Research Notes

The consequences of the failed Telenor Telia merger in Denmark and what it means for mergers in the UK, Italy and the global telecom market – Post Mortem Part II

Read Post Mortem Part I.

On Monday September 15, 2015 Strand Consult published The EU Competition Authority’s Role in the Failed Telenor Telia Merger in Denmark and the Consequences for Europe – A Post Mortem in which we gave our assessment of what went wrong with the Telenor Telia merger in Denmark and why the proposal was withdrawn. Our conclusion is clear. DG Competition, the EU authorities who approve mergers, committed a Type I regulatory error by failing to understand the role of technology in creating competition in the mobile market. As such, they acted in such a way to force Telenor and Telia to propose untenable remedies which ultimately made the merger unacceptable. That the parties withdrew the merger rather than DG Comp having to make a ruling is politically advantageous to DG Comp.

This research note describes the opportunities for Telenor and Telia in Denmark as well as for other telecom operators wanting to merge. The analysis is based in part on incomplete statements and documents from DG Comp provided to different actors, illustrating that the agency is a black box. A black box is a system in which inputs and outputs can be observed but the inner workings are unknown. This research note then describes how the fallout in Denmark will affect merger and acquisition activities in other countries. The Danish case will likely have an impact on mergers in the United Kingdom and Italy and also on TeliaSonera’s attempt to exit from Eurasia.

The European Commission has two key agencies for telecommunications. DG Connect, led by Gunther Oetinger and Andrus Ansip, is responsible for the strategic framework for the industry, but does not intervene directly with firms. Rather it is the sister agency DG Comp led by Margrethe Vestager, that defines the speed and direction of the European telecom market by its decisions and influence on M&A activity. Even though competition theory and research has advanced considerably, DG Comp works from an outdated paradigm that counts the number of players in a marketplace and not the level of technology. Their actions and statements demonstrate that they do not have the relevant insight to what creates competition in the telecommunications market.

It is a bad sign for the telecom industry and investors that a merger cannot be approved in Denmark, a country considered at the forefront of the mobile industry, with a high level of competition and some of the lowest mobile prices among developed countries. The failure to enact a merger in Denmark should not be seen as an isolated incident. Investors looking for guidance for mergers in other countries have this takeaway: DG Comp is a black box, and mergers will not be assessed purely on the facts. This complicates the ability of financial analysts to advise their clients, as banks’ financial models have little value if DG Comp adds an unpredictable political variable to the equation. Companies may think the authority employs a modern, evidenced-based approach to merger review but politics is an important and unpredictable driver in DG Comp’s decision making.

The black box of DG Comp and information leaks
The telecom industry wants to know how DG Comp will look at proposed mergers, but this cannot be determined from the black box of DG Comp and the different information it leaks to different parties. For example there is the press release from DG Comp and Vestager on September 11 saying that Telenor and Telia have rescinded their merger. However this version is revised. An earlier version of the document noted that more information about the merge from DG Comp would be fortcoming. This was subsequently removed in the current version.

There is also an email received by a Strand Consult team member from DG Comp’s Ricardo Cardoso. There is yet another communication provided by DG Comp to a Danish bank on Friday 11 September at 14:30 that within 20 minutes DG Comp would provide some explanatory information about the merger. This material was not sent to the bank, but on Monday, September 14 Ricardo Cardoso informed the bank that no further information would be shared. Yet on that same Friday, September 11, a Danish journalist received a document from DG Comp with additional information about the failed merger. It is possible that this is the document that was promised to the Danish bank but was never sent.

The Danish bank asked DG Comp if they would present at an investors’ meeting to explain their decision, but DG Comp declined. However on Tuesday, September 15 DG Comp presented at a meeting for Credit Suisse where a DG Comp representative explained why the merger failed.

It appears that DG Comp does not want to reveal what is happening inside the black box, though it decides to share different information with different actors. In light of the proposed mergers in the EU and the importance the European Commission has placed on increasing investment by the telecom industry, transparency is needed to how DG Comp is working. To be sure, each party likely has an perspective to why the merger failed. That’s why an independent study is needed to investigate the role of DG Comp in the failed merger of Telenor and Telia in Denmark. Would Telenor and Telia willingly present a merger they knew would not be approved (or were they misguided by their advisors)? Or does DG Comp employ an arbitrary set of politics?

What’s next for Telenor and Telia
Telenor has a negative cash flow in Denmark and Telia’s cash flow is marginal, so going forward, both firms will have to reduce costs significantly, with Telenor having more fat to shed. Telenor is on that path already with the implementation of a new OSS/BSS system.

Telenor and Telia are equal owners the TT Network company, a shared infrastructure company. The goal of the merger was the combine to the two operators on the same network, but the number of networks would still be the same. Now that the merger won’t happen, there is a chance that Telenor will withdraw from the Danish market. The question is whether HI3G can make an “in market consolidation” in the same way it did in Austria and Ireland and now attempts in Italy and England. Here are the options for Telenor from Strand Consult’s perspective.

1. Telenor sells its business to HI3G. The Telenor share of TT Network goes to HI3G. DC Comp will probably not accept Denmark to become a two network operators market.

2. Telenor sells its customer base and spectrum to HI3G. Then HI3G intakes the new customers and uses the spectrum to expand its network. The EU may look more favorably on this model, but it’s not clear what the shareholder agreement between Telia and Telenor will require as to divesting parts of TT Network. Telia would be left with a large network, large commitments, and only a small customer base on which to earn a return on investment. Unless a sizeable chuck of the TT network and its customers are offered, the model is not realistic.

