Risk of Conflict Shaped Terms of $39 Billion Merger

(Bloomberg) -- Liberty Global Plc Chairman John Malone famously clashed with fellow media magnate Barry Diller during an almost 20-year business partnership that involved joint ownership of the IAC Interactive media empire.

“These last 17 years of my association with John Malone and Liberty Media have been a great, and occasionally, wild ride,” Diller said in 2010 after an acrimonious business breakup that involved lawsuits, accusations of bad governance and sometimes heated negotiations.

Malone is embarking on another major media tie-up -- this time merging broadband network Virgin Media with O2, the U.K. wireless business of Spain’s Telefonica SA, to challenge former monopoly BT Group Plc as Britain’s dominant phone company.

Negotiators for both sides have worked for months to structure the 31.4 billion-pound ($39 billion) partnership in a way that minimizes the kind of strife that has often characterized jointly owned businesses -- including Malone’s.

“When joint ventures fail, it tends to be when one side takes a long-term view and the other a short-term view and investors get confused,” said Javier Borrachero, an analyst at Kepler Cheuvreux.

It isn’t temperament or worldview that have brought together Malone and Telefonica Chairman Jose Maria Alvarez-Pallete. Malone, a libertarian who once described taxes as “economic leakage,” has earned billions from serial dealmaking and complex financial engineering. Pallete is a quietly spoken devout Catholic known for weighing the social impact of his decisions and exhausting every option before ditching an underperforming business.

The alliance hammered out over months of talks overseen by Pallete and Liberty Global’s Denver-based Chief Executive Officer Mike Fries is born of necessity. Europe’s telecommunications industry has become a wasteland for profit growth and the venture announced on Thursday will bring merger benefits worth 6.2 billion pounds, according to the companies.

The structure -- an equally owned joint venture -- is nonetheless unusual for such a big European telecom business.

Strict Rules

To ensure the different business cultures don’t lead to tension down the line, the agreement goes well beyond the initial deal terms to include agreements on debt ratios, the scale of future investments and a stipulation that any spare cash must be distributed equally to the two owners.

Plenty could still go wrong. Phone companies are sinking billions of pounds into a new generation of 5G wireless networks just as the U.K. economy reels from Europe’s deadliest coronavirus outbreak. The new company will be racing against BT to build Britain’s strongest fiber-optic network, but the outlook for profits is uncertain.

Risk of Conflict Shaped Terms of $39 Billion Merger

Fries and Pallete have rarely done business together and the complexity of combining a mobile operator and a cable broadband and TV business adds to the challenge. Their priorities have also differed: Fries has made Liberty Global a byword for leverage and multi-billion-dollar share buybacks. Pallete has focused on preserving cash to pay down a debt pile of 37.7 billion euros ($40.1 billion), one of the biggest in the industry.

“Liberty are very financial-engineering focused, with lots of leverage and management fees paid to the parent company,” Bloomberg Intelligence analyst Matthew Bloxham said. “Telefonica is a bit more traditional, but I think they’ll be happy with this approach too, if it’s all done off balance sheet.”

The alliance is crafted carefully to ensure a balance of power. Liberty and Telefonica will have equal equity stakes and board representation, with a chairman from one of the parent companies that will rotate every two years. The neutral approach will allow the owners to avoid having to consolidate the venture’s debt.

Different Strokes

Diller referred to Malone as a “nightmare,” with a tendency to conduct endless negotiations over every transaction, according to court testimony when the two clashed over a new structure for IAC a decade ago. Malone’s Liberty Media was the company’s largest shareholder at the time. The two sides eventually settled, letting IAC proceed with a spinoff in exchange for additional board seats for Liberty. The two had further run-ins over investments in concert promotion, online travel review company TripAdvisor Inc. and Expedia Inc.

In 2018, Malone began to step back from his empire, saying he’d like to reduce travel and spend more time with his wife.

People in Pallete’s entourage say the 56-year-old trained economist prefers to work by consensus and avoids the pushy showmanship of many dealmakers. In late November, three months after Telefonica’s shares reached their lowest in more than two decades, he responded to criticism that he is slow to act by announcing a sweeping restructuring that includes the sale of underperforming Latin American businesses and plans for a flurry of deals.

Alongside M&A, he’s equally focused on developing in-house technology to accelerate revenue growth, convinced there are missed opportunities to monetize the data flowing through Telefonica’s pipes.

In the U.K. in 2020, the interests of Malone and Fries have aligned with Pallete’s. All are viewed as shrewd corporate financiers, and see the sector’s future in combining mobile, internet and TV services into packages that users won’t ditch if prices rise.

Still, the terms of their partnership include an opportunity for an initial public offering after three years or a sale of the venture after five years, and each may be harboring plans to buy their partner out.

“I think Liberty is more committed to the U.K. than Telefonica right now,” said Kepler’s Borrachero. “But who knows? Maybe Malone wants to retreat from Europe in the long run.”

©2020 Bloomberg L.P.

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