Virgin Media and O2 to join forces in £31bn deal

Madrid/London — Telefonica and Liberty Global have agreed to create the UK’s largest phone and internet operator, a deal that threatens its rivals and marks another merger for billionaire John Malone.

The deal values the new company at £31bn, with Telefonica’s O2 being valued at £12.7bn and Liberty’s Virgin Media valued at about £18.7bn. The companies, which started negotiations in December, said in a statement on Thursday there are £6.2bn in synergies.

The joint venture, first reported by Bloomberg, is a chance for both parent companies to rework two middling-assets into a fully fledged competitor to BT Group in so-called converged services, which combine fixed and wireless phone, broadband and television.

Telefonica will receive an initial payment from Liberty Global of about £2.5bn and another £5.7bn in future recapitalisations, and both companies will have equal stakes in the new venture. Each company will name half of the eight-member board, which will have a chair who will rotate every two years. The deal is set to be completed in mid-2021.

The announcement is the latest deal for John Malone, Liberty’s billionaire chair, who has been on a relentless M&A spree since selling cable provider Tele-Communications to AT&T for $48bn in 1999. His track record took a knock late in 2019 when his effort to sell UPC Switzerland for $6.4bn fell apart.

For Telefonica chair Jose Maria Alvarez-Pallete, it’s also an opportunity to signal to investors he’s committed to restructuring the debt-laden company.

Investors have punished Telefonica stock since Pallete became chair four years ago, as the Madrid-based company failed to deliver clear prospects for growth and cutting debt. The shares are down 30% so far in 2020, even after he introduced in November a strategy to focus on Spain, Brazil, the UK and Germany, which generate the bulk of sales, and place other Latin America activities into a separate division.

Key terms

• O2 will be debt-free, while Virgin Media comes with £11.3bn of net debt.
• Any cash flow generation and financing needs will be divided equally between Telefonica and Liberty Global.
• The new unit will service more than 46-million video, broadband and mobile subscribers.
• Banks have underwritten £4bn for financing for O2 business.
• The companies have yet to announce who will lead the new unit, with the board equally split, and the chair to rotate every two years, first going to Liberty Global.
• Both sides will have the right to kick off an initial public offering three years after the deal closes.

By partnering with Liberty in the UK, Telefonica puts Vodafone Group in a difficult position. It deprives it of a potential partner that could have set it on the road to offering consumers fixed-line services wrapped into lucrative bundles at a national scale. And Virgin will no longer need to pay it for mobile wholesale access. That’s something Liberty would have needed to keep doing to capture potential new revenue streams from the next generation of wireless technology, such as the proliferation of smart devices. Analysts have not ruled out a fightback from the Newbury, England-based carrier.

The tie-up comes at a crucial moment for Virgin. Rival BT is the only UK operator to own both a mobile and fixed network, and it’s been investing to upgrade to fibreoptic broadband. This threatens one of Virgin’s key selling points — the speed of its internet services. It also gets a partner with significant experience in convergence and building and operating fibre networks.

However, the merger means O2 can grow beyond the mobile-only market in which it currently operates.

Telefonica was one of the first European carriers to make the shift to convergence: offering fixed- and mobile-phone services, along with broadband and television. The company is also Europe’s leading operator of fibreoptic broadband, a crucial type of infrastructure the UK is still struggling to roll out.

But it hasn’t always been able to take a leading market position with this know-how. In 2018 it was left as a mobile-only carrier in Germany, reliant on buying wholesale access from rivals to offer fixed and broadband services, after Liberty sold its cable business there to Vodafone.

“The UK remains one of the most fragmented telecoms markets in Europe, and Virgin Media remains as one of the few stand-alone cable operators” without a mobile network operator, James Ratzer, an analyst at New Street Research, said in a May 1 note. “The opportunity for value creation through the combination of Virgin Media with either O2 UK or Vodafone UK is a pretty compelling one.”

Bloomberg