Vodafone and Three merger to test how much national security law can gum up M&A activity

The proposed merger between Vodafone's UK arm and Three UK would, if permitted, represent the biggest shake up in the UK's mobile telephony sector in more than a decade.

It would take the number of UK mobile players down from four to three.

Nothing like that has happened since T-Mobile and Orange combined their UK operations in 2010 to form EE, now owned by BT, which took the market down from five to four players.

The rationale behind the deal is that the UK mobile telephony market is just too competitive for the smaller players in it - Vodafone has a market share of 20% and Three UK one of just 10% - to make the kind of returns they need in order to justify investing more in the country.

This is a point that was made repeatedly by Nick Read, Vodafone's former chief executive, over a prolonged period of time.

The impact of these poor returns has also been felt in Vodafone's share price, which rose by more than 3% on Wednesday's announcement, but which before that had been languishing at their lowest level for 25 years.

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Investors have hung up on the stock in recent years amid scepticism over Vodafone's ability to generate a better return on the capital it puts to work. It ultimately cost Mr Read his job.

But competition regulators are going to take some convincing to wave this deal through.

Accordingly, Margherita Della Valle, Vodafone's new chief executive and Canning Fok, the group co-managing director of Three's Hong Kong-based parent company, CK Hutchison, were at pains on Wednesday to stress the benefits of the deal, as they see them, for the broader economy and to the wider public.

Jobs and 5G promises

They are promising that the combined business will invest £6bn in the UK the first five years after the merger - and £11bn over 10 years in the first 10 years - on the roll-out of 5G services and claimed that, "by having a best-in-class 5G network in place sooner, the merger will deliver up to £5bn per year in economic benefit by 2030, create jobs and support digital transformation of the UK's businesses".

A big selling point, as the pair see it, is that they expect the merged company to have delivered 5G coverage to more than 99% of the UK population - and this business will have nearly 28 million customers - by 2034. They are also promising that data speeds will increase, on average, by up to six-fold by 2034.

Those are attractive propositions for a government desperate to boost the UK's lacklustre record on productivity through initiatives like 5G.

Yet note also the emphasis on jobs.

The pair predicted that the kind of infrastructure investment they are promising "would be expected to support between 8,000 and 12,000 new jobs in the wider economy".

That point on jobs is particularly important because the unions are already raising concerns about the job losses that may result from a deal.

Union concerns

Unite on Wednesday described the proposed tie-up as a "reckless merger" that would "mean job losses for Vodafone and Three workers".

The union also flagged concerns about a possible hike in bills as a result of the deal - although the pair insist that is less of an issue.

They argue that the combined entity will "be better able to compete for all customers driving further network, retail mobile and fixed broadband competition in the UK, including the ability to make converged offers in competition with the two largest operators BT EE and Virgin Media O2".

Vodafone and Three UK also make the point that this is not just about retail pricing.

More competition?

They suggest their tie-up would create more competition in the wholesale market and provide better choice for the so-called MVNOs (mobile virtual network operators) - those players like Tesco Mobile, Sky Mobile and iD Mobile (part of Carphone Warehouse) which do not own their own mobile networks but piggyback on networks owned by the likes of EE, Vodafone or O2.

They pointed out that, at present nine in 10 MVNOs are currently either on the EE or O2 networks. Tesco Mobile, Virgin Mobile and Sky Mobile, for example, all use O2's network.

These are all points that will have to be weighed up by the Competition & Markets Authority in an investigation widely expected in the industry to drag on for between 12 and 18 months.

The CMA blocked a proposed takeover by Three UK of O2 in 2016 on competition grounds, a deal which eventually drove O2 into the arms of Virgin Media, but Vodafone and Three UK will be hoping the regulator accepts that the UK mobile market has changed sufficiently since then.

They will be taking hope from the fact that, early last year, Ofcom, the telecoms regulator, indicated it was less concerned by a consolidation in the market per se than it was about competition in that market.

Testing the Johnson era law to call in acquisitions that may pose a national security threat

However, the competition landscape has also changed in other ways since 2016, not least the new National Security and Investment Act.

This was passed by the Johnson government in 2021 with the specific aim of enabling ministers to "call in" mergers and acquisitions that they believe may pose a threat to national security. Vodafone and Three UK acknowledged on Wednesday that their proposed deal would need to win ministerial approval under the act.

And, to judge by Unite's comments, the union is hoping this may be one area in which the deal falls down.

Gail Cartmail, executive head of operations for Unite, said: "This deal will give a company with deep ties to the Chinese state an even more prominent place at the heart of the UK's telecommunications infrastructure."

Vodafone and Three UK are likely to argue, in response, that Three UK already has a prominent role in the UK mobile market and has not to date posed any kind of threat to the country.

To that end, this deal will be an interesting test of the extent to which the new act - brought in partly to emulate the tough approach the United States takes towards foreign takeovers of its companies - is capable of gumming up M&A activity.

This deal, should it be waved through, would be a huge and lasting reshaping of the UK telecoms market.

Getting it past the regulators will be a hugely costly and time-consuming issue for both Vodafone and CK Hutchison.

It tells you a lot about how poorly they regard prospects for their two UK businesses, on a standalone basis, that they are prepared to go through with such hassle.