Vodafone Group PLC (LSE:VOD) could reduce its debt by a tenth by the planned merger with Three UK, according to analysts at Jefferies, though they suggested the deal might not be approved by regulators.
The FTSE 100 group confirmed on Monday that it is in talks with Three owner Hutchinson to combine UK mobile operations, with Vodafone owning 51% of the merged company.
In its main merger scenario, Jefferies estimated €400mln of pre-tax synergies and on the expectation that Vodafone would spin off the 51%-owned new entity with debt of 2.5 times earnings, in-line with its own leverage target.
With the new combined vehicle supporting an estimated €6.6bn of debt, its implicit equity value would be €10.2bn, which would value Vodafone's 51% stake at €5.2bn.
Assuming that merging parties share synergies equally, Vodafone would be contributing €10.8bn of the new company’s €16.8bn enterprise value.
Raising debt for the merged entity “would seem more straightforward” than moving specific the parent companies’ bonds or initiating a bondholder exchange, Jefferies said.
Proceeds would therefore be repatriated to shareholders to achieve the value consistent with 51%/49% equity stakes, with Vodafone forecast under this scenario to receive €5.5bn and Three €1.1bn, with no cash consideration required.
The effect of this equalisation payment would be to lower Vodafone's consolidated leverage by March 2023 by around 0.11 times to roughly 2.52 times.
If Vodafone UK’s standalone leverage of 7.5x was used instead, Vodafone's consolidated leverage would fall by an extra 0.07 to around 2.45x.
However, how the competition authorities treat the deal is another matter, the analysts suggested, with the current cost of living crisis potentially weakening support for such in-market consolidation deals – even though the Virgin Media O2 was recently waved through and current market leader EE is a product of a merger before being bought by BT Group PLC (LSE:BT.A).
A Vodafone/Three merger would consolidate the UK mobile market to three network operators with similar market shares, with Jefferies estimating the revenue market shares at 37% Vodafone-Three (from VOD’s current 25% and Three’s 12%) versus BT at 32% and Virgin Media O2 at 31%.
On a post-pay customer share basis, the new merged vehicle would have 39% (VOD 24%, Three 15%) versus BT at 33% and VMO2 at 29%.
“Even with MVNO presence, it is hard to argue that this set-up creates competitive tension in consumer interests.”
Earlier this year Jefferies downgraded Vodafone to ‘hold’ after getting insight from legal experts into future policy intent at the Competition & Markets Authority.
“Notably, the CMA is aligned with the opinion of US/European competition regulators believing there has been a concentration in markets over recent years (across industries), which may be detrimental to consumer interests and exacerbating inflation,” said analyst Jerry Dellis.
“Furthermore, political influence that has shaped the CMA's approach to merger reviews since its creation is unlikely to change. The CMA is heavily resourced and incentivised to remain a defender of public interest.
“Finally, CMA merger reviews make extensive use of consumer opinions gathered in surveys, and this is also unlikely to change.”