The merger of Vodafone UK and Three UK has finally been announced, but must gain regulatory clearance. This comment assesses the chances of it gaining approval, looking at the effect on competition and potential spectrum divestment.
Omdia view
Summary
A deal to merge Vodafone UK and Three UK has finally been announced, but it will be subject to close scrutiny by the competition authorities. A previous merger proposal was blocked in 2016, but this new plan has a better chance of success. Approval will likely be contingent on spectrum divestment.
The merger deal has been a long time coming, and brings few surprises
Vodafone and Three first confirmed that they were discussing a possible merger in October 2022, after months of rumors. But it has taken until now for the deal to be sealed, after delays due in part to the change of leadership at Vodafone Group. Margherita Della Valle was appointed CEO in April 2023, and has spearheaded an overhaul of the group’s strategy, aiming to simplify and streamline its operations, while empowering its national opcos to focus on building consumer NPS, and focusing its investments on the most profitable parts of the business.
Vodafone Group will maintain a 51% share in the merged firm, which will be achieved through differential contributions of debt by Vodafone Group and CKHGT, the owner of Three UK. The new firm (dubbed MergeCo) has made a commitment to investing £11 billion in its network over the next ten years, in an effort to reassure the competition authorities that the merger will not lead to a reduction in investment in this critical infrastructure.
Three UK has long been a vocal advocate of market restructuring in order to provide a sustainable return on investment, arguing that it lacks the scale to compete effectively against the two large converged operators in the market, BT/EE and Virgin Media O2 (VMO2). With Vodafone also voicing concerns about the low ROCE in many of its market, both firms hope that the merger will allow them to gain sufficient scale to justify the necessary investments to create a 5G network that is the “best in Europe.”
The competition authorities must balance the potential efficiency gains of the merger with the loss of competition
The Competition and Markets Authority (CMA), the UK’s competition regulator, will be scrutinizing the proposed merger closely before deciding whether to allow it to proceed, and if so under what conditions. Foremost in its mind will be the potential impact on consumers from the loss of competition in the market, which it must set against the cost savings from the reduction in duplication of infrastructure.
Almost every major market in Western Europe has either three or four national mobile networks, and the merger would reduce the UK from four to three. The CMA blocked a similar move in 2016, which would have seen Three merge with O2, but a lot has changed since then. The cost of 5G rollout presents a major challenge to mobile network operators (MNOs), and the investment environment is considerably tighter than seven years ago, with much higher interest rates following the shocks of Covid and the war in Ukraine. The UK also now has two strong converged players following the merger of Virgin Media and O2 in 2021, and the MVNO market has continued to grow. Across Europe, service providers are divesting their network infrastructure, e.g., through the sale of mobile tower sites, which serves to weaken the link between infrastructure ownership and the consumer market. Therefore, the case for blocking the merger on competition grounds is much less potent than in 2016.
One indicator of competition is the Herfindahl–Hirschman Index (HHI), which measures the degree of concentration in a market. Under this measure, the UK is currently the 5th most competitive of the 16 major markets in Western Europe. The merger would see it become less competitive, but it would still rank 8th, ahead of all the other three-operator markets except Finland and Germany:
Figure 1: HHI for mobile subscriptions, and number of mobile networks, Western Europe, 1Q 2023
Note: Network count only includes national networks. Source: Omdia
Approval from the CMA may come with conditions, especially around spectrum
If the CMA does rule in favor of the merger, it may apply conditions in order to maintain fair competition with the other MNOs. In particular, it will want to ensure that the combined spectrum holdings of Vodafone and Three do not give MergeCo an unfair advantage over BT/EE and VMO2. Analysis of the existing spectrum holdings suggests that this will be an area of concern – without intervention, MergeCo would hold 49% of the available spectrum, well ahead of BT/EE on 30%, and VMO2 on 21%:
Figure 2: Mobile spectrum holdings by operator and band (MHz)
Source: Ofcom
Requirements to offload spectrum have been a feature of a number of mobile network mergers, e.g., Sprint/T-Mobile USA (2020); O2 Ireland/Three Ireland and E-Plus/O2 Germany (both in 2014); and Orange UK/T-Mobile UK (2010). In this case, MergeCo would hold a particular advantage in the higher frequency bands (>3GHz), which are particularly suitable for providing high-speed 5G capacity in urban areas, and this would be a likely focus for any spectrum divestment requirements. But the CMA must ensure that any such conditions do not undermine MergeCo’s £11bn infrastructure investment plan, which would lessen the benefits to the consumer.
Appendix
Further reading
“The UK is at a crossroads as consolidation approaches” (May 2023)
UK: Service Provider Market Report – 2022 (December 2022)
Author
William Hare, Practice Leader, Service Provider Markets Europe
