Opportunities For UPC In O2 Spectrum Divestiture

BMI's view that Telefónica Deutschland would be required to divest excess spectrum in order to secure regulatory approval for its proposed acquisition of rival E-Plus looks set to play out. Specifically, the Federal Networks Agency (BNetzA) believes the merged entity would dominate in the 1800MHz band, giving it an unfair advantage in the nascent 4G mobile broadband market. Observers believe that a new player could enter the market by buying this spectrum but we believe a newcomer would face - in extremis - the same difficulties that prompted O2 and E-Plus to merge in the first place.

The deal, as announced on October 2013, would see KPN sell E-Plus to Telefónica Deutschland for EUR5bn in cash plus a 20.5% stake in the enlarged business. At the time, BMI took the view that the transaction would be approved in order to safeguard investments in infrastructure and services, but that concessions would be demanded of Telefónica, specifically the sale of excess resources such as spectrum and infrastructure. BNetzA's statement, following six months' analysis of market conditions and consulting with industry players is, therefore, not surprising and we expect Telefónica to respond in short order with proposed remedial measures.

Between them, Germany's four mobile network operators have rights to use a total of 607MHz across five important bands. Currently, the overall distribution of spectrum is fairly equitable, with E-Plus owning 139.4MHz and O2 158.7MHz, versus Vodafone's 154.5MHz and T-Mobile's 154.6MHz. However, post-merger, O2 would effectively have control of 49% of frequencies used to provide public mobile communications services in Germany. More significantly, it would control 64% of spectrum in the 1800MHz band, a set of frequencies that are increasingly being used to offer advanced mobile broadband services - via 4G LTE technology - in urban areas.

UPC Stays Tuned To Spectrum Developments
Spectrum Holdings By Operator By Band (MHz)

Opportunities For UPC In O2 Spectrum Divestiture

BMI's view that Telefónica Deutschland would be required to divest excess spectrum in order to secure regulatory approval for its proposed acquisition of rival E-Plus looks set to play out. Specifically, the Federal Networks Agency (BNetzA) believes the merged entity would dominate in the 1800MHz band, giving it an unfair advantage in the nascent 4G mobile broadband market. Observers believe that a new player could enter the market by buying this spectrum but we believe a newcomer would face - in extremis - the same difficulties that prompted O2 and E-Plus to merge in the first place.

The deal, as announced on October 2013, would see KPN sell E-Plus to Telefónica Deutschland for EUR5bn in cash plus a 20.5% stake in the enlarged business. At the time, BMI took the view that the transaction would be approved in order to safeguard investments in infrastructure and services, but that concessions would be demanded of Telefónica, specifically the sale of excess resources such as spectrum and infrastructure. BNetzA's statement, following six months' analysis of market conditions and consulting with industry players is, therefore, not surprising and we expect Telefónica to respond in short order with proposed remedial measures.

UPC Stays Tuned To Spectrum Developments
Spectrum Holdings By Operator By Band (MHz)

Between them, Germany's four mobile network operators have rights to use a total of 607MHz across five important bands. Currently, the overall distribution of spectrum is fairly equitable, with E-Plus owning 139.4MHz and O2 158.7MHz, versus Vodafone's 154.5MHz and T-Mobile's 154.6MHz. However, post-merger, O2 would effectively have control of 49% of frequencies used to provide public mobile communications services in Germany. More significantly, it would control 64% of spectrum in the 1800MHz band, a set of frequencies that are increasingly being used to offer advanced mobile broadband services - via 4G LTE technology - in urban areas.

Naturally, this significant market power could be used to competitive advantage by O2 as it could deliver faster and more reliable mobile broadband access in major metropolitan markets and at a lower cost than its rivals. Selling surplus spectrum is, therefore, the key to ensuring that the deal is approved.

Germany's mobile network operators are finding it increasingly difficult to secure new customers in the highly saturated mobile market, yet need to find new ways of growing their business amidst falling usage of billable voice and messaging services in light of IP substitute services such as WhatsApp and Skype. In addition, regulator-imposed cuts to mobile termination rates (MTRs), the need to invest heavily in new infrastructure to cope with increased data traffic flows and increased price competition wrought by both MVNOs and converged service providers are weighing on profit margins and KPN has concluded that the German market offers little in the way of improved profitability.

Any spectrum relinquished by O2 would pique the interest of existing players and prospective new investors alike. BMI the likeliest candidate is cable operator UPC Unitymedia, which sees Vodafone as a threat to its well established triple-play business in Germany and has let it be known that it wants to expand into the mobile market wherever possible. Vodafone's acquisition of Kabel Deutschland cannot go unchallenged and UPC will want a mobile network of its own if it is to compete with the enlarged Vodafone-KDG. Through a reseller agreement, UPC served 239,500 mobile subscribers in Q413, but this is a very small number relative to its 11.699mn revenue-generating units (RGUs) and the total 115.225mn subscribers served by all German mobile operators at that time.

Yet, UPC will be reluctant to overpay for the spectrum - which may yet be contested by Vodafone and T-Mobile - as building a new mobile business from scratch in a saturated market is a cash-intensive proposition. Telefónica may yet be asked to sell excess base stations, transmission facilities and towers, as well as its discount and MVNO partnerships. In that case, UPC could quickly build a small but credible network operator business that may justify adventurous bidding for O2/E-Plus assets. But with BMI forecasting mobile subscription growth of just 0.6% per annum, amidst declining mobile ARPUs, over the next five years, we believe it will need to refrain from aggressively pursuing any assets Telefónica may put up for sale.

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