BT's plan to buy EE raises questions about O2's future

BT's announcement this week that it has entered into exclusive negotiations with Deutsche Telekom and Orange over a potential acquisition of EE was generally given the thumbs up by analysts and industry players, although one question now being asked is what a successful deal might mean for rival mobile operator O2 UK and its parent company Telefónica.

"O2 is likely to be the biggest loser should the move be successful," said Ovum analysts Matt Howett and James Robinson in a research note. "Telefónica has made it clear that it was interested in exiting the UK and it could now struggle commercially against its convergent rivals BT, Virgin and Vodafone."

Bloomberg also noted that Telefónica has missed out on an opportunity to reduce its €45 billion ($56 billion) in net debt, which is among the highest in the European telecoms sector.

"They have a strained balance sheet," Paul Marsch, an analyst at Berenberg Bank, told Bloomberg. "Telefónica has backed itself into a strategic corner in the UK with a pure-play mobile operator just at the time when the UK market is going to go down a converged route."

According to Jefferies analysts, there appears to be no feasible way back for Telefónica.

"Mobile-only O2 UK risks becoming a 'problem asset'," Jefferies said in a research note. "For BT this is the big opportunity to elevate its ambitions in mobile."

Ovum's analysts noted that Hutchison Whampoa has also been reportedly eyeing EE or O2 UK and might consider making a bid for O2 if BT finalises a sale agreement with Orange and Deutsche Telekom. However, it is far from certain if Hutchison would make such a move, and indeed if Telefónica would still want to pursue a sale.

In addition, a combination of Hutchison-owned Three UK with O2 UK would attract considerable scrutiny from UK regulators as it would reduce the number of mobile operators in the market from four to three.

"It's important to stress that the competition issues raised by BT's acquisition attempt of EE will be handled by European competition authorities, rather than by Ofcom," Ovum's Howett and Robinson said. "Competition issues would be more relevant if Hutchison Three turned their attention to acquiring O2…This would see a change in the number of operators, something Ofcom has fought tirelessly to preserve."

It has further been suggested that BT may be required to divest the wireless spectrum it acquired during the UK's LTE spectrum auction because it would have a large 2.6 GHz holding together with EE.

"O2 and 3 could be interested in this as they currently don't have anything in that band," Ovum's analysts said.

According to a research note from Fitch Rating, potential mobile consolidation in the UK might reduce competitive pressures for the remaining players, depending on regulatory remedies.

"Vodafone has already announced its plans to offer fixed broadband services to residential customers. BSkyB and Virgin Media have strong positions in the UK triple-play market. Both companies have increased leverage after acquisitions, which might limit their flexibility to consider M&A activity," the ratings agency said.

Ovum also noted that if the BT/EE tie-up goes ahead, the other mobile network operators in the UK market are likely to ask for a guarantee that wholesale products BT currently provides for mobile backhaul will continue to be offered on a non-discriminatory basis--"something which has recently become an active debate in the UK," the analysts commented.

Indeed, Reuters reported that Vodafone plans to ask Ofcom to set conditions for BT's proposed acquisition of EE to ensure that mobile operators, which rely on BT's fibre network, are treated fairly when BT sets prices.

For Vodafone, a successful acquisition of EE would also revive competition with BT in the mobile market for the first time since 2001. As well as planning to launch its own fixed broadband services in the first half of 2015, using a mix of its own fibre broadband network and wholesale lines supplied by BT, Vodafone has been linked to a possible acquisition of cable operator Liberty Global.

"Vodafone could have taken its time, over the next three to five years, (to buy or build its own fixed-line network) but with BT buying a mobile business they're going to have to do something pretty quickly now," an unnamed telecoms industry executive told Reuters.

For more:
- see this Bloomberg article
- see this Reuters article
- see this separate Reuters article

Related Articles:
BT enters into exclusive talks on £12.5B deal to buy EE
Report: BSkyB hires advisers in reaction to BT merger moves
Reports: Vodafone mulls Liberty Global move as it considers UK options
Rumour Mill: Hutchison mulls bid for EE or O2 UK
BT, O2 and EE: kickstarting UK consolidation?

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