December 4, 2012 12:09 am

Consolidation: A heavyweight contest

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At an FT conference in Brussels in October, chief executives of the big European telecoms groups were unusually vocal in their criticism of regulatory policy on mergers in the region.

The industry’s top executives took the stage to express dismay about the attitude towards consolidation in the market, with particular vitriol from France Telecom's chief executive, Stéphane Richard.

“The main problem we have today in the European environment is competition policy,” said Mr Richard. “In-market and cross-border market consolidation is very difficult. We self-prevent this kind of operation because we know that if we had the crazy idea to implement in-market consolidation we would be prevented by Europe.”

His anger is born out of a frustration that consolidation would normally be the inevitable outcome in recession-hit markets where revenues are dropping sharply even as the need increases to invest billions of euros in next-generation fibre and 4G networks. This, say executives in the industry, is putting the region at a competitive disadvantage to the US and Asia, where high-speed networks are becoming the standard.

Jean Abergel, global co-head of media & communications at Morgan Stanley, says: “Telecoms is a capital-intensive industry, in particular due to the necessary investments to fund next-generation infrastructure. In that context, profitability and returns are closely linked to scale and capital efficiency, which we see as key drivers of future M&A in the sector.”

But European competition regulators have so far favoured arguments that lower prices through having at least three, and mostly four, operators are better for the consumer. In particular, regulators have tried to protect what has become known as the “maverick” in the market – normally the smallest and cheapest of the operators that competes mainly on price.

One executive at a European telecoms group warns that the regulator is favouring market theory over market reality. The arguments have found some sympathy in Brussels, according to those close to the EU, in particular within the digital agenda commission headed by Neelie Kroes that is tasked with pushing superfast broadband access across the region, an ambition that has already missed crucial milestones along the way to a 2020 target.

Ms Kroes wants the private sector to invest in the networks to help make this happen, and has already indicated flexibility over pricing in future to allow some inflation back into the market.

In France the decision to grant a fourth mobile licence to Iliad is under scrutiny given warnings that this has led to job losses in rival groups, with the government recently asking the competition tribunal to look at whether the conditions have been fairly agreed.

The costs of competition against job losses is being scrutinised publicly for the first time in any large European market. But against a softening backdrop, Bill Kennish, head of TMT for Europe, the Middle East and Africa (Emea) at Macquarie Capital, says many attractive mobile targets would be ruled out on competition grounds. “Everyone likes in-market consolidation as there is a significant free-rider effect resulting from the lower level of competition for all. And often it is the disrupter that gets taken out in such deals. Unfortunately, this has largely played out in European markets.”

Dan Bailey, head of Emea TMT at Citi, says: “Everyone has gone through every country to look how to do this. It is not just about market repair – there are real cost synergies so companies can justify paying control premia and therefore higher multiples. It is a double benefit but getting it done has become much more difficult due to more aggressive regulators.” He instead predicts more active network sharing – a quasi-merger of infrastructure that allows the regulator to be content with competition at the retail level.

Angel Vilá, finance director of Telefónica, confirmed recently that it was looking at network sharing in other countries following a successful arrangement with Vodafone in the UK. “It doesn’t make sense to have so many networks in so many countries,” he says. “It is moving to a market in the UK where there are four [mobile network operators] but two networks.”

The list of potential mergers that could have happened is long, with the most recent being the long running “will they/won’t they” talks over the respective German businesses owned by Telefónica and KPN. The decision by Telefónica to instead list a stake in its business suggests that this deal will be off the table for some time. Even so, there are still candidates for consolidation, not least Yoigo, the Spanish group, that has attracted interest from France Telecom and Vodafone. Indeed, those with knowledge of the business say that they could be the only realistic buyers.

Vittorio Colao, chief executive of Vodafone, refused to comment on Yoigo at a recent conference, but added that, in general, the company “always looks at in-market consolidation deals” as well as expansion in emerging markets.

. . .

Meanwhile in Austria, the merger of two small mobile operators has become a test case about whether market consolidation will be allowed in the European telecoms sector. The €1.3bn takeover of Orange Austria, France Telecom’s business in Austria, by Hutchison Whampoa has taken on an unlikely – and, for the companies, unwelcome – significance given the struggle that the two groups have had in pushing the deal for approval by the European competition watchdog.

The case is being scrutinised by the industry for signals of any softening in the stance from the European regulators, which have prevented in-market consolidation of businesses that the groups claim to be necessary to buttress falling profits in recession-hit Europe.

The Austrian case is unusual in that the “maverick” is pursuing the consolidation, given that Telekom Austria is the biggest player, followed by Deutsche Telekom’s T-Mobile. Although the combined Hutchison Whampoa-owned group would still have an Austrian market share of less than 25 per cent – seen as a cut-off for competition complaints – the very fact that it is a move from four operators to three in a relatively developed telecoms market is seen as significant.

Joaquín Almunia, the EU competition commissioner, has said that Hutchison, which is controlled by Hong Kong billionaire Li Ka-shing, would need to offer sufficient concessions to ease regulatory concerns and allow clearance of its bid for Orange Austria.

There are remedies on the table, such as opening the networks at a cheaper rate for wholesale access to competitors, as well as the sale of some spectrum.

One person with knowledge of the situation says: “It is moving towards allowing consolidation but with clear guidelines about the process. If Austria happens, then the industry would see it as a good signal for other countries. This is totemic – and the commission knows it, which is why it hasn’t referred it back to the national regulator.”

If blocked, it would be a warning signal for many of the long-mooted deals of consolidation in Europe. As Mr Richard told the FT conference: “We can do many things and bring a very important contribution to the development of the European economy but we need ... a deep, deep change in competition policy.”

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