the CMA could be a hard task, “given that both companies have been outperforming the market for the last year or so,” he added.
Kester Mann, director, consumer and connectivity at CCS Insight agreed that the £11 billion network investment plan seeks to allay regulatory concerns but added that “Vodafone and Three may have shot themselves in the foot by recently hiking tariffs by up to 14.4%.”
However, Gurses takes a different view: “The CMA may also aim to strike a more delicate balance between the sector's investment needs amid 5G roll-outs and consumer welfare, especially when you consider the UK mobile prices have remained relatively low compared to large counterparts such as Spain or Germany.”
A merger could also be good for competition in the UK’s healthy Mobile Virtual Network Operator (MVNO) space, which is accountable for 16.5% of the UK’s mobile customers, but according to Mergeco, 90% of MVNO’s use EE or VM02’s networks.
“With a strong third operator in place, the UK’s MVNO’s will have more choice on which network they use and benefit from increased competition on price,” James Gray, managing director of Graystone Strategy said.
A better functioning MVNO marketplace will also help to keep competition on retail pricing fierce and limit the impact on customers, Vodafone said.
4) A tie up will offer annual cost and capex synergies of £700 million a year.
While certainly leading with appeasing regulator concerns, Vodafone and Three have both outlined the value-generating nature of the deal.
By the fifth full year post-completion, Vodafone and Three expect to see annual cost and capex synergies of £700 million a year.
The potential magnitude of the capex and cost synergies have raised some eyebrows. “Over £7bn Net Present Value may surprise some [as being] on the upside,” said Ridsdale.
In a statement to Capacity prior to the deal being announced, Gurses said his team thought “if a deal can manage to pass all regulatory hurdles, it promises cost synergies worth as much as £2.7 billion in net present value.”
Mergeco expect to save its £700 million through combining its network infrastructure and scaling its network at lower unit costs compared to standalone capabilities.
It will also see savings from consolidating IT systems, combining marketing, sales, distribution and logistics activities and efficiencies in general & administration costs.
Integration costs are expected to exceed £500 million, most of which will be incurred in the first five years after the deal is closed.
“M&A’s, while undoubtedly bringing immense benefits, are no easy feat. It’s quite a challenge to successfully merge two distinct business cultures, data sources, and documentation while keeping up with specific regulatory requirements.” Abu Khan, industry lead, TMT at Anaplan, a planning and forecasting platform that counts BT and Virgin Media as customers.
Integration issues can seriously negatively impact operational effectiveness, which can often overshadow the long-term benefits of a transaction.
Successfully combining the two businesses will require careful planning and consideration. To do so effectively, Khan recommended the Mergeco focus on two key areas, people and data & technology.
5) A merger would allow for faster and better investment in the UKs telecom ecosystem
The operators believe that millions of customers of Vodafone UK and Three UK will immediately enjoy a better network experience with greater coverage and reliability at no extra cost. The merger would immediately boost Three’s coverage above the government's 2027 targets.
Mergeco will also combine each company’s full fibre and fixed wireless access home broadband offering to create the UK’s widest availability of connections with over 100Mbps speeds.
Mergeco plans to reach more than 99% of the UK population with its 5G standalone network, which it claims will deliver a six-fold increase in average data speeds by 2034, compared to each standalone company today.
The operators also claimed that a merger that combines their networks will help the new company almost double its capacity as a result of the investment that will be pumped into the network over the next ten years on top of the combined capacity of both individual networks.
“As a country, the UK will benefit from the creation of a sustainable, strongly competitive third scaled operator – with a clear £11 billion network investment plan – driving growth, employment and innovation,” said Margherita Della Valle, Vodafone group chief executive.
Depending on 5G adoption rates, Mergeco claim that by having a best-in-class 5G network in place sooner, the merger will deliver up to £5 billion per year in economic benefit to the UK by 2030. This will include every school and hospital in the UK having access to standalone 5G by 2030.
To meet these demands, mergeco use 6 of the £11 billion it has set aside for investment in its network in the first five years. The full investment is expected to support between 8,000 and 12,000 new jobs in the wider economy.
While this reads as good news “inevitably, there will be widespread fears over job cuts” as part of the merger Mann pointed out. New Vodafone boss Della Valle is hardly shy about cutting Vodafone’s staff, as she announced in May that 11,000 layoffs would be implemented to simplify the business globally over the next three years.
Vodafone has not commented on how many UK roles would be affected as part of these plans, but its big UK offices in Paddington and Newbury are expected to be impacted.
“[Della Valle] has shown clear intent to make changes at Vodafone as she bids to turn the embattled company’s performance around. Securing approval for a tie-up with Three would be a major boost to her early tenure,” Mann added.
In addition to the wider benefits to the UK economy, refreshed investment in 5G networks Mergeco also outlined plans to reduce energy consumption by accelerating the installation of energy efficient 5G equipment and replacing less power-efficient 2G and 3G systems.
