Hong Kong group Hutchison Whampoa has entered exclusive talks with Telefonica to buy O2 and merge it with its British business, Three, which would create the UK’s largest mobile network operator.
The parties have agreed on a £10.25bn (US$15.4bn)…
Hong Kong group Hutchison Whampoa has entered exclusive talks with Telefonica to buy O2 and merge it with its British business, Three, which would create the UK’s largest mobile network operator.
The parties have agreed on a £10.25bn (US$15.4bn) price, of which £9.25bn will be paid at closing, and then a further £1bn once the combined business hits an undisclosed cash flow target.
Hutchison and Telefonica now have several weeks to iron out the finer details of a transaction while the Hong Kong telco, owned by Asia’s richest man Li Ka-shing, undertakes due diligence.
Frank Sixt, Hutchison’s finance director, said his company is in talks with private equity firms and other investors that could buy minority stakes, although Hutchison will not relinquish more than 30% of the UK business.
Sixt also said funding for the deal, which is not expected to close until mid-2016, would include a bank loan in the region of £6bn (US$9bn). In a memo, Fitch noted that Hutchison has included non-recourse debt and equity financing in large acquisitions it has made in the past.
The Spanish incumbent is being advised by UBS while Hutchison is reported to have mandated Moelis.
Both Hutchison and Telefonica’s shares rose more than 3% this morning as investors rallied behind the merger.
From four to three
The tie-up would take the number of UK mobile network operators down from four to three. The European Commission (EC) – which would review the deal – has set a precedent in approving such transactions elsewhere in Europe in the last two years.
Hutchison itself has successfully got four-to-three mobile mergers in Ireland and Austria past the regulator since 2013.
Furthermore, last August, the EC green-lit Telefonica’s acquisition of E-Plus in Germany, serving as an example for a four-to-three merger in a larger EU market.
However, the EC approvals have come at a price for the consolidator – recent decisions in Ireland and Germany enforced capacity agreements for virtual operators and gave them access to the consolidators’ 4G networks.
Earlier this week, Berenberg analysts wrote: “The risk that the consolidating players therefore take on, to some degree on behalf of the whole market, is of opening up a better market for UK MVNOs like Virgin Media, Tesco and TalkTalk, among others.”
However, Berenberg argued that the MVNOs had already proven disruptive and wondered how much potential there was for them to challenge further.
UK market reshuffle
Last year, Hutchison said Three had 9.7 million customers in the UK split between pre-paid and post-paid contracts, while Telefonica said O2 has 24 million mobile accesses.
Berenberg estimates that a merged O2-Three would have 41% of the UK mobile market, followed by EE with 32% and Vodafone with 24%.
BT’s rejection of O2 in December set up the combination with Hutchison. The fixed-line incumbent said in November it had been approached by the owners of O2 and EE regarding a potential transaction where BT would buy their UK mobile businesses.
In mid-December, BT signed an exclusivity agreement with Deutsche Telekom and Orange, EE’s shareholders. The non-binding terms of the contract would see BT pay an enterprise value of £12.5bn (US$19.6bn) for EE, which the continental giants own on a 50-50 basis, in cash and stock.
BT is currently undertaking due diligence and a final agreement could be reached in the coming weeks.
Telefonica also held talks with Sky regarding a potential tie-up with O2 and considered listing the unit. A partnership with the DTH giant could yet happen, which could enable the companies to offer quad-play services to rival BT.
However, based on its behaviour in other markets, Hutchison’s prime concern is mobile and it has not chased mobile-fixed convergence deals.
