Monday 24 October 2016

Dunne in pole position in battle for O2

The blocking of 3's bid for O2 puts its Irish-born boss Ronan Dunne in the lead to reshape its future, writes Dan White

Published 22/05/2016 | 02:30

Chief executive Ronan Dunne had been due to leave O2. Photo: Pau Barrena/Bloomberg
Chief executive Ronan Dunne had been due to leave O2. Photo: Pau Barrena/Bloomberg

On May 11, European Competition Commissioner Margrethe Vestager announced that she would not allow Hutchison's proposed £10.25bn bid for Telefonica UK to go ahead. She justified her decision on the grounds that the combination of Hutchison's 3 and Telefonica's O2 would reduce competition and increase prices for consumers in the UK mobile market.

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Between them, 3 and O2 would have had a combined 31pc share of the UK mobile phone market, just behind BT's EE network, which has a 33pc market share.

The deal had already run into trouble at home with Sharon White, chief executive of UK communications regulator Ofcom warning that a 3 takeover of O2 could reduce competition and push up prices.

Then last month, Alex Chisholm, the chief executive of the UK's Competition and Markets Authority, wrote to the Commission urging it to kill the deal, arguing that it would "create significant impediments to effective competition".

Despite this domestic opposition, most analysts had expected the Commission to wave through the deal, albeit with some strings attached, given that the merged 3/O2 would have still been marginally smaller than EE.

"While it was not a massive surprise, I still thought that the deal was going to go through. I thought that the Commission would come back with some remedies. Instead they dug their heels in," says Phil Kendall, director of the global wireless practice at research firm Strategy Analytics.

Ms Vestager wasn't having any of it. A 3 takeover of O2 would have reduced the number of UK mobile operators from four to three - Vodafone, with a market share of about 18pc, is the other major player.

"Allowing Hutchison to takeover O2 at the terms they proposed would have been bad for UK consumers and bad for the UK mobile sector. We had strong concerns that consumers would have had less choice finding a mobile package that suits their needs and paid more than without the deal. It would also have hampered innovation and the development of network infrastructure in the UK, which is a serious concern, especially for fast-moving markets. The remedies offered by Hutchison were not sufficient to prevent this."

She may have had a point. While the market share of the merged 3/O2 would still have been marginally lower than that of EE, the O2 market share figures don't include Tesco Mobile, which has an 8.5pc market share and operates on the O2 network.

In addition, there is already less competition in the UK mobile than might be apparent from the raw market share statistics. EE and 3 have combined their networks under the MBNL banner, while Vodafone and O2 have also combined their networks to form Beacon.

While these four operators, along with Tesco Mobile and the other MVNOs (mobile virtual network operators) such as Virgin and Talk Talk, continue to compete vigorously for customers, the potential for a rapid erosion of competition in UK mobile is obvious.

"The merged entity would have been part of both network sharing arrangements, MBNL and Beacon. It would have had a full overview of the network plans of both remaining competitors, Vodafone and EE. Its role in both networks would have weakened EE and Vodafone and hampered the future development of mobile infrastructure in the UK," according to the European Commission.

Whatever the rights and wrongs of the matter, it is now clear that, following such an emphatic rejection by the European Commission, the 3/O2 deal is now dead - 3's €780m takeover of O2's Irish operations in 2013 is unaffected by the Commission's decision.

While Hutchison said that it was "deeply disappointed" by the Commission's decision and was considering all options, including a legal challenge, it's difficult to see how the deal could possibly be resurrected. Spanish telecoms giant Telefonica put the "for sale" sign up over O2 in 2014 as it sought to reduce its debts. It first tried to sell O2 to BT, which had previously spun off O2 in 2002, but BT opted to purchase EE from Deutsche Telekom and Orange for £12.5bn in February 2015 instead.

With the benefit of hindsight, it can now be seen that BT was the deal that Telefonica should have done. Having had no existing mobile network of its own, a BT purchase of its former subsidiary O2 would almost certainly have been waved through by the Commission.

