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This show’s not over: What next for Three and O2?

The European Commission may have shut down Three’s attempt to buy out O2 in the UK, but nobody thinks the story’s going to end there

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The European Commission’s (EC’s) decision to block the proposed £10.25bn acquisition of O2 by Three in the UK came as no big surprise to anyone who had been following the deal closely over the past 12 months.

The acquisition of the two smaller UK mobile networks was always going to be a tough one to push past the authorities. Coming just a few years after Orange and T-Mobile were permitted to merge to form EE, and – some would argue – hot on the heels of BT’s acquisition of EE, it attracted a lot of negative attention from the outset.

From the perspective of the two parent companies involved – Hong Kong’s CK Hutchison representing Three and Spain’s Telefónica representing O2 – things were made even more complicated by repeated broadsides from the UK’s telecoms regulator, Ofcom, and the Competition and Markets Authority (CMA), both of which briefed at length against the deal, and urged the EC to block it.

Logical decision?

In its lengthy statement on the matter, the EC’s commissioner, Margrethe Vestager of Denmark, said the takeover would have left only two operators, EE and Vodafone, to challenge the merged entity, resulting in higher prices for mobile services and less choice. The combined company would have had 40% of the market sewn up and, therefore, much less incentive to compete fairly with EE and Vodafone, she argued.

Vestager said the deal would likely also have a negative effect on quality of service for UK consumers by hampering future development of network infrastructure and reducing the number of operators willing to host others on their networks.

The EC decided that as the UK currently has one of the more competitive mobile markets, with retail prices among the lowest in the EU, and a well-advanced 4G roll-out, healthy network-sharing arrangements between all four major operators, and a number of mobile virtual network operators (MVNOs), it made no sense to disrupt this.

A merger, it suggested, would have further weakened EE and Vodafone by disrupting their respective network-sharing arrangements – EE’s with Three and Vodafone’s with O2 – and weakened the position of MVNOs, such as Tesco Mobile and Virgin, when negotiating for wholesale network access.

The proposed remedies set out by CK Hutchison – which included price freezes, asset sales and the creation of a new MVNO – did not adequately address the EC’s concerns and did nothing to address the potential structural problems caused by the disruption of the network-sharing agreements.

The end of big deals?

So what now? In the immediate future, suggested Cable.co.uk analyst Dan Howdle, the EC’s rejection of the deal probably put the kibosh on any future, similar moves.

“When EE was formed from Orange and T-Mobile, it reduced the number of network operators in the UK from five to four – a number still regarded by Ofcom and the EC as able to provide a competitive enough marketplace,” said Howdle.

Unfortunately for Three and O2, he went on, current thinking seemed to suggest that going from four down to three was not acceptable under any circumstances.

“Likely this will feel staggeringly unfair to O2 and Three, having watched as Orange and T-Mobile were allowed to do exactly what they are being denied. 

“This ruling will almost certainly prevent any future merger attempts by UK network operators,” he said.

Acceptable alternatives

In the wake of the EC decision, analysts were quick to turn the spotlight on potential alternative deals that would pose less of a problem for Brussels.

CCS Insight’s Kester Mann said it was likely that O2’s parent Telefónica would either sell O2 to private equity, or to Virgin Media’s parent Liberty Global, which would be allowable, he said, because Virgin is a less significant player in the UK mobile market.

Alastair Masson, client partner at NTT Data UK, agreed with this assessment, but suggested that as well as continuing to try to sell O2, Telefónica might now be open to approaches from others.

“There is now a significant chance a counterbidder will emerge,” he forecast. “Either from one of O2’s existing MVNO customers looking to protect its position, or an overseas entrant that could use O2 as a platform for rapid UK and European expansion.”

Meanwhile, Three, now looked even more vulnerable “as a sub-scale mobile operator in a market rapidly transitioning to multiplay”, argued CCS’s Mann.

A future as a multiplay or quadplay operator – one offering multiple bundled services such as broadband, landline, mobile and TV – could work for Three, he said.

Bundling of services was part of the motivation behind BT’s acquisition of EE, so such a move could suit Three, as it would improve its competitive position against the BT-EE axis.

“A possible option,” said Mann, “could be to acquire TalkTalk. The broadband and TV provider deploys a similar low-cost strategy and could be available in a cut-price deal having been badly damaged by a recent security breach. Such a deal would not attract major competition concerns.”

Matt Howett, regulation practice leader at analyst firm Ovum, agreed that neither O2 nor Three could remain as they were, for their relative size in the market was too small, both in terms of subscribers and owned spectrum.

Furthermore, the combination of BT-EE, the growth of multiplay operators such as Sky, TalkTalk and Virgin, and the interdependence of the UK’s communications and broadcast sector meant that being a mobile-only operator was an increasingly unviable position. Something, he said, would have to give.

“Telefónica wants to sell O2; Three has an appetite to grow. Other players in the market have declared their interest in merging. Virgin Media and TalkTalk are among them, and the next wave of M&A talks will likely include them in dealing with either Three or O2,” said Howett.

“Fewer networks would ensure regulators can control the operator ecosystem more effectively, which could lead to fewer security breaches and better overall customer experience”
Claire Hassar, Haud

“As to what combination will prevail, it is still uncertain and will largely depend on the financial structure of the deal. One thing is certain: no combination will rebalance the mobile market in the same way that allowing Three and O2 to merge would have achieved.”

But other market-watchers argued that operators would do better to forget about acquisitions altogether, and work to better serve their existing markets. This was the line taken by Jonathan Bell, vice-president of marketing at mobile service layer specialist OpenCloud.

“Consumers can expect to benefit from better network speed and coverage in the short term, but it is difficult to turn these into long-term differentiators. Operators will need to invest in the creation of unique value-added services for their business and consumer subscribers,” said Bell.

“This is a sustainable route to enhanced customer satisfaction and loyalty, as well as incremental revenue.”

Claire Hassar, CEO at Haud, a supplier of network firewall equipment, disagreed, saying that, having rejected the merger, the EC risked leaving mobile operators exposed to reduced investment and, therefore, a drop in the efficiencies in product research and development.

“Equally, fewer networks would ensure regulators can control the operator ecosystem more effectively, which could lead to fewer security breaches and better overall customer experience,” she pointed out.

Tricky position for Brussels

NTT’s Masson said the EC had been shortsighted in its decision, and missed its chance to restore balance to the market. Masson accused Brussels of having failed to pay heed to the need for a viable competitor to BT-EE.

“The sector needs a free market entity big enough to keep BT in check [and] a competitor capable of facing BT across several consumer and business-facing activities,” he said.

CCS Insight’s Mann also had harsh words for Brussels, saying it had taken the wrong decision.

“The sector needs a free market entity big enough to keep BT in check [and] a competitor capable of facing BT across several consumer and business-facing activities”
Alastair Masson, NTT Data UK

“After similar deals were waved through in Austria, Ireland and Germany, the European Commission has either been hugely inconsistent in its merger and acquisition policy or failed to foresee the alleged negative impact in these markets that have already consolidated,” he said.

Ovum’s Howett suggested the EC had gone too far in the concessions it had demanded from Three’s parents to allow the merger to go ahead.

What the EC had wanted all along was the creation of a fourth mobile operator, said Howett, but this would have resulted in a major divestment from Three and O2 to create a significant enough player to compete effectively.

“It is not surprising that Hutchison has not gone that far. As well as there being no obvious taker for such a remedy, in many ways it would also have undermined the whole economic rationale of the merger and would have only set to reinforce the spectrum inferiority and capacity constraints of both operators,” he said.

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