VOD - Vodafone's Roaming Deal With 1&1 Has Many Implications

2023-08-02 15:05:40 ET

Summary

• Vodafone and 1&1 signed a surprise exclusive 5G roaming deal.
• While the immediate impact on Telefónica Deutschland and Vodafone is pretty clear, we will also examine how the other players in the market will be affected.
• We will also look at the key question, i.e., how Vodafone and 1&1 will be impacted.

Vodafone and 1&1 agree on roaming deal

Vodafone ( VOD ) ( OTCPK:VODAF ) ( VOD PF) and German MVNO 1&1 signed an exclusive roaming deal which included 5G service that caught many investors by surprise. The deal will deliver 5G mobile coverage nationwide to 1&1's customers from the second half of calendar 2024.

Key terms of the agreement:

• Exclusive national roaming partnership, supporting current and future mobile technologies.
• Long-term commercial agreement of up to 18 years, with gradual implementation during FY25.
• 1&1 wholesale unitary costs indexed to Vodafone's mobile network cost, to reflect the impact of inflation and technology evolution over time, providing long-term visibility to both parties.

The agreement is expected to be accretive to Group cash flow from FY26.

Effectively, 1&1 already had a national roaming agreement with Telefónica Deutschland ( OTCPK:TELDF ), but that excluded 5G and had been the origin of many disputes among the two companies.

Furthermore, 1&1 actually had also initiated litigation against Vodafone, since it believed that Vodafone was behind Vantage Towers' ( OTCPK:VTAGY ) ( OTCPK:VTWRF ) massive delays in building out 1&1's own 5G network. (Vantage Towers is still controlled by Vodafone.)

Moreover, the established players in the German market had often complained about 1&1's delays and there had been open speculation about 1&1's real intentions. The consensus thesis was that 1&1 did not really want to build out that expensive 5G network (despite having bought the necessary spectrum). Instead, its competitors insinuated that 1&1 boss Dommermuth wanted to extort a national roaming deal either directly from its competitors or indirectly through regulatory intervention.

The consensus opinion was that such a deal would have represented an unfair advantage for 1&1, since it could basically piggyback on its competitors' investments for the economically unattractive rural locations, while using its own towers and pre-existing fiber network in more lucrative urban settings.

So this deal was certainly not on every investor's radar.

What are the financial implications of 1&1's and Vodafone's roaming deal?

Telefónica Deutschland will lose an uncomfortable, but economically important customer. As stated by Dommermuth, 1&1 contributed €600m of MVNO fees to its competitor's income statement, translating presumably into about 10% of Telefónica's EBITDA of currently €2.5B. This is why TELDF stock is down 15% today, which seems roughly right.

On the sunny side of this deal, Vodafone will gain these fees or likely a bit more (since it also provides the higher value 5G service), which will increase its EBITDA by about 1-2%, which is how much its stock has gained in current trading.

1&1 itself doesn't gain much immediately. However, its less valuable deal with Telefónica Deutschland was set to expire earlier and the terms of its 18-year agreement with Vodafone seem very fair. So this removes an overhang. The stock is up 15% as I write, after having lost over 80% of its market value over the past six years.

The impact on competitive dynamics of the roaming deal between Vodafone and 1&1

There had actually been some speculations out there that, given the enormous delays of the network build-out, regulators might have "killed" 1&1. This is now much less likely, given that the company will be able to offer 5G service to all its customers from late 2024 anyway, regardless of how many towers it will have installed. So Vodafone, to some extent, might have "saved" a competitor from a slow death.

This is quite interesting: Why would Vodafone do that? Or could Vodafone actually even have forced 1&1 into such a deal by causing Vantage Towers' build-out delays in the first place?

Vodafone is in an uncomfortable position in its most important market, which is Germany. Because of recent legislation, next year it will lose many cable TV customers that until now were effectively forced into buying TV subscriptions by their landlords. Moreover, its wireless business got squeezed between Deutsche Telekom's high-quality premium service and Telefónica's low-cost promotions. It changed the CEO of its German business, the CEO of its overall business and is now actively trying to reduce costs, increase network utilization, find partnerships, etc.

Therefore, gaining a large wholesale customer is not the worst thing to do. Most importantly, this new customer will now have the same cost base as Vodafone, while Telefónica will have to spread its costs over a smaller pool of customers. Hence, mobile plan costs in Germany will likely increase because of this deal, and at the same time Vodafone will also severely burden its current low-cost competitor.

It remains to be seen whether Telefónica will be able to keep the recently gained market share at higher price points.

So Vodafone is back in the game.

As far as Deutsche Telekom is concerned, I don't believe it will notice much of an impact. Its plans mostly cater to business and premium customers that are willing to pay more for a premium brand offering. What is most important for Deutsche Telekom is the general price level in the market - and this is likely to stay high or go even higher after this deal.

Long-term implications for 1&1 and Vodafone

As of today, 1&1 remains obligated to build out its own network, while routing most of the traffic over its competitor's network. And maybe even a higher cost than before. So in the near term, 1&1 doesn't gain any money from this deal.

However, over time, this could change massively, since it already owns a large fiber network and can strategically build its own towers in locations served by this network. This means it can save fees. It will also very likely privilege high-traffic locations in order to route most of its clients' traffic over its own towers and fiber.

This means that Vodafone will likely see reduced MVNO fees over time and 1&1 will increase its own competitiveness. Given its lower costs, 1&1 will be able to lower prices.

While this is the likely preferred narrative, it is not without holes. In fact, first of all there will be massive expenses, and we still don't know how fast 1&1 will build its towers. The pace will still depend on Vantage Towers. In the meantime, it will remain the smallest among four players in the German market and face a relatively high cost base. So it might lose share - and this might reduce its build-out speed, which would again lower its competitiveness. So 1&1 is not out of the woods yet.

The only certain winner from today's news is Vodafone.

For further details see: