From McLaren's Title Sponsors to the Next Company on Regulators' Mind: What's Going to Happen with Vodafone and Three UK
Issue 9 (01/07/2023) - An article charting the merger between Vodafone UK and Three UK. A merger that might never happen, unless the two companies convince regulators of their good intentions
My understanding of Vodafone began from sponsorship deals, most notably that of Manchester United (the team I support, yes, It’s not been the most fun seeing City win the Treble); and more famously for me, seeing it covered on the McLaren F1 livery. I remember photos of Lewis Hamilton’s first championship in the Silver McLaren in 2008.
Vodafone parted ways with McLaren after 7 years at the end of the 2013 season, which seemingly coincided with my gradual understanding of Vodafone and all the things it does. Recently, however, it has popped back up in the news, firstly due to its layoffs and now, this merger.
Vodafone in Recent News
At the turn of the year, Margherita Della Valle became CEO after Nick Read stepped down amid shareholder frustrations with the business. Della Valle erupted onto the scene with specific goals in mind stating “[her] priorities are customers, simplicity and growth”. With this in mind, she seeks to revitalize the company and consolidate it through 11,000 global job cuts [1]. This more specifically comes in light of underperforming regions of Germany, Spain, as well as Italy, with the former being traditionally its most successful region. The share price, trading at its lowest level since 2002, hitting under 10 at the time of writing this {June 17, 2023}, potentially caused by it missing its forecast for cashflow.
With the continued lackluster performance in the first two quarters of 2023, decisions are being made regarding the long term future of Vodafone. Certain analysts predicted companies mustering the courage to send a purchase offer, whilst others predicted the consolidation of markets. Funnily enough, Vodafone and the owner of Three have agreed on a deal to merge their “British telecom networks”, to yield the “UK’s largest mobile phone operator” [2]. I guess some people can truly predict the future.
Shouldn't Market Consolidation Hamper Competition?
We are taught from grade school in economics that the more companies there are, the better off consumers are because of a little thing called competition. Competition drives the top line down, encourages companies to cut costs, and to price goods lower to beat out their competitors. But, can there be such a case where economies of scale play too big of a role for your competition where you are just unable to keep up? Or, is Vodafone wrapping up a bad deal in cute paper to evade the Competition and Markets Authority (CMA) who could block this deal.
This is something I’m going to try to answer by the end of this, by looking at the competition, the industry timing, and a bit of intuition.
How Consolidated is the Market?
In the 90s, and even up until the early 200s, Vodafone controlled the industry as UK’s biggest mobile carrier. However, O2 and EE continued to chip away on the market share with the latter being the consolidation of T-Mobile UK and Orange UK. Three UK remained rather hidden in the scene until the late 90s. Nowadays, however, as is evident from Figure 1, BT and O2 comprise of over half of the operators market with Vodafone and Three trailing behind. With the consolidation of the two, it would catapult the combined entity 5% clear of the top spot, which seems to be the predominant proponent for this merger.
Fast forward to recent years, should this merger go through, the structure of the telecom industry looks seemingly like an oligopolistic market. Of course, this should be a non collusive oligopoly which encourages certain levels of competition but still disengages the firms from innovating - in my opinion at least.
Explaining the Deal
In this new combined entity, known as “MergeCo” (official name TBD), Vodafone will own 51.00%, whilst Hutchison, the holding company of Three, will own 49.00%. Along the deal, it states that Vodafone has the right to appoint the CEO, whilst CK Hutchison the CFO, who will be the current Vodafone UK CEO Ahmed Essam and the Three UK CFO Darren Purkis respectively. The board will remain equally split, with 3 represented by each of the previous companies.
They would merge their current user bases of Vodafone and Three with 18 and 10 million respectively, and state that MergeCo should save upwards of 700 million pounds per annum by the fifth year after the deals completion.
During their press conference, Margherita Della Valle, the group CEO of Vodafone, stated that given the intentions to maintain the 51-49 share structure, each business “will contribute different amounts of debt to the new entity”. Vodafone will contribute 4.3B pounds, whilst Three UK will contribute 1.7B pounds.
Is Marriage Always the Solution?