3. Telenor sells its customer base to HI3G, which then intakes the customers to HI3G’s network. HI3G obtains spectrum in the 2016, 2018 and 2019 auction. The model is the same #2 above but with the difference that HI3G first reaps synergies as they intake customers. It is not a realistic model.

4. Telenor sells its Danish business to a private equity fund that can optimize the operations and hope that the next head of DG Comp makes it possible to carry out the sale to Telia. This is the model TDC and Orange selected in Switzerland after competition authorities refused the merger of Sunrise and Orange. It is probably the most likely exit model for Telenor to get out of Denmark.

5. Telenor sells its Danish business to a new company that consolidates FTTP providers such as SE/Stofa. It requires that the utility power companies raise the necessary capital. The model is impaired by the history that utility power companies have not worked well together.

6. Telenor sells its Danish business to a yet another international operator. This is most unlikely as no operator is interested to enter Denmark, a country where achieving profitability is almost impossible for network entrants.

7. Telia and Telenor sell TT Network P/S to an actor that offers a carrier’s carrier. Telia and Telenor become an MVNO on top of the network. Strand Consult has described this model. It is a model seen in other countries, though the EU market may not yet be ready for it. Mobile operators still see their core competence to build and operate networks.

8. Telia and Telenor reduce OPEX and CAPEX further and attempt to raise prices. If they can survive, perhaps the next European Commission will be effective to provide the needed framework for telecommunications. But three years is an eternity in fast changing mobile markets, so that both providers remain at that time is unlikely. As Strand Consult describes, the European Commissions has consistently failed the telecom industry in recent years first with Neelie Kroes and now with Ansip and Oetinger.

In any case Telenor Denmark must reduce costs and attempt to postpone investments while it tries to raise prices on the lowest offers in the market. The hope is that Telia and TDC would follow. But HI3G is the “dark horse” in this game. If HI3G maintain the lowers prices, then Telenor will not succeed to increase price.

Regardless of the next step in Denmark, nothing changes that fact that HI3G has a spectrum challenge moving toward 2017. Moreover the Danish government has established strict coverage requirements for the auctions in 2016, 2018 and 2019. HI3G´s spectrum crunch will not be resolved before these auctions. HI3G lacks the spectrum to continue to be aggressive going forward, as they can’t get more spectrum before 2017. Telia and Telenor are under such financial pressure that they will do little to push the market.

The official reason DG Comp opposed the Telenor Telia merger was it would create higher prices. However by not allowing the merger to happen DG Comp has ensured a self-fulfilling prophesy of higher prices. As the players in the Danish market can’t consolidate, they will continue to bleed cash. Raising prices is the only way they can stay afloat, absent another M&A activity. The other point is that the lowest offers in the market will be eliminated first. This means that the most-price sensitive customers suffer.

Consolidation is inevitable, either through optimal, efficiency-enhancing market conditions selected by the operators, or the worst case scenarios driven by competition authority. Without higher prices or an M&A event, Telenor will simply have to shut its doors. Thus the outcome is inevitably a reduced number of players on the market.

To be sure, the position of DG Comp does reward one player in particular, that of Danish market leader TDC. With a large market share and great cash flow, TDC is best prepared for the future. Such an outcome is aligned with frequent observation that government intervention tends to reward incumbents and harm entrants. That is exactly the perverse situation which DG Comp has created here.

What are the implications for the mergers and acquisition under way in the global telecommunications market
Had DG Comp been a private company, they would be censured for publicly divulging misleading information, but given that they are a governmental entity, they can get away with it. Old ideas die hard, and competition authorities are reluctant to update their analytical skills, both because it requires effort and it reveals the failings of their past decisions. So many bureaucrats use the same obsolete skills they had more than a decade ago when they started their job. Telecom companies and their trade associations may have succeeded to communicate the industry’s challenges to DG Connect, but this has not worked for DG Comp, namely that consolidation is needed to shore up an industry with declining profitability brought on by technological disruption. Thus the European Commission remains a schizophrenic branch of government with two agencies working a opposite purposes for telecommunications. See EU Commission’s schizophrenic telecom policy: hurts investments, costs jobs, and pulls EU’s digital development even further back compared to other parts of the world.

What happened in Denmark will have profound consequences for mergers in England and Italy. It is also likely that there will be a ripple effect to other parts of the world with negative impacts to TeliaSonera in their attempt to sell their Eurasian operation, seven mobile operators in seven nations that were part of the former Soviet Union. TeliaSonera would like to maximize the price for these assets by selling them to an actor that makes in market consolidation. Let’s hope that the regulators in these countries are not inspired by the obsolete and short-term thinking of Margrethe Vestager and DG Comp.

Investors should heed the case of Denmark for the future of mergers in Italy and UK. When it comes to DG Comp, the black box and confusing communication observed in Denmark is par for the course. Politics will be a driver in the decision in those countries, regardless of the facts.

The Telenor Telia merger was an option that would have best satisfied the market and ensured fair competition. It is unfortunate that the merger came at a time when the Danish Margrethe Vestager came to her post at DG Comp. At the risk of appearing soft on her own country, Vestager appears to have deliberately sabotaged the merger and simultaneously sent a signal to the operators in the UK and Italy that it will be difficult to find a solution.

Ultimately mobile industry is about remedies and how DG Comp plays favorites with players in the market, rewarding one set of shareholders at the cost to another. Remedies are the advantages player C gets when players A and B merge. Studying the remedies is how to determine who wins today and how the market will look in the future.

It is increasingly dark for the telecom industry in Europe. Danish operators are in a coma, and Margrethe Vestager’s DG Comp remains a black box.

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