More than eight months since first mooting a possible tie-up, Vodafone (VOD) has confirmed plans to merge its UK operations with Three’s UK arm.

If the proposed deal completes, it will create a UK mobile business on a par with rivals EE and Virgin Mobile/O2 in terms of subscribers, although still smaller in terms of revenue.

WHY DOES VODAFONE WANT THE TIE-UP?

Greater scale will allow the merged business to make the significant investment in next generation mobile network infrastructure to create what it believes will be a ‘best in class’ 5G network. This would cover 99% of the UK population by 2034, with average data speeds six-times faster than today and double the standalone capacity.

Vodafone has placed emphasis on its plans to invest £11 billion in 5G roll-out, with Ahmed Essam, Vodafone’s UK chief, telling a media briefing that the ‘case for the deal (to the regulator) stands on strong grounds’.

Vodafone and Three say a combined business would introduce more mobile virtual network operator competition, where third parties buy bulk capacity to resell to customers, as Tesco (TSCO) does through its Tesco Mobile offering. This market is currently 90% in the hands of BT/EE and VM/O2, according to Megabuyte analyst Philip Carse.

Crucially, the proposed merger could have a huge impact on the pair’s return on capital dynamics, which has previously irked investors. A deal ‘clearly makes sense for both companies given their evident no/low cash flow returns,’ says Carse.

MIGHT REGULATORS BLOCK THE DEAL?

This remains the key question. Communications watchdogs have previously been against consolidation in the European mobile space because of the potential impact on consumer choice. In 2015, EU competition authorities blocked O2 and Three UK joining forces, although this ruling was overturned in May 2020, obviously too late for that proposal.

Now, theoretically free of Eurozone intervention, the decision will be left to UK regulator Ofcom, which has been making more supportive noises about industry consolidation. The Vodafone/Three proposal is likely to be judged on its impact rather than a simple numbers/market share game.

IMPACT FOR VODAFONE INVESTORS

The agreement is complex, involving debt implications, various call and put options, that will allow Vodafone to buy Three UK’s stake from parent Hutchinson after three years, assuming a minimum enterprise valuation of £16.5 billion. Vodafone will initially own a 51% stake in the merged UK operation, Three the remaining 49%.

Vodafone hopes to conclude the tie-up by the end of 2024, while new chief executive Margherita Della Valle says there will be no change to the company’s dividend policy. However, integration could be a long and expensive process, which could alter shareholder payouts in future.

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