Vodafone’s “Together we Can” tagline celebrates collaboration. It must wish regulators could get the message. The UK telecoms company wants to combine its UK operations with its domestic rival Three UK, owned by Hong Kong’s CK Hutchison. This marks a big test for the post-Brexit telecoms regulatory regime. A deal makes sense. But cutting competition in a cost of living crisis looks a big ask.
Both sides have reason to get together. Three UK is struggling badly. Vodafone faces pressure from Europe’s largest activist investor, Cevian Capital, to improve returns. If they pull together their UK operations in a joint venture, significant savings on back office, marketing and some network costs should follow. If, say, a tenth of Three’s operating and capital expenditure was cut, the benefits — taxed and capitalised — might be worth £2bn.
If this was a takeover, and half those savings were paid to Hutchison, it would imply a takeout price for Three of about £4.3bn. But Vodafone’s balance sheet is strained, with net debt-to-ebitda of nearly four times. A joint venture in the UK is a more likely outcome.
But it will only happen if it gets past the Competition and Markets Authority. Some scepticism is merited. In a December 2020 study of the mobile industry, Ofcom found no evidence that service quality increased when markets became more concentrated. Politically it is tricky to justify reducing consumer choice to improve companies’ profits without guarantees of higher investment.
But the CMA may still be swayed. Analysis by New Street Research suggests that a tie-up between Vodafone UK and Three UK would be less harmful, in terms of upward pressure on prices, than any similar telecom combinations in Europe.
In a fixed cost industry, small scale companies do not reap adequate returns. With an 11 per cent market share, Three’s costs are spread over too small a customer base. Its 5 per cent return on capital employed (ROCE) is well below its likely 9 per cent cost of capital, according to Enders. Vodafone’s ROCE is not much better at 8 per cent.
The need to keep down consumer prices is greater than ever. But the UK — along with the rest of Europe — is allowing the quality of its network infrastructure to slip. A cost-cutting merger that boosts shareholder returns is justified. Structural changes are needed to spur investment.