Telefonica's O2 And Hutchison Deal Fails To Cross EU Hurdle

The proposed merger between Spanish telecom behemoth Telefonica (MC:TEF) SA (NYSE:TEF) -controlled O2 and U.K. wireless giant Hutchison Whampoa, which is currently operating under the 3 UK brand, has been vetoed by the European Union Competition Commission (EC) on anti-competitive grounds.

At present, the U.K. wireless market is dominated by four large players, namely, O2, 3 UK, Vodafone Group (LON:VOD) Plc. (NASDAQ:VOD) and EE – recently acquired by BT Group Plc (NYSE:BT) . Meanwhile, if the deal would have been approved, the number of incumbent players would reduce to three.

Currently, O2 serves over 22 million customers. Post merger, the combined entity, with a consolidated subscriber base of more than 30 million, would have formed the largest wireless operator in the U.K. The regulators fear that this would have muted innovation and led to higher prices for consumers.

Notably, in Mar 2015, Telefonica had decided to divest its O2 brand to 3 UK. The deal – worth GBP 10.25 billion (approximately $15.25 billion) – has been facing opposition since announcement owing to anti-competitive concerns. Thus, the rejection of the Telefonica-Hutchison merger is not much of a surprise.

Regulatory Concerns

In Feb 2016, the communications regulator in the U.K. -- Ofcom – attempted to influence the EC against the proposed Telefonica-Hutchison deal in the country and warned of its possible consequences.

Last September, Hutchison informed the EC about its proposed takeover of O2. Soon after, in October, Ofcom submitted a request with the EC to refer all or part of the deal for assessment to it. In the same month, the EC launched an in-depth investigation into the proposed deal. In Dec 2015, the EC rejected Ofcom’s plea to take over the evaluation of the deal despite its claims of having a better understanding of the domestic market.

On Apr 11, 2016, U.K.'s Competition and Markets Authority (CMA) expressed concerns over the proposed merger deal and urged the EC to stall it as it would likely raise prices of wireless services in the nation and may also reduce the quality of services. It is to be noted in this regard that the U.K. is set to have a referendum on Jun 23 on whether or not to remain in the European Union.

Hutchison Efforts Fail

In order to clear the deal, Hutchison had even decided to grant additional concessions to small-sized wireless operators. 3 UK had proposed to allot 20% of its existing network capacity to Sky – which would be a new entrant in the mobile space – and 10% of the combined network’s capacity to Virgin Mobile.

However, the EC believes that these concessions would not have been able to resolve the issues that might have cropped up following the merger.

Bottom Line

After the failed deal with 3 UK, Telefonica is presently on the lookout for potential buyers and is also mulling over an initial public offering or strategic shift into fixed line markets.

Only recently, U.K. cable TV behemoth Liberty Global plc (NYSE:BT) hinted at the possibility of a potential acquisition of O2 in order to expand its mobile operations in Europe and boost its subscriber count and efforts to offer quad-play services. Nonetheless, it remains to be seen whether Liberty Global pursues the O2 takeover.

Meanwhile, over the last couple of years, the U.K. telecom sector has been witnessing a wave of consolidations. Introduction of the latest network technologies has significantly intensified competition in this market. In order to attain economies of scale and remain competitive, several telecom companies are looking for merger options in a bid to offer competent quad-play services of wireless, wireline, Internet and video services.

However, a trade-off between achieving scale economies and continuation of competitive prices is of utmost importance. EC’s decision to block the Telefonica-Hutchison merger deal and its emphasis on maintaining effective competition in the market is likely to discourage similar deals in the future.

Telefonica currently sports a Zacks Rank #1 (Strong Buy).

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