Liberty, Telefonica in talks to build $30 billion UK arm

Bloomberg

Telefonica SA and John Malone’s Liberty Global Plc have never been closer to finally creating the UK’s biggest telecom operator after flirting with various combinations over the years.
Racing for a potential announcement as early as this week, talks hinge in part on striking equal control for the merger of O2 and Virgin Media, while structuring a deal that’ll help the Spanish giant pay down its huge debt pile.
In a statement on Monday, Telefonica confirmed that talks are ongoing “on a potential integration of their respective telecommunications businesses in the United Kingdom” and there is no guarantee that an agreement can be reached.
Liberty Global’s New York A-class shares surged 15% after Bloomberg revealed talks, the biggest jump since 2009. Telefonica shares rose 1.8% in early trading on Monday, while rival BT Group fell as much as 4.6%.
Clinching a deal this month amid a collapse in global deal-making would be no small feat. A combination of O2 and Virgin Media could create a business with an estimated enterprise value of about $30 billion, according to analysts at Goldman Sachs Group Inc., which could make it the largest deal struck since the coronavirus was declared a global pandemic.
Telefonica, currently trading at close to a 25-year-low, is demanding two companies have equal voting rights in the new venture. Executives and advisers must reconcile that with Telefonica’s need to pay down $41.7 billion of debt, which means it’s unlikely to put cash into the deal, said analysts at New Street Research.
Liberty is likely to make a significant cash payment to Telefonica as part of the transaction, two of the people said.
Although the talks are advanced, executives on both sides are being cautious following recent strategic upsets, the people said. Telefonica’s plan to sell its UK business to CK Hutchison Holdings Ltd. was blocked by regulators and an initial public offering was shelved by Brexit and the subsequent market turmoil.
Liberty Global Chief Executive Officer Mike Fries said in September that buying a UK mobile operator would bring hundreds of millions of dollars in synergies. Extra cash would flow from combining infrastructure and back-office savings, and eliminating the need to pay for access to networks they don’t own.
Previous joint ventures have cut costs such as Liberty Global’s 2016 deal with Vodafone Group in the Netherlands. As of February that partnership was yielding 85% of a planned 210 million euros in synergies, a year ahead of schedule.
The combined entities would take 34% of Britain’s telecom service revenues between them, eclipsing the current No. 1 operator BT Group Plc, according to research from Goldman Sachs. If successful, the new venture would be BT’s only rival offering customers fixed-line and mobile services.
BT’s leading position in UK communications market would be threatened by a merger of rivals O2 and Virgin Media, we believe. A second, scaled fixed-mobile carrier would pressure BT’s consumer-broadband and enterprise-mobile market share, and boost investment in alternative full-fiber infrastructure to rival Openreach’s own expansion plans.
Vodafone and Liberty Global’s close relationship — solidified by their Dutch joint venture — has previously fuelled speculation that the two groups could do a UK deal. Vodafone recently won BT’s contract to wholesale mobile services to Liberty’s UK customers, a deal which would have to be re-examined if Virgin merged with O2.

“Vodafone would be the big potential loser” from a Virgin-O2 match-up, said New Street analyst James Ratzer in a note Friday, adding they would miss out on the synergies and also lose wholesale payments from Virgin.
Matchmaking the UK’s fixed and mobile operators has been a favourite game of bankers and executives for years as Britain lagged neighbours in a global telecommunication trend of “convergence,” which has seen companies meld cable and radio networks together. A wave of investors are being drawn to the infrastructure-like returns of fiber optics. Startups are also building UK fiber and consolidating.
Executives at the leading UK telecoms companies have regularly spoken about potential combinations, with advisers pitching Virgin Media as a partner to both Vodafone and Comcast Corp.’s Sky unit, in addition to Telefonica, people familiar with the talks said.
Liberty’s investors have been waiting to learn what the company plans to do with what remains of $11 billion in proceeds from selling its Germany and eastern European operations. In November, Liberty’s Chief Financial Officer Charlie Bracken said the company is looking at the merits of listing local units to unlock more value, as the company’s stock price has wilted.
While Telefonica has never publicly said it wanted to move into the U.K.’s fixed market, it has always advocated for consolidation in its markets, and internally the company has been open to considering options for the UK O2 was born as a joint venture controlled by BT called ‘Cellnet’, before it was bought by Telefonica in 2006 for 18 billion pounds. BT looked at buying O2 in 2014 but opted instead to buy EE, the joint venture built by Deutsche Telekom AG and Orange SA.
For Telefonica, a UK merger would advance a sweeping strategy change announced in November. It’s focusing on four core markets of Spain, Brazil, the UK and Germany and considering all options for the rest of its Latin American units. It also announced the creation of new tech and infrastructure units. It’s looking for ways to accelerate growth in those core markets and the latter new divisions through partnerships and deals.