No, but Vodafone and Three convincingly portray otherwise. This deal could be lucrative irrespective of their true intentions. On the one hand, the marketed reasons for this merger remains the ability to implement infrastructure capable of delivering the best 5G network to the UK, which will provide customers with better quality internet and mobile services alongside more competitive pricing.
The pair of companies are heavily marketing this merger as “great for customers, the country, and for competition”. (Check out their investor deck here). During Vodafone’s press conference, held in the UK, the current CEO of Vodafone UK, Ahmed Essam, mentioned that “the current structure of the UK mobile industry is unsustainable”. He refers to the “two larger operators [who] have the ability to invest” in broader segments of the market and that “merging Vodafone and Three will create a new operator with sufficient scale and return to invest and compete effectively”[3]. Therefore, the rational internally seems to be one of if you can’t beat them, join them - a running theme in the telecom industry in the last few decades. What was once a fragmented market has consolidated itself into two (and potentially soon, three) large players. Arguably, the Vodafone UK CEO continued by stating that “The net present value of these costs and CAPEX synergies in total is over 7 billion pounds”. This seems like fantastic news all around. As marketed, great for customers, the country, and for competition, and most evidently, great for Vodafone UK and Three UK.
One argument in favor of this deal, and one that excites me, remains the increased ability to adopt, implement, and integrate seamless infrastructure to push closer to the 5G goal that the globe has set out for itself. Reassuringly, the MergeCo has “pledged” 11 Billion pounds to build more networks in the UK. To what extent this value will be realised is a different story, however the optimistic in me feels like it will not. The one element I do believe will be realised is the fiber network coverage, in which MergeCo aims to provide 99% of households with it by 2034.
Who Objects?
Regulators. The answer is always regulators. So let’s break this down a little and try assume the role of every stakeholder here and what the potential outcomes could be. The two potential outcomes are: this is good for the end customer, or that this is bad for the end customer. There are dozens of ways to reach either of these conclusions, but the conclusion has to fit one of the two.
Great for the Customer
As marketed, the merger successfully catapults MergeCo to have the resources and the financial strength to compete against the existing goliaths. MergeCo reduces the prices, makes telecom services more accessible and affordable for customers (or just more reliable), and everyone is happy.
Not so Great for Customers
This is the potential eventuality that the regulators remain apprehensive. History suggests that in the long run, market consolidation is not ideal. It encourages larger firms to become price setters over time, focus less on innovation, and make abnormal profits at the expense of the customers. However, this usually happens when we notice a collusive oligopoly, which I don’t expect to happen.
Yash’s Key Takeaways
Something similar was attempted by Hutchison, when they wished to merge with Telefonica’s O2 in the UK just over half a dozen years ago. It was blocked. Technically, actually, this previous deal is still an “open case”, but the conclusion at the time yielded that “it would lead to higher mobile phone bills and job cuts” - according to Unite, one of Britain’s biggest trade unions[4]. What’s to convince the regulators otherwise this time? Especially when the deal value remains a tad larger than the last one.
I remain unconvinced of a few things:
MergeCo will not live up to their investment claims. I say this because things happen, come up, and change. It’s hard to commit to such an extravagant investment, especially one with a ticking clock. Although I would love to see all these investments, competition will encourage them to consolidate their market, focus on the merger deal, and attempt to encroach on the market share of their existing competitors. Of course, they will invest in the UK but I just remain weary for this number to hit 11B pounds in the timeframe that they have allotted. But, I remain hopeful to not be correct. Because then, the customers would have actually won in this merger.
The deal will get blocked. Mergers of this magnitude, especially ones that are to impact the customer so directly and intimately such as telecom services will always be scrutinized far more than other industries. Whether the two firms have the correct intentions, which I’m sure they do, the regulators won’t be convinced.
It always makes me happy to see Vodafone sponsoring sports teams. That’s how I got to know about the company, and partially the reason Vodafone has become an iconic brand. I hope that this merger does not change how iconic the brand has been.
The deal still remains in its early days and it’s hard to tell whether it will go through or not. All I know is that this deal means a tremendous amount to Vodafone and Three UK, so whatever happens, they will not back down from throwing everything at this to see it through.
[3] https://www.investis-live.com/vodafone/64788215e262e70c000f07f1/gdgh