So with the 3 deal no longer a runner, what does Telefonica now do with O2? With almost €50bn of debt on its balance sheet, doing nothing is not an option. Telefonica debt is rated two notches above junk by both Moody's and Standard & Poor's.

While a sale of its Telxius wireless mast business could raise up to €3.5bn, this would hardly be enough to ease investor fears about the security of the Telefonica dividend - the company had already said that some of its promised dividend of 75 cent a share might be paid in shares rather than cash if the O2 sale didn't go through.

At the current share price of €9.19, Telefonica is on a dividend yield of over 8pc, the second-highest of the 21 telecommunications companies in the Stoxx 600 index of European companies.

Telefonica's difficulty could represent an opportunity for O2's Dublin-born chief executive Ronan Dunne. The 52-year-old, who had been due to leave O2 following the completion of the 3 takeover, was reportedly approached in recent weeks by a number of private equity buyers about the possibility of leading a leveraged buyout in the event of the O2 deal being blocked by the Commission.

With both BT and now 3 out of the running, and Telefonica anxious to raise cash, the likely price for O2 has dropped from £10.25bn to about £8.5bn.

Telefonica paid £17.7bn for O2, including its German and Irish operations in 2005. When contacted by the Sunday Independent, all that an O2 spokesperson would say is that: "We remain in an exclusivity agreement with CH Hutchison until the end of June and there are a number of different options being considered by Telefonica from people who have approached us".

While UK buyout giants APAX and CVC have both been mentioned as possible buyers for O2, it is an IPO - with O2 shares being sold to the company's customers, staff and the general public in a privatisation-style flotation - that may win out in the end.

Although relatively unknown on this side of the Irish Sea, Dunne has long been a serious player in the UK telecoms sector.

Educated at Dublin's Blackrock College, he qualified as a chartered accountant with Deloitte and moved to London in the mid-1980s. After stints at BNP, Waste Management International, NFC and Exel, he joined O2 in 2001, becoming chief financial officer in 2005 and chief executive three years later.

In February, he was one of a group of 200 businesspeople who signed a letter published in the Times newspaper urging UK voters in the June 23 referendum to opt to remain in the EU. Reluctant to tell people how to vote - he thinks it's highly inappropriate for business people to do so - Dunne has nonethless argued that it is hard to make an economic case for leaving the EU.

The married father of one, whose daughter is studying at Trinity College, Dublin, has been a non-executive director of the Guardian Media Group, owner of both the Guardian and Observer newspapers since 2013.

Last week the controlling Scott Trust blocked former Guardian editor Alan Rusbridger from becoming chairman after the announcement of heavy losses and cutbacks at themedia group.

So will Dunne be transformed from O2 chief executive into part-owner in the space of a few months? Maybe, maybe not.

The departure of Hutchison and BT from the field certainly reduces the number of likely buyers for O2. But does this leave the field clear for a Dunne-led leveraged buyout?

Not necessarily.

If a trade buyer for O2 does emerge then the betting is on either Liberty Global, which trades in the UK and Ireland as Virgin Media, or Sky. With most analysts reckoning that Sky's controlling shareholder, Rupert Murdoch's 21st Century Fox, will sooner or later renew its bid for the rest of Sky - a move that would cost over £10bn at the current share price, that makes Liberty the clear favourite.

Although primarily a cable company, Liberty already has 7 million mobile customers globally - including 3 million Virgin Mobile customers in the UK. An O2 deal would allow Liberty to speed up the implantation of its strategy of offering customers the "quad play" of cable, mobile, broadband and fixed-line.

Liberty hasn't ruled out the possibility of an O2 bid with chief executive Mike Fries telling analysts that "it would be strange if we didn't evaluate that option" in a recent results call.

"Telefonica is reasonably keen to do something with the asset. While some kind of MBO or private equity sale could make sense, I would put a little more money on another player buying O2," says Mr Kendall.

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