T-Mobile, Tele2 merger in Netherlands no-brainer for scale benefits, as spectrum licence window opens ahead of 5G auction

Thursday 16 November 2017 | 16:28 CET | Market Commentary

Deutsche Telekom is considering merging its Dutch business T-Mobile Netherlands with Tele2's local unit or listing the company on the stock market, CEO Tim Hoettges said at an investors conference in Barcelona. A merger is more than likely, for a variety of reasons. Both operators are in need of greater scale, especially with 5G around the corner. Restrictions in spectrum licences will open a window soon during which it will be now or never for a merger on the Dutch market.

What form the merger would take is still unclear. The operators would need to negotiate on their respective shareholdings or if one buys out the other, and for how much. What is clear is that T-Mobile has more assets to bring to the table (network, customers) than Tele2.

The comments from DT's CEO are not unexpected:

  • Deutsche Telekom clearly favours integrated fixed-mobile operators, as it operates in its home market and throughout Eastern European. T-Mobile US is an exception that could be considered 'non-core' since abandoning merger talks with Sprint. 
  • DT has grouped T-Mobile Netherlands with a number of other assets (Deutsche Funkturm, Deutsche Telekom Capital Partners, its stake in BT, Scout24, Stroer) in a separate division called Group Corporate Development (GCD).
  • DT already tried to sell T-Mobile NL two years ago. The Dutch company was reportedly valued at EUR 5 billion then. The price later sunk to EUR 3.6 billion and no suitable bidder was found, so DT shelved the plans in February 2016. With the added possibility of an IPO, the company is now pursuing a dual track, strengthening its negotiating position vis-a-vis Tele2. Nevertheless, we assume the preference is for a merger over a stock listing. 

Tele2 has also opened the door to a potential merger. CEO Alison Kirkby said a few quarters ago that "we are big fans of consolidation".

From a financial perspective, both parties would benefit from the increased scale a merger would bring - especially Tele2 (see more below). Prices are falling on the Dutch market, which is dominated by KPN and VodafoneZiggo and their multi-play strategies, and a major spectrum auction is planned for 2019. The details of the auction still need to be determined, but the government has said it plans to impose caps on how much spectrum each operator can acquire. With four mobile operators on the Dutch market, the risk is one could be left short after the auction. Consolidation to three operators could help limit the cost of the new frequencies. 

Consolidation from four to three mobile operators has been blocked by EU regulators in the past, in countries such as Denmark and the UK. However, the market positions of T-Mobile and Tele2 in the Netherlands, along with the above factors, will likely cause less concern for competition regulators. 

Last but not least: from early 2018 until the auction in late 2019 a window for consolidation will open. The current 4G licences prevent a merger before the end of 2017, but that will change from next year, giving the companies until the next auction expected in late 2019 to do a deal. 

To underline the case for a merger and potential strengths and weaknesses in the negotiations, we look at the financial situation of T-Mobile and Tele2 following their latest quarterly results. 

Tele2 NL still not break-even

Tele2 is winning mobile customers, and its ARPU is more or less stable at EUR 17.20. Still, mobile revenue growth was negative in Q3 2017, for the first time since the start of 2012, and the mobile business still has not reached EBITDA break-even. The business is showing some improvement, such as the falling capex. This is helping improve free cash flow, but this was again negative in Q3 (EUR -16.5 mln). The company aims for positive EBITDA in Q4 2017, but even if achieved, this is much too late. 

Tele2 is still rolling out its own 4G network, which is expected to be completed by mid-2018. The cumulative investment (capex) in mobile has reached EUR 411 million (excl. the cost of the 4G licence, EUR 160 mln). Over the same period, it's generated negative free cash flow of EUR 593 million. And that's despite the positive contribution of the existing mobile activities (at best EUR 3 million per quarter). This gives an idea of the costs (opex and capex) of building a mobile network from scratch. 

The neglect of its fixed-line services in recent years means fixed telephony, broadband and TV are no longer the cash cows of earlier years. At the time of the 4G auction in Q4 2012, these activities generated cash flow of EUR 27.2 million, making them an important source of financing for the mobile network. In Q3 2017, the free cash flow from the fixed business had fallen to just EUR 5.4 million. 

T-Mobile NL: healthy

T-Mobile is leading the Dutch market in terms of postpaid net additions, but its revenues were still falling in Q3. The reason is regulation (roam-like-at-home, termination rates and new consumer credit rules on handset sales) as well as price pressure. Postpaid ARPU fell 15 percent to around EUR 22, and prepaid ARPU was down 25 percent to EUR 3. Its unlimited offer at EUR 35 per month was expected to help lift ARPU, by attracting lower-spend customers to a 'care-free' plan with no risk of out-of-bundle costs, but this has yet to bear fruit. Churn is doing better though, at just 1.2 percent in postpaid, compared to double the rate a couple years ago. 

T-Mobile's free cash flow has fallen in recent years, from almost EUR 100 million per quarter in 2012 to EUR 50 million in Q3 2017. However, with an EBITDA margin of 30 percent this is not a company in trouble.

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