Vodafone and Three UK Announce Merger; Regulatory Hurdles and Limited Synergies Main Hurdles

Vodafone VOD and CK Hutchison (Three UK) announced the merger of their mobile businesses in the U.K. Vodafone will own 51% of the new entity, with an option to buy CKH’s stake if the enterprise value of the merged business increases to at least GBP 16.5 billion. If approved by the Competition and Markets Authority, or CMA, this move would reduce the number of mobile operators from four to three in the U.K., consolidating the market and allowing the merged entity to earn better returns on invested capital, or ROICs. Vodafone and Three UK have had poor ROICs historically due to a lack of scale. We are maintaining our fair value estimates for Vodafone and CK Hutchison.

We see several hurdles for this transaction to reach its full potential. It needs approval from the CMA—which is not expected until late 2024. European competition authorities have a long history of blocking horizontal telecommunication mergers, including the blocking of a mobile merger between O2 and Three UK by the European Commission in 2016. Although after Brexit the decision now relies on the CMA, not the EC, we expect the merger to be challenged. The amendments imposed by the CMA could have important competitive implications. Vodafone’s pitch to the CMA seems to be an improved network that can better compete with BT Group and Virgin Media – O2. Management claims the market share of mobile virtual operators has increased (17%), so there is enough competition in the market.

Vodafone predicts 50% of the GBP 700 million in annual expected synergies will come from network and IT optimization. We are skeptical given both companies have different network setups. Vodafone shares its active and passive mobile network with O2 (Cornerstone), while Three UK’s passive infrastructure is owned by Cellnex. Tower firms like Cellnex or Cornerstone normally have mechanisms in place to prevent their financials from being hurt if there is consolidation in a certain market, which increases our skepticism on network synergies.