11 May 2016
John Delaney, Associate VP, Mobility – IDC, firstname.lastname@example.org , @john_p_d
London, 11 May 2016 - In a widely expected decision, The European Commission has blocked the sale of Telefonica's UK mobile operator O2 to Hutchison, the owner of UK mobile operator Three. The deal would have left the UK with three mobile network operators, and Europe's Competition Commissioner, Margrethe Vestager, expressed strong concern that this outcome would reduce customer choice and raise prices in the UK mobile market.
To a degree, Three could be forgiven for feeling like a victim of its own success. In 2003, with no 2G mobile spectrum and no customers, it entered a mature UK market which hosted four well established mobile operators and several substantial MVNOs. In those circumstances, Three could not compete by playing by the other operators’ rules. Rather, Three had to play the challenger: to win customers through appealing offers that other operators were unwilling to provide. For example:
Its strategy has succeeded, in the sense that Three’s primary objective has been to scale up its customer base. That base now stands at 9 million, grown entirely organically from zero in 2003. Impressive in its own terms: but still much smaller than those of the other operators. Scale is a big advantage, and Three wanted to achieve it in one bound by merging with O2. It has been blocked from doing so because both the EU and the UK regulators believe that Three would compete less vigorously as the UK’s largest operator than as its smallest, and that it would thus be less inclined to challenge the other operators to respond with vigorously competitive moves of their own. It has not said so explicitly; but the implication of the EU’s decision is that it thinks Three has successfully played the role of challenger in the UK market, and it wants Three to carry on playing the role of challenger.
What next for Three? It has worked hard to accommodate the EU’s competitive concerns during the process of regulatory scrutiny, and it evidently feels that it has sufficient grounds to appeal against the EU’s decision. Three is also awaiting the EU’s decision about another proposed European merger: in Italy, with the operator Wind. (Competition concerns feature in this debate too, though they appear to be less intense than in the UK case.)
Meanwhile, O2 is back in play. Its owner, Telefonica, is one of the most indebted telcos in Europe, and it was intending to use some of the proceeds from selling O2 on reducing the size of its debt and improving its credit rating. Telefonica could change its mind about all that – there will soon be a new man and some new thinking at the top, following the imminent end of Cesar Alierta’s long tenure – but we believe it is more likely that Telefonica will remain interested in selling O2. It is clear from the EU’s decision that selling it to another mobile operator is not an option, but selling O2 to a fixed-line operator is much more likely to gain regulatory approval. There is, after all, a large and recent precedent for that, in the form of BT’s acquisition of the mobile operator EE. The UK’s cable operator, Virgin Media, is owned by the US Liberty Global group, which is currently pursuing a strategy of adding mobile capability to its fixed-line assets in Europe. Most recently, Liberty Global has acquired the Belgian mobile operator Base from KPN, to combine with its cable operator Telnet; and it has established a joint venture between its cable operator Ziggo in the Netherlands, and Vodafone’s mobile operator in that country. With O2 up for sale again, it may be that Liberty Global now sees an opportunity to extend its European fixed/mobile convergence strategy to the UK. It would be an expensive one, for sure – but Liberty Global has shown a strong appetite for highly leveraged acquisitions in the past.
Another possibility is that to pre-empt a Virgin/O2 merger – which would leave it in a competitive difficult position – Vodafone might prove willing to make further concessions to Liberty Global, in order to re-activate the talks that the two parties have been having about using asset swapping to form a tie-up of some sort between Virgin and Vodafone in the UK. This might be a merger, or it might be a joint venture along similar lines to the one in the Netherlands.
Either way, we believe the likely outcome of the EU’s decision to block the merger of Three and O2 in will be the emergence in the UK of a new nationwide fixed/mobile converged operator. BT became the only such converged operator in January 2016, when its takeover of EE completed, but that status may prove to be fairly short-lived. It will last for while yet, however. A proposed tie-up between Virgin and a mobile operator would need to go through a lengthy period of regulatory scrutiny, and if approval was granted there would be another lengthy period in which the two operations would need to be integrated. From BT’s perspective, it is essential to exploit that interim period by maximizing its advantage in the market for converged fixed/mobile services as quickly as possible.