Virgin Media, O2 Combine to Create New Telecom Giant

(Bloomberg) -- Telefonica SA and Liberty Global Plc have agreed to create the U.K.’s largest phone and internet operator, threatening their rivals and marking another industry-defining deal for billionaire John Malone.

The deal values the combination of Telefonica’s O2 with Liberty’s Virgin Media at 31.4 billion pounds ($39 billion). The companies said in a statement Thursday they plan a joint venture with equal stakes that will account for Virgin’s higher value -- and debt load -- with a payment to O2.

The transaction, first reported by Bloomberg, is a chance for both parent companies to rework two mid-tier rivals into a fully-fledged competitor to BT Group Plc in so called converged services, which combine fixed and wireless phone, broadband and television. It is also one of the largest deals since Covid-19 was declared a pandemic in early March.

Telefonica’s shares rose as much as 4.4% as the announcement overshadowed mixed earnings before swinging to a loss, while BT revealed that it is canceling its dividend payments until 2021, causing shares to fall over 11%. Liberty was up as much as 12% after reporting steady sales late Wednesday before pulling back.

The transaction values O2 at 12.7 billion pounds and Virgin at about 18.7 billion pounds. The Spanish parent has been weighed down by about 38 billion euros ($41 billion) of borrowing. The arrival of new funds, including a 2.5 billion-pound equalization payment, could give its deleveraging efforts a boost, Bloomberg Intelligence analyst Erhan Gurses said in a note.

Each company will name half of the 8-member board, which will have a chairman who will rotate every two years. The deal is set to be completed in mid-2021.

The announcement is the latest deal for John Malone, Liberty’s billionaire chairman, who has been on a relentless M&A spree since selling cable provider Tele-Communications Inc. to AT&T Inc. for $48 billion in 1999. His track record took a knock late last year when his effort to sell UPC Switzerland for $6.4 billion fell apart.

For Telefonica Chairman Jose Maria Alvarez-Pallete, it’s also an opportunity to signal to investors he’s committed to restructuring the debt-laden company.

Read More: Telefonica Pulls 2020 Guidance, Offers to Pay Scrip Dividend

Investors have punished Telefonica stock since Pallete became chairman four years ago, as the Madrid-based company failed to deliver clear prospects for growth and cutting debt. The shares are down by about 31% so far this year, even after he introduced in November a strategy to focus on Spain, Brazil, the U.K. and Germany, which generate the bulk of sales, and place other Latin America activities into a separate division.

Key Terms

• O2 will be debt-free, while Virgin Media comes with 11.3 billion pounds of net debt
• Any cash flow generation and financing needs will be divided equally between Telefonica and Liberty Global
• The new unit will service over 46 million video, broadband and mobile subscribers
• Banks have underwritten 4 billion pounds for financing for O2 business
• The companies have yet to announce who will lead the new unit, with the board equally split, and the chairman to rotate every two years, first going to Liberty Global CEO Mike Fries.
• Both sides will have the right to kick off an IPO three years after the deal closes

By joining with Liberty in the U.K., Telefonica puts Vodafone Group Plc in a difficult position. It deprives it of a potential partner which could have set it on the road to offering consumers fixed-line services wrapped into lucrative bundles at a national scale. And Virgin will no longer need to pay it for mobile wholesale access. That’s something Liberty would have needed to keep doing to capture potential new revenue streams from the next generation of wireless technology, such as the proliferation of smart devices. Analysts have not ruled out a fightback from the Newbury, England-based carrier.

While a potential IPO could provide “transparency” on the value of the new venture, the two companies aren’t “entering the deal with the idea of leaving,” Fries said in a conference call Thursday. He added the transaction is a huge vote of confidence in the U.K., in spite of the uncertainties surrounding Brexit, which will “occur, and everyone will manage their way through it.”

Liberty was advised by JPMorgan Chase & Co. and LionTree Advisors LLC while Telefonica worked with Citigroup Inc.

The tie-up comes at a crucial moment for Virgin. Rival BT is the only U.K. operator to own both a mobile and fixed network, and it’s been investing to upgrade to fiber optic broadband. This threatens one of Virgin’s key selling points -- the speed of its internet services. It also gets a partner with significant experience in convergence and building and operating fiber networks.

The merger means O2 can grow beyond the mobile-only market in which it currently operates.

Speaking in an earnings call Thursday, BT CEO Philip Jansen said the deal wasn’t a surprise. “Personally I think the industry needs consolidation,” he said.

Telefonica was one of the first European carriers to make the shift to convergence: offering fixed- and mobile-phone services, along with broadband and television. The company is also Europe’s leading operator of fiber-optic broadband, a crucial type of infrastructure which the U.K. is still struggling to roll out.

But it hasn’t always been able to take a leading market position with this know-how. In 2018 it was left as a mobile-only carrier in Germany, reliant on buying wholesale access from rivals in order to offer fixed and broadband services, after Liberty sold its cable business there to Vodafone.

“We think this deal will trigger a ripple effect on the U.K. market,” said Kester Mann, analyst at CCS Insight. “Vodafone, Three, Sky and TalkTalk will all be assessing their positions and further deal-making can’t be ruled out.”

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