Hutchison Whampoa on Friday entered exclusive talks with Telefonica over a £10.25 billion deal to acquire O2 in the U.K. and merge it with 3UK, creating the cou ntry’s largest mobile operator by subscribers.
The proposed transaction will see Hong Kong-based Hutchison pay Telefonica £9.25 billion upfront, and a further £1 billion once the cumulative cash flow of the combined company reaches an agreed threshold. The negotiations are expected to last several weeks, and any resulting transaction will no doubt attract intense regulatory scrutiny.
If the deal goes ahead, it will create a mobile operator with around 32 million subscribers – comfortably ahead of EE, the current market leader with 24.5 million. Based on figures for 2013, the combined entity would generate annual revenue of approximately £7 billion.
"This will strengthen our future as a leading, and highly trusted, U.K. communications provider at a time when the demand for mobile connectivity has never been greater," said an O2 spokesman, in an email to Total Telecom.
"We are confident that an agreement will mutually benefit the customers of both companies, as well as drive better value, quality and investment in one of the most digitally competitive countries in the world," he said.
However, the merged company would not own a fixed-line network, which may hamper it at a time when the country’s other players are looking to offer bundles of fixed, mobile and TV services.
Indeed, BT is set to acquire EE for £12.5 billion, Virgin Media and TalkTalk each offer MVNO services, and Vodafone – which would become the U.K.’s smallest mobile operator by customers if the 3UK/O2 deal goes ahead – plans to re-enter the fixed broadband market.
"Hutchison will need to make a quick decision regarding the intended future direction of the company," said Kester Mann, principal analyst at CCS Insight, in a research note.
&q uot;If it decides to pursue a multi-play strategy, competing directly with the likes of BT, Vodafone and Virgin Media, it could look to either wholesale access to fixed-line networks or consider making an additional acquisition such as TalkTalk," he suggested.
Rumours that Hutchison Whampoa was planning to make a move emerged in late November, after U.K. incumbent BT revealed it was in talks to acquire either O2 or EE. According to a report by Reuters, Hutch was lining up a bid for whichever one did not end up merging with BT.
BT entered exclusive talks with EE parents Orange and Deutsche Telekom in mid December about a deal worth £12.5 billion.
Meanwhile, for Spanish incumbent Telefonica, selling O2 would help it pay down its hefty debt and give it a way out of the U.K.’s highly-competitive mobile market, allowing it to focus on its businesses in Spain, Germany and Latin America, where it operates in 10 countries.
For Hutchison Whampoa, acquiring O2 is in line with its strategy of building scale at its European divisions via acquisitions.
The other actors in the proposed merger are the competition authorities, which will almost certainly carry out an in-depth review and in all likelihood impose strict conditions in a bid to protect competition.
Ahead of the 2013 LTE auction, U.K. regulator Ofcom imposed rules to ensure that at least four players emerged with sufficient spectrum to operate national networks.
The European Commission, which will have the final say on whether the merger can proceed, has softened its stance slightly on consolidation in the continent’s mobile sector, approving deals in Austria, Germany and Ireland that saw the number of players reduced to three from four.
However, Brussels’ approval required the players in volved to divest spectrum and provide wholesale access to their networks on favourable terms.
One or both of Telefonica and Hutch were involved in the consolidation that took place in those aforementioned markets: in early 2013, Hutchison Austria completed its acquisition of local rival Orange, while Telefonica exited Ireland in July last year by selling its O2 unit to Hutchison, and bulked up in Germany by acquiring E-Plus.
"[Telefonica] may have set a precedent that could see the deal receive the green light, albeit with significant concessions," Mann noted.
"One possible scenario is that the new company is forced to open its network to virtual providers. This could offer an opportunity for Sky, which lacks a mobile presence." he said. "Other companies such as Tesco and TalkTalk could also benefit from wholesale mobile access."
With BT acquiring EE, and 3UK set to merge with O2, the U.K. telecoms market is on course to change dramatically in 2015.
