Liberty, Telefonica in Talks to Build $30 Billion U.K. Arm

(Bloomberg) -- Telefonica SA and John Malone’s Liberty Global Plc have never been closer to finally creating the U.K.’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, according to people familiar with the matter, asking not to be identified because the talks are private.

In a statement 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% on Friday after Bloomberg revealed the talks, the biggest jump since 2009, and were up 6% in premarket trading Monday to $23.62. Telefonica shares rose 4.2% at 2:41 p.m. Madrid time Monday, while rival BT Group Plc rose 1.1%, rebounding from a drop earlier in the day.

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 may seek a payment from Liberty Global of between 6.2 billion euros ($6.8 billion) and 8.5 billion euros, an amount which may keep its leverage ratio from climbing from pre-deal levels, Deutsche Bank analysts Keval Khiroya and Robert Grindle said in a note to clients. They see 6 billion pounds ($7.5 billion) of synergies, and value O2 at 11 billion pounds and Virgin Media at 16 billion pounds.

Telefonica, currently trading at close to a 25-year-low, is demanding the two companies have equal voting rights in the new venture, one of the people said. Executives and advisers must reconcile that with Telefonica’s need to pay down 38 billion euros 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 U.K. business to CK Hutchison Holdings Ltd. was blocked by regulators in May 2016. It then started working on plans for an initial public offering of O2, but they were shelved by Brexit and the subsequent market turmoil. The company never said officially that it was scrapping the IPO plans.

Liberty Global declined to comment.

New Rivals

Liberty Global Chief Executive Officer Mike Fries said in September that buying a U.K. 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 Plc 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 published Friday. If successful, the new venture would be BT’s only rival that owns both fixed-line and mobile services.

BT’s leading position in the U.K. 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.

-- Matthew Bloxham, BI telecom analyst

Vodafone and Liberty Global’s close relationship -- solidified by their Dutch joint venture -- has previously fueled speculation that the two groups could do a U.K. deal. Vodafone recently won BT’s contract to wholesale mobile services to Liberty’s U.K. 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.

Musical Chairs

Matchmaking the U.K.’s fixed and mobile operators has been a favorite game of bankers and executives for years as Britain lagged neighbors 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 U.K. fiber and consolidating.

Executives at the leading U.K. telecom 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 U.K. 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 U.K. merger would advance a sweeping strategy change announced in November. It’s focusing on four core markets of Spain, Brazil, the U.K. 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.

(Updates share prices in fourth paragraph, adds analyst comment in sixth paragraph, detail on O2 history in ninth paragraph.)

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