It's not unheard of for rebuffed suitors to seek comfort in a younger lover's arms. Weeks after telecoms giant BT (BT.A) chose to acquire mobile carrier EE over O2, the latter has struck up talks with the UK's smallest carrier, Three. A tie-up would create the largest domestic mobile operator, but also reduce the number of providers from four to three, potentially easing BT's entry into the fiercely competitive market.
Hong Kong-based conglomerate and Three-owner Hutchison Whampoa is willing to shell out around £10.3bn for Telefónica's (SP:TEF) O2. A successful deal would give it 32m subscribers, or 41 per cent of the market, compared with 32 and 24 per cent shares for EE and Vodafone (VOD). Hutchison's offer values O2 at about six times Morningstar's forecast cash profits for O2 in 2015 - in line with BT's offer of £12.5bn to buy EE from co-owners Orange and Deutsche Telekom. BT may not be overly concerned about EE's potential demotion to number two in mobile, as that fact may help it appease anti-trust regulators. Equally, Hutchison may look to sway authorities by pointing out that BT could soon offer packages of TV, broadband and both fixed-line and mobile telephony, meaning its services should be viewed in the context of the entire 'quad play' market, not just the mobile space.
Both O2 and Three will be aware that industry watchdog Ofcom is a strong proponent of having four domestic carriers, as it believes that gives operators the scale and resources to invest and improve their services, but allows pricing to be determined by competition, not regulation. Telecom operators worldwide disagree, claiming that such a market is cumbersome. They argue that falling landline revenues, competitive pressures, regulator-driven price cuts and their immense network and infrastructure costs - which continue to rise as surging demand for superfast '4G' connectivity strains their capacities - are challenging enough without interference.
Ofcom is likely to be doubly concerned that the latest deal involves Three, which has shaken up the UK market with low prices, attractive deals - including this writer's 'unlimited' data for £15 a month - and by abolishing roaming charges in the US and other countries where it owns networks. Promoting the nimble upstart to market leader could mean it downplays innovation and scraps cut-price offerings. But as both Three and O2 have overseas owners, the decision may fall to the European Commission, which has already allowed Austria, Germany and Ireland to move from four to three providers. As in those cases, regulators will likely require Three to set aside spectrum for virtual network operators - such as TalkTalk and Virgin Media - and charge them an affordable price. But such measures have dubious value; Telekom Austria hiked its tariffs for smartphone users by nearly half in 2014.
A Three-O2 tie-up is likely to relieve pressure on BT and Vodafone. Debt-laden Telefónica will welcome the deal windfall, and its talks with BT and now Hutchison suggest it's worried about owning a pure-play mobile provider in a fast-converging market. Analysts think a deal could slash £400m in yearly expenses - or about half of Three's annual running costs - while Hutchison touts £3bn-£4bn in operational savings. Combining forces would also improve Three's key 4G coverage, and its pricing power will benefit from the removal of a rival.
Three's disruptive approach is mirrored by T-Mobile - another Deutsche Telekom venture - in the US. T-Mobile has grown rapidly by freeing customers from the industry standard of restrictive, multi-year contracts, and even paying their early-termination fees if they switch to its service. Moreover, it recently sought to merge with larger carrier Sprint, in order to better compete with telecoms giants AT&T and Verizon Wireless. But the pair scrapped the idea after realising regulators would never green light a deal - a potentially worrying precedent for the UK sector.
