Liberty and Telefonica to merge UK operations

Liberty Global and Telefonica are to merge their respective Virgin Media and O2 operations in the United Kingdom in an equal joint venture. Combining a high-speed broadband network with emerging 5G services will create a stronger fixed and mobile competitor in the market. The deal is expected close in the middle of 2021, subject to regulatory approval.

O2 is valued at £12.7 billion and Virgin Media valued at £18.7 billion, both on a total enterprise value basis. O2 will be transferred into the joint venture debt-free, while Virgin Media will come with £11.3 billion of net debt and transfer its tax loss allowances.

The companies expect to receive net cash proceeds at closing, following a series of recapitalizations that will generate £5.7 billion for Telefonica and £1.4 billion for Liberty Global, after paying Telefonica £2.5 billon.

Proceeds from any future free cash flow generation and financing will be distributed equally between Liberty Global and Telefonica.

The combination will have around £11 billion in annual revenue. Virgin Media had revenues of £4.76 billion in 2019, while O2 had £6.24 billion. They respectively generated £751 million and £819 million in operating free cash flow.

The merged operation is expected to save around £430 million a year, achieved through a combination of sharing networks, infrastructure and systems, site rationalisation and reduced administration and marketing costs, including migrating Virgin Media mobile traffic to the Telefonica network in the United Kingdom.

To achieve these synergies will require around £700 million of integration costs within the four years of closing.

With the prospect of further spectrum auctions in the United Kingdom, the companies said that each party would make independent decisions regarding strategy and participation, bearing its own costs.

“With Virgin Media and O2 together, the future of convergence is here today,” said Mike Fries, the chief executive of Liberty Global. “When the power of 5G meets 1 gig broadband, U.K. consumers and businesses will never look back. We’re committed to this market and are right behind the Government’s digital and connectivity goals.”

He referred to the experience of fixed mobile converged in Belgium and the Netherlands, where Liberty Global has a joint venture with Vodafone. It seems that Liberty was unable to pull off a similar deal with Vodafone in the United Kingdom as the companies disagreed about valuation.

That leaves Vodafone without a major fixed access network in the United Kingdom. The company had previously agreed to provide a virtual mobile network for Virgin Media.

The chief executive of Telefonica, Jose Maria Alvarez-Pallete, said: “Combining O2’s number one mobile business with Virgin Media’s superfast broadband network and entertainment services will be a game-changer in the U.K., at a time when demand for connectivity has never been greater or more critical.”

The reference to migrating mobile traffic to the Telefonica network and reducing overall marketing expenditure points to the possibility that the Virgin Media and O2 brands may somehow be merged.

The joint venture will not include the Liberty Global operations in Ireland.

The companies said there are no plans to consolidate the joint venture. However, either party has the right to initiate an initial public offering of the joint venture after the third anniversary of the closing. After five years, either company will be able to sell the joint venture to another party, subject to a right of first offer by the other party.