With UK Three/O2 Likely Dead, Is Cross-Border M&A Way of Future?

With the European Commission reportedly preparing to nix UK Three's buying O2, questions are being raised whether the carriers will pre-emptively withdraw their proposal, and whether cross-border tie-ins are the way forward. It would be yet another deal that European authorities effectively quashed amid heightened scrutiny on how telecom mergers and acquisitions hurt customers by raising prices (see 1508030002). The Competition Directorate has signaled that mobile consolidation in the domestic markets isn't welcome, telecom consultant Innocenzo Genna blogged Wednesday.

Mobile operators should look at cross-border consolidation, creating pan-European carriers better able to compete when and if roaming charges are phased out in July 2017, said Genna, who advises smaller telecom and Internet players. The problem is that operators aren't that excited about such consolidation, said Antonios Drossos, managing partner of Finnish telecom consultancy Rewheel, in an interview.

Three/O2 was blocked Wednesday by senior technical officials charged with ironing out areas of contention among the 28 EU members, and their position will be voted on by the EC next week reported The Wall Street Journal (paid access). An EC case team presentation we saw for a March 7 oral hearing on the proposal tentatively concluded that the transaction "is likely to significantly impede effective competition because of non-coordinated effects on the retail and wholesale markets, and because of coordinated effects on the retail mobile market, in the United Kingdom." The U.K. Competition & Markets Authority backed that position in an April 11 letter. The EC has until May 19 to decide. "The investigation is ongoing," said a Commission spokesman. Three and O2 didn't comment.

The British precedent "will create a fundamental landmark case" for Europe's telecom sector, making it unlikely that similar deals, such as the current one in Italy between Hutchison's Three and Wind "will ever be approved in the future," Genna wrote. Concerned mobile operators "will probably complain that the '4 to 3' consolidation is necessary in UK, like in Italy or France, to boost network investment," he said. But it's "crystal clear" the EC has heard and carefully considered that argument, and found it unsupported by evidence, he said. If the investment argument were credible, the merging entity should have accepted the EC's desired remedy -- creation of a new mobile operator through a transfer of spectrum, network resources and customer base -- but by ignoring that option, Three and O2 have reinforced the suspicion that cutting the number of players is mainly about limiting competition and increasing margins to the detriment of customers, Genna wrote.

For future guidance, the EC should provide "robust reasoning" for its decision, which it didn't in an earlier proposal by TeliaSonera and Telenor in Denmark (see 1509110010) because the parties withdrew their plan before it was rejected, Genna wrote. The EC should now clarify that encouraging players to fully compete and gain new customers is more important than whether there are four or three players in a national market, he said. In mobile markets, that kind of competition happens when market shares are unbalanced and there are small players, mobile operators and mobile virtual network operators (MVNOs) all vying to increase their shares, he said. That's why Three/Wind in Italy is "a dead man walking," Genna said. After such a tie-in, the three operators left would retain balanced market shares, which the EC believes creates mutual collusion rather than competition, he wrote.

As in Denmark, Three and O2 "might choose to withdraw in order to avoid forcing the Commission [to put] the objections in writing and create a precedent," Drossos told us. If the EC does that, it will have no option but to make the same arguments and block all subsequent 4-to-3 mergers, he said.

"If you can't find a way to clear four-to-three mobile consolidation in the UK then you're probably not going to find a way to clear it in other European national markets," emailed Brussels telecom and competition lawyer David Cantor. The question now is whether the EC seeks to set out a sweeping doctrine geared to discouraging in-country, four-to-three mergers by fashioning a legal precedent that essentially pre-empts approval of any similar deal in other EU countries, he said: If the only possible remedy is to create a new, fourth network operator, restoring the market structure before the deal, then "what's the point of the deal? The Commission would, in effect, be saying: 'Don't bother.’”

Drossos predicted a Hutchison challenge to an EC deal rejection before the General Court of the European Court of Justice would likely fail. Hutchison would need Telefónica to agree to wait two years to learn O2's fate in the UK, when it's already signaled that it's looking for other buyers, he said. If Hutchison goes to court, it will "basically shoot dead any slim chances" it has in Italy, he said. If the EC has to defend its UK decision in court, there's no way it will say something different or be softer on Hutchison in Italy, he said.

The EC is "looking towards cross-border mergers but it takes two to tango," Drossos said. "Operators are not that eager," because mobile broadband access networks are national, and there are no cost savings in owning and running networks in two countries, he said. Being present in many EU countries might mean operators could be forced to eliminate roaming and price arbitrage between expensive and cheap markets and offer a pan-European price to please the EC, said Drossos, when that's the "last thing big telco groups want to do right now.”

Two issues will likely remain open after the EC's expected rejection of Three/O2, Genna wrote. One is whether the EC sufficiently considered the MVNO commitments offered by the parties; the second is whether in the future there will be discrepancies among countries, such as Germany, Ireland and Austria, where acquisitions were OK'd, and those nations where such M&A will now be barred by the stricter approach taken by Competition Commissioner Margrethe Vestager, he said. "Should the European Commission start to think about how to redress [past] mistakes?”

A decision along the lines of Three/O2 "wouldn't necessarily cast a more general cloud over European telecoms M&A going forward," said Cantor. The outcome wouldn't say anything per se about four-to-four tie-ins such as BT/Everything Everywhere; in-country fixed telecom deals such as the recent Orange/Jazztel in Spain; cross-border M&A such as Liberty Global and Vodafone in the Netherlands; convergent fixed-mobile consolidation deals more generally; or potentially major cross-border combinations such as Deutsche Telekom and BT, he said. "The legal implications of this case will be specific to in-country, four-to-three mobile consolidation deals in my view.”