2023-06-15 11:44:24 ET
Summary
- Vodafone and CK Hutchison finalized a deal to merge their UK operations.
- The deal would give the new company an enterprise value of £15 billion with 27 million customers, surpassing BT and Virgin Media-O2.
- The agreement would still need approval from UK competition authorities, who have previously blocked deals that reduced the number of telecom operators from four to three.
- We decided to remain neutral on the deal; however, on an FCF basis, we believe that Vodafone is undervalued.
We recently analyzed Vodafone ( VOD , OTCPK:VODPF ) with a publication called the company " Needs to Change ", lowering our target price to £130 from £135 and confirming our long-standing investments. With a new CEO, today Vodafone announced an important milestone. In detail, the company communicated the merger agreement with Three UK , a subsidiary of CK Hutchison, for the creation of the largest telecommunications operator in the country by market share (37%) which overtakes BT (31.6%) and Virgin Media O2 (31.6%). Negotiations started more than a year ago, and as expected , Vodafone will control 51% of the new company, while the remaining 49% will be in the hands of Ck Hutchison. Before the potential deal, Three UK and Vodafone were the two smallest operators in the UK. Transaction closing is scheduled for 2024 end.
Looking at the detail, no cash is involved in the transaction. Vodafone and Three UK will take on £4.3 billion and £1.7 billion of debt respectively. A total of £6 billion will be refinanced. In addition, the new entity will invest approximately £11 billion over the next decade in the creation of a standalone 5G network. More importantly, this combination will likely create a new entity with an overall EV of £15 billion and will become the largest UK operator with 27 million customers. Here at the Lab, we are probably more inclined to see expected synergies and ongoing target evolution. The deal is forecasted to result in important efficiencies. In numbers, cost savings are estimated at more than £700 million on an annual basis, with also CAPEX synergies. According to the presentation, the implied net present value is over £7 billion.
Source: Vodafone merger presentation
For Vodafone, the agreement is a turning point for the UK market and is a testament to faith in Britain and its ambitions to be the center of the future of technology. It should be remembered that also due to the difficulties in completing the negotiation with CK Hutchison, the CEO of Vodafone Nick Read resigned, further slowing down the process. The definitive appointment of Della Valle as the new CEO, after five months in which she had assumed an ad interim position, contributed to the deal's closure. This deal is pending the regulatory authorities. Indeed, there would remain three market operators in the telecommunications sector in Great Britain, and the outcome is by no means obvious. As a reminder, in 2016, the British authority rejected the merger between Three and O2. Based on our assumption, the Antitrust examination could last up to 18 months.
A potential risk
Even if the market positively reacts to the news, we have some additional concerns. History often teaches us valuable lessons, and looking at other markets helps our analysis (and offers to Seeking Alpha readers' different perspectives).
In Italy, Wind (an Italian operator) and Three (same Chinese ownership of CK Hutchison) merged in December 2016 . At that time, they formed a new entity with the largest customer base. In May 2018, there was the official launch of Iliad Italy . The French operator's arrival was a direct consequence of the merger, precisely this was due to antitrust regulation. If we are looking at the latest data, today Iliad become the element that is making this marriage between Wind and Three useless. In fact, almost all the customers who had a Three sim have switched to Iliad. The Italian merger is continually losing market share, while Iliad announced that it reached a double-digit market share penetration before its fifth Italian anniversary. According to the latest data , Iliad is now at approximately 12.2% share of the Italian mobile market. The below chart presented Iliad's market share penetration just 8 weeks after its Italian launch with Wind-Three which already was the main victim of Iliad's. In detail, they lost almost 2% share in the mobile voice. This year, Vodafone Italy announced a corporate restructuring plan which should concern around 1,000 units to bring more efficiencies . The Italian negative case could hurt the new JV proposal between Vodafone and Three UK. Other new mobile entrants and also Iliad has a fearsome reputation with a lower cost structure. Currently, we are not forecasting a UK margin decline or lower sales growth (due to new entrants); but we believe this is a risk worth considering. History teaches but has no pupils.
Source: Iliad storms the Italian mobile market
Conclusion and Valuation
Last time, we call a change, and this is one of the first potential deals that the new CEO decided to pursue. Spanish assets and Italian assets might follow. Here at the Lab, we decided to remain neutral. According to our estimates, there is a high probability that regulators will stop the transaction from going ahead. Last time, CEO resettled FCF's bottom guidance and confirmed Vodafone's dividend per share. Wall Street is focused on the company's recovery plan on profitability and new M&A accretive deal changes. We already lowered our internal 2024 projection; however, on an FCF basis, we continue to believe that Vodafone is undervalued. Therefore, we confirm our buy rating target. Have a look at our publication called: ' Value Pick Or Value Trap? '. In addition, our downside risks section is included here .
For further details see:
Vodafone UK And Three UK Merger: A Contrarian M&A Idea