Vodafone to gobble up Liberty Global operations in Germany and further east

Vodafone has agreed to acquire Liberty Global's operations in Germany, the Czech Republic, Hungary and Romania for an enterprise value of €18.4bn, the telco giant announced on Wednesday.

The FTSE 100 company said the deal would accelerate its converged communications strategy through in-market consolidation in Vodafone's largest market, Germany, and in its Central and Eastern European markets of the Czech Republic, Hungary and Romania.

Vodafone would become the “leading next generation network” owner in Europe, its board claimed, with 54m cable and fibre-optic homes on-network and a total next generation network reach of 110m homes and businesses, including wholesale arrangements.

The deal would creates a “converged national challenger” to the dominant incumbent in Germany, with the scale to accelerate the achievement of the German government's digital ambitions, bringing gigabit connections to around 25 million homes in the country - or 62% of total German households - by 2022.

Vodafone said the combination of its own and Unitymedia's non-overlapping regional operations would establish a “strong second national provider” of digital infrastructure in the German market.

The deal would also “transform” Vodafone's fixed line and convergence strategy in key Central and Eastern European markets, complementing its existing mobile operations in the Czech Republic, Hungary and Romania.

In those markets, the combined businesses would reach more than 6.4m homes - or 39% of total households - and would serve 15.8m mobile, 1.8m broadband and 2.1m television customers.

Vodafone’s acquisition would also brings together “leading talent” in the mobile and cable sectors.

Estimated cost and capex synergies of approximately €535m per year before integration costs were being anticipated by the fifth year post completion, with an estimated net present value of more than €6bn after integration costs. Estimated revenue synergies with a net present value exceeding €1.5bn were expected from cross-selling to the combined customer base.

The deal valued the acquired operations at 2019 financial year multiples of 12.5x operating free cash flow and 8.6x EBITDA, adjusted for year five cost and capex synergies before integration costs, and 10.9x EBITDA before synergies.

“Substantial” free cash flow accretion was anticipated over time, which the board said reflected the attractive standalone growth potential and synergy realisation of the transaction.

The deal was expected to be accretive to free cash flow per share from the first year post-completion, and double digit accretive from the third year post-completion, after cost and capex synergies and before integration costs, supporting Vodafone's intention to grow its dividend per share.

AVOIDING DILUTION

Vodafone said it intended to finance the acquisition using existing cash, new debt facilities - including hybrid debt securities - and around €3bn of mandatory convertible bonds. The board said it would have the option to repurchase the shares issued under the terms of the mandatory convertible bonds at maturity, thereby avoiding equity dilution.

Once complete, the transaction would increases the company’s exposure to “resilient converged revenues”, the board added, and enhance Vodafone's growth outlook, supporting an increase in its long-term targeted net debt-to-EBITDA ratio to 2.5x to 3.0x.

Pro forma for the transaction, Vodafone's 2018 net debt-to-EBITDA was expected to be at the upper end of that range.

The transaction remained subject to regulatory approval, with completion expected around the middle of calendar 2019.

“This transaction will create the first truly converged pan-European champion of competition,” said Vodafone chief executive Vittorio Colao. “It represents a step change in Europe's transition to a ‘Gigabit Society’ and a transformative combination for Vodafone that will generate significant value for shareholders.”

Colao said the company was committed to accelerating and deepening investment in next-generation mobile and fixed networks, building on Vodafone's track record of ensuring that customers benefited from the choice of a “strong and sustainable” challenger to dominant incumbent operators.

“Vodafone will become Europe's leading next generation network owner, serving the largest number of mobile customers and households across the EU.”

ANALYST REACTION

Analysts were quick to react to the deal, with a number pointing out that the primary concern in the transaction was the regulatory backdrop in Germany, although Olivetree noted that its previous work suggested that to be a “surmountable” challenge, if Vodafone can offload its excess wireline subscribers.

“The potential sticking point here is that there are potentially only few motivated third-parties, and therefore executing these complex remedy transactions seems to be the largest potential obstacle.”

The analysts said there remained two points of concern around this. First, there are only very few buyers for the assets that potentially need to be disposed. If German internet conglomerate 1&1 does not purchase VOD’s xDSL subscribers, unloading them could be difficult.

“There could also be an upset with regards to EC view of this tie-up on incentives to invest / infrastructure competition, something that was largely absent from EC’s assessment of mergers before 2015 but surfaced in the Orange/Jazztel ruling.”

Olivetree said the deal did remove two potential NGN competitors and co-investors from the market, so it remained conceivable this situation will engender some regulatory concern.

“Nonetheless, arguments that Germany needs a second converged NGN are likely to carry a lot of weight and thus we can see a path through the regulatory review, albeit a lengthy one - and hence the mid-2019 close date.”

Citi said the deal looked "better than expected", with "much higher synergies that we and the market were looking for...However, with a long approval process ahead, the focus will likely remain on the remedies that may be required for approval."

Analysts said the "focus will be on Liberty’s potential use of cash that could be used for deleveraging or buying out the Telenet minority, ITV or potentially mobile acquisition in the UK", which others suggested could mean O2.

RBC Capital Markets pointed out negative read-through for Sky and BT as it said investors "should consider the implications from the UK data" in Liberty's recent trading update, where it reported 31k broadband net adds in the UK.

"The headline figure is seemingly unremarkable, but we believe the implications are not, given the context of the market." With Vodafone and TalkTalk expected to post "very strong" broadband net adds, "with the overall market slowing, we believe the main loser in broadband is likely to be Sky, though BT is also likely to see a substantial slowdown in net adds".