John Malone Proves Market Wrong Again With Virgin Media Deal

Chris Hughes

08 May 2020, 02:32 AM IST

(Bloomberg Opinion) -- John Malone has proved the market wrong again. The billionaire “cable cowboy” is merging his U.K. Virgin Media broadband business with Telefonica SA’s British mobile unit, O2, on much better terms for him than investors anticipated.

The deal creates a company that offers internet and television services, as well as fixed and mobile telephony. It will be a strong second to BT Group Plc in the U.K. telecoms market, and will be 50% owned by each side. The founding companies reckon that Virgin, owned by Malone’s Liberty Global Plc, is worth some 19 billion pounds ($23 billion). Deduct net debt and Liberty contributes assets worth roughly 7 billion pounds to the combination. O2, debt free, they value at 13 billion pounds.

Tot it up and each side starts out with 10 billion pounds of equity value in the new company. Liberty then makes a 2.5 billion-pound payment to Madrid-based Telefonica so both partners get out what they put in. Analysts had expected that this “balancing payment” would be much higher based on their lower valuations for Virgin.

The market’s implied valuation of Virgin has long frustrated Liberty. This deal looks like a riposte to that. True, Virgin’s value is flattered by tax credits from past investments, estimated to be worth about 1.5 billion pounds. Some observers will also question the high multiples put on both businesses — 9.3 times 2019 operating income before depreciation and amortization at Virgin, and 7.8 times at O2. Either way, the terms say Virgin is worth more than common wisdom assumed.

How so? Is this what happens when big deals are done on Zoom? Perhaps the market simply hadn’t analyzed Virgin in enough detail — it’s a U.K. asset trapped in a U.S. holding company. The terms may also reflect the relative negotiating positions of the two sides. Telefonica arguably had fewer plan Bs than Virgin if it walked away from talks. Pairing O2 with a rival British mobile group would have run into antitrust issues, although an alliance with Comcast Corp.-owned Sky may have been a possibility. The capital markets look shut to an initial public offering of the size of O2 right now.

But Telefonica hardly leaves empty handed. The Virgin-O2 combination will immediately take on more debt, allowing the Spanish company to extract 5.7 billion pounds of cash from the merger. Ceding full ownership means it will lose the O2 earnings from its accounts, so the overall impact on its leverage will be negligible. But Telefonica should enjoy a more reliable stream of dividends from the combination.

What’s more, the “converged” internet, TV and mobile offering of Virgin-O2 will give it a much stronger investment case. A sale of a stake in an IPO further down the line would really give Telefonica the ability to pay down its debts. The jam in this deal is coming to Malone today, and Telefonica tomorrow.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.