Few can deny that a merger of Ziggo and Liberty Global's Dutch operator UPC will happen at some point. As we have noted previously, UPC especially would benefit from a merger. The question is whether the rest of the cable market would support the move to form a national operator. Different technology choices by the smaller cable operators (which account for around 8 percent of the market) are an obstacle to a full merger in the sector. Not so much the choice for FTTH, but more the transition to IP, which the smaller operators are embracing while Ziggo and UPC are not.
Another consideration is whether a merger of Ziggo and UPC would receive regulatory approval. Together they would be bigger than KPN in revenue terms. On the various service markets, they would be bigger than KPN in TV, smaller in telephony and roughly the same in broadband. If the merger goes ahead, either regulation of KPN could be relaxed, or regulation could be extended further to cable. In general, the government leans towards less, rather than more, regulation, and cable is valued as the most important counterweight to the incumbent.
On the TV market, purchasing power is another important issue. In Germany, this has been a reason to block mergers. This could be overcome by putting conditions on the regulatory approval. The government is likely to choose not to regulate the original core services (telephony at KPN, TV at UPC/Ziggo), but instead focus on the broadband market. However, if only KPN remains subject to regulation, there is no symmetry. And if this market is deregulated, the existence of any number of smaller players on the copper and fibre networks is threatened.
The impact on consumers will also be taken into account. These are fairly limited, as Ziggo and UPC's footprints do not overlap and they do not compete directly. There are possible secondary effects:
- Integration: Ziggo's formation from the merger of three separate operators was a long and costly process. A new integration process could in theory put pressure on the quality of its service delivery.
- Synergies: the aim of a merger is to exploit synergies. It's questionable whether these will be passed on to the customer.
- Regulation: as outlined above, it's uncertain whether regulation will increase or be relaxed in the event of a cable merger. In theory prices fall as regulation increases, that is, if cable becomes subject to regulation.
Parallel with Telenet
Ziggo's share price rose strongly on the news, as did that of Telenet, the Belgian operator controlled by Liberty Global.
While it's too early to predict Ziggo's future, there is a parallel with Telenet. Under former CEO Duco Sickinghe, Telenet fought off a bid from LGI to acquire the rest of its shares, while also raising its financial outlook based on a new mobile strategy. One could expect a similar scenario with Ziggo. The Dutch operator will also want a high price for its shareholders, and the same as Telenet, Ziggo could be considered a somewhat conceited company, valuing its own strategy and vision and not keen on being swallowed up by the LGI family.
Ziggo also has room to demand a premium with its own mobile strategy. However, the current strategy, based on Wi-Fi, is mainly aimed at reducing churn and selling more services to current customers; it will not do much to increase revenues. If it opens up its MVNO to non-Ziggo customers, it could see a more substantial boost to sales, as has been seen recently at Tele2 (which achieved 92% annual growth in mobile revenue in Q3 2013).
We can make the comparison with Telenet went it 'let loose' with mobile. When LGI launched its takeover bid (19 September 2012), Telenet promptly raised its outlook. The forecast for revenue and EBITDA growth in 2012 was raised to 7-8 percent from 5-6 percent. Thanks to the expansion in mobile, Telener raised its revenue growth forecast at the end of October to 10-11 percent and forecast EBITDA growth of 7-8 percent (at its last quarterly results Telenet even said it expects to achieve the high end of these ranges).
In the meantime, LGI asked Morgan Stanley to conduct a valuation of Telenet. This resulted in a value of EUR 28-35 per share, and LGI put its bid at EUR 35. Telenet hired Lazard to do its own valuation and came up with a figure of EUR 37-42, or EUR 41.50 on a discounted cash flow (DCF) basis. In the end, LGI reached just 58.4 percent of Telenet's shares, versus 50.04 percent before the bid.
DCF valuations are strongly influenced by assumptions for growth and margins (or in other words garbage in, garbage out). LGI's advisors are likely to conclude a lower price than Ziggo's, and much will depend on whether Ziggo is willing to surrender to a takeover. With its own vision and a hankering for independence, a scenario a la Telenet is not difficult to imagine.
A possible bid from LGI has been in the market for some time and has already been partially priced into Ziggo's shares. If we assume that LGI still offers a premium, the same as with Telenet (this was 14 percent above the average price in the month prior to the bid), then a bid for Ziggo would be worth around EUR 34 per share. If Ziggo is not ready for a merger and wants to get the most it can out of the deal, it will likely aim for a value much higher (around EUR 42 say), in order to put LGI off from raising its offer. Exactly as Telenet did.
