Deutsche Telekom and France Telecom have agreed to merge their UK units T-Mobile UK and Orange UK into a 50-50 joint venture. The new company will become UK market leader with 28.4 million mobile subscribers. The venture will also include Orange's broadband activities and T-Mobile's 50 percent share in a 3G network-sharing venture with 3 UK. Orange UK CEO Tom Alexander will lead the new company, while T-Mobile UK CEO Richard Moat is COO of the venture.
Pending due diligence, the companies expect to have a final agreement on the deal by end-October. During the following 18 months, they will continue to operate under the two different brand names, after which the shareholders will consider the possibility of introducing a new brand. The entire deal also depends on regulatory approval, with the venture's market share and spectrum holdings to come under scrutiny. While their combined market share of 37 percent may not raise any red flags, UK regulator Ofcom will likely use its review of the T-Mobile-Orange deal as a means of pushing through an industry-wide deal on spectrum refarming.
For T-Mobile and Orange, there are numerous benefits to the deal. To start with, the crowded UK market shrinks to four players, with the number three and four players moving up to first place. Customers should also see a significant improvement in network coverage, including indoors. However, the most important reason for the deal is financial: merging the two networks will result in enormous cost savings. This is a logical extension of the numerous infrastructure-sharing deals agreed in the past year in Europe. For Orange, which recently lost its network infrastructure agreement with Vodafone in the UK, the cost savings will be most welcome, while both companies will benefit from the freed-up cash to invest in more innovative services and marketing. Shareholders will also be happy, as the two operators pledged to return 90 percent of free cash flow from the joint venture to the parent companies. The deal is expected to add to free cash flow from 2010 and earnings from 2011. Deutsche Telekom and France Telecom plan to account for the venture via the equity method, so deconsolidating the poorly performing UK operations will also give a boost to group EBITDA margins.
Consolidation on the UK market had been expected for some time, with rumours about the sale of T-Mobile circulating since the poorly performing unit caused a profit warning at Deutsche Telekom earlier this year. Surprising is that T-Mobile and Orange started the consolidation, rather than the market's smallest player, 3 UK, which has long been the subject of takeover speculation. T-Mobile will contribute its 50 percent stake in its 3G network-sharing venture with 3 UK to the joint venture with Orange, meaning 3 will also benefit from access to increased network scale. As O2 and Vodafone also announced a network-sharing deal earlier this year, the mobile infrastructure market has shrunk considerably in the UK. All of this should hopefully help resolve the long-running negotiations over spectrum refarming in the UK, with Vodafone-O2 likely to surrender some 900MHz spectrum and Orange-T-Mobile giving up frequencies in the 1800MHz band. Again, 3 UK could ultimately see its position strengthened by taking over some of these frequencies.
For the future, the important question for Orange and T-Mobile will be how to brand the new venture. Both companies have built up a strong international brand. The Orange name, originally started by Hutchison Whampoa, came out of the 2G era and is now used worldwide by France Telecom, including at the parent company. Deutsche Telekom has also invested significantly in the T-Mobile name, which besides Eastern Europe, is also strong in the Netherlands and the US, where it's put in the market as a strong ‘mobile-only’ and ‘fixed replacement’ brand. Ironically, the brand name 3, thought up by Hutchison Whampoa for the 3G world, won't disappear, but instead one of two major international names could drop from the UK market. And this when 3 UK was the operator seen as having the weakest network and balance sheet.
The UK deal also raises the question of further market consolidation led by Deutsche Telekom and France Telecom. This is not the first market they have consolidated. In 2007 T-Mobile gave up its position on the Spanish brandband market to sell its local ISP Ya.com to Orange, while Orange withdrew from the Netherlands and sold its operations there to T-Mobile. Further overlap in their portfolios is limited. Neither is present in the other's home market, while FT is strong in West Europe and Africa and DT focuses on the US and East Europe. The only overlap is the competitive Polish mobile market, as well as Austria, Slovakia and Romania. If the two operators continue their deal-making, these last markets may be the next areas for consolidation. In the long run, this may even pave the way for a full merger of the German and French incumbents, something once rumoured in the distant past.
While the financial rationale for the UK deal is strong and the UK market was clearly too crowded with five players, the structure of the deal poses some risks. The problem with joint ventures is that if business is going well, one partner always wants to increase its stake, while if business is bad, someone ends up wanting to sell out. A 50-50 shareholding structure also means no one player has clear control - a situation that may prove troublesome when it comes to the difficult decision over what branding to use. The other operators in the UK will benefit from any problems. In the first 18 months it takes to get the venture up and running, the management at Orange and T-Mobile may be easily distracted with the integration issues, while after that, the risky step of introducing a new brand name could send customers over to the competition. In comparison, the recent Vodafone and 3 Australia merger proved a simpler solution, as their 50-50 venture chose the Vodafone name from the start.
A solution could be to maintain both brands, with each functioning similar to a MVNO on the combined network. Even 3 UK could operate similarly on the network. In addition to the high cost of re-branding, there is also the commerical question of whether it's a good idea to abandon a strong brand. The next 18 months will show the answer.
