Vodafone and CK Hutchison have agreed to a UK mobile merger

Vodafone and Three’s owner CK Hutchison warned that vital investment in 5G networks would be curtailed unless the regulators allowed them to merge into one of the UK’s biggest operators.

The plan announced on Wednesday will create a network of 28mn mobile customers, which would surpass EE to become the UK’s biggest mobile group. The plan will reduce the number networks in the UK to three from four, and face regulatory approval due to the potential for less choice and higher costs for consumers.

In the agreement, Vodafone will combine its domestic business and CK Hutchison’s Three UK. Hutchison, based in Hong Kong, will hold 49 percent of the combined group.

The two companies are hoping that the merger will boost profits on a market they believe is overcrowded.

Analysts expect the Competition and Markets Authority to be very scrutinizing, as they have long-standing concerns over market concentration. The combined group will also control almost half of UK mobile spectrum, which is much more than the 37 per cent limit set at the previous auction of 5G bandwidth.

Hutchison stated on Wednesday that customers will “pay the same but receive significantly more value because of the significantly improved network”, and executives from both companies said they needed to merge in order to secure a financial foundation to invest in the 5G networks.

The combined company has promised to invest PS11bn over a period of 10 years in the UK to create Europe’s most advanced 5G network to support UK Government targets.

Vodafone UK Chief executive Ahmed Essam and Three UK CFO Darren Purkis are the chief financial officers of this new group.

Essam stated that the UK lags behind North America and certain parts of Asia in 5G rollout. It also argued that it is “unsustainable” to continue current investment levels as separate companies.

Three UK has experienced low investment returns and earnings for many years. It has earned less than the cost of capital in 2019.

Analysts believe that the two companies will need to make concessions to regulators. For example, they may have to sell some mobile spectrum.

Essam stated that spectrum shouldn’t be an issue, as the regulator will need to evaluate holdings on a market of three companies, not four. He said it was premature to discuss possible remedies to antitrust concerns.

Analyst Paolo Pescatore at PP Foresight said that Three UK and Vodafone UK have already outperformed their market in terms of customer growth. “This is the reason it’s hard to sell in the eyes regulators. . . Why would these two companies join forces, potentially reducing the choice and resulting in higher prices? It’s difficult to justify.”

Hutchison stated that the group would be able to invest in UK 5G networks and benefit at least 7mn customers immediately.

Both groups, it said, “currently lack sufficient scale to earn their own cost of capital. This puts their ability to make investments efficiently and sustainably at risk”.

The companies estimated that synergies could amount to PS7bn in five years. The executives said it was still too early to comment about the impact of job duplication, but acknowledged that there would be some.

Margherita Dela Valle, CEO of Vodafone, said that she expects a positive impact on the jobs market as a result of 5G investment.

The two parties will not pay cash, but they will each contribute a different amount of debt based on their respective shares.

Vodafone UK will pay Three UK PS1.7bn, and Vodafone UK PS4.3bn to settle existing debts. The merged group is left with about PS6bn of debts. Vodafone has the right to purchase the entire business if the enterprise value exceeds PS16.5bn after three years.

Analysts at Berenberg believe that the deal could be cancelled under the UK National Security and Investment Act due to CK Hutchison being owned by China and Vodafone having contracts with the UK Government.

Essam stated that the deal will be reviewed for national security.

The agreement comes just a month after Della Valle revealed plans for 11,000 job cuts in the next three-year period.

She stated on Wednesday that the UK would benefit from a third-scaled operator with a strong competitiveness and a plan to invest PS11bn in its network.

Canning Fok is the group co-managing Director of CK Hutchison. He said that Three UK and Vodafone UK lacks the scale to cover their capital costs. Three UK has struggled to compete and invest for many years.

Hutchison, a Hong Kong listed conglomerate, has businesses that range from retail to ports and telecoms.

Vodafone and Hutchison argue that a UK merger will enable the level of investment needed to roll out 5G network and improve broadband connectivity.

In the past, however, regulators have refused to accept deals that would reduce the number of major operators in the industry from four down to three.

Hutchison failed in its first attempt to consolidate in the UK in 2016. EU regulators stopped the deal for Hutchison to purchase O2 from Telefonica in order to create a mobile network that would have controlled around 40% of the UK market. CMA and UK telecoms regulator Ofcom also opposed the merger.

In February, Ofcom announced that its decision regarding any merger between the four largest UK operators will now “be informed by the specific circumstances surrounding the merger rather than the number of competitors.”

James Gray, managing Director of Graystone Strategy mobile industry consultancy, stated that “quite a few market changes have occurred since the Three UK/O2 merger has been overruled.” . . [Including] the successful merge of Virgin Media and O2 as well as consolidation of networks throughout Europe.

There is a sense in general that consolidation can be positive under the right conditions.

The CMA stated: “Both Vodafone, and Three, are key players on the UK’s communications market. With millions of consumers and businesses depending on their services, it is right that the CMA examines the impact on competition this deal may have.”