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Irish consolidation: a reality check
● The second precedent since Austria: In our 400-page sector piece on the prospects for in-market mobile consolidation (see Telecommunications - Mobile consolidation: a reality check, Volume 1: Thematic thinking, dated 18 June 2013), we discussed the potential for in-market consolidation to come to the rescue of the struggling European mobile market. We concluded that a cautious stance on European mobile consolidation prospects was appropriate, not because of a zealous belief that consolidation will not happen but because we believe the Austrian precedent shows that the EC will take a remedy-heavy approach to in-market mobile consolidation. Thus consolidation prospects will be defined by where remedies are likely to be least effective. With Hutchison announcing its acquisition of O2 in Ireland, the EC is likely to once again take a tough stance on remedies.
● The EC sequel – expect Irish remedies to be far-reaching: We expect the EC to look to impose far-reaching remedies on the Irish market. The combined Hutchison-O2 business will see revenue share concentration peak above other potential consolidation opportunities in Europe, giving it a 61% share of the mobile broadband market and 50% of the postpaid segment. In addition, if we take the Austrian precedent on spectrum, the combined business may need to divest to a new entrant over 20MHz of sub-1GHz spectrum, which could be auctioned if ComReg decides to go ahead and auction the 1.5GHz band in the next couple of years. Pricing in the Irish market stands out as being neither particularly expensive nor cheap, while the immature MVNO segment would likely make MVNO obligations another EC remedy, as it was in Austria. However, Irish margins are low and Hutchison as the smallest MNO is still losing money. This arguably makes any new entrant opportunity unappealing. Hence, in the case of Ireland, we can see the arguments why remedies may not have the impact they could in stronger markets.
● What Irish consolidation means for the rest of Europe: Ireland could provide another test case, along the lines of the Austrian example. Given an immature MVNO sector and a high spectrum concentration though, this deal will also likely be accompanied by material remedies on both regulated MVNO access and substantial spectrum divestments – possibly to a new entrant. However, also like Austria, the Irish market seems to be suffering from a distressed situation, with low margins and Hutchison still losing money in the market. The calculation may therefore be that, as in Austria, the new entrant threat and MVNO threat are viewed as immaterial, due to the lack of attractiveness of the market. Our view remains that consolidation will be based on the potential effectiveness of remedies; we see Germany and France as the two best-placed EU 4-player markets to deal with those remedies.
26 June 2013
Paul Marsch Analyst +44 20 3207 7857 [email protected]
Stuart Gordon Analyst + 44 20 3207 7858 [email protected]
Barry Zeitoune Analyst +44 20 3207 7859 [email protected]
Usman Ghazi
Analyst +44 20 3207 7824 [email protected]
Wassil El Hebil Analyst +44 3207 7862 [email protected]
Laura Janssens
Marketing Analyst +44 20 3465 2639 [email protected]
Julia Thannheiser Specialist Sales +44 20 3465 2676 [email protected]
Telecommunications
Irish consolidation will result in large concentrations, especially in the mobile broadband market
Following on from the Austrian precedent, the EC has another test case, which will have far-reaching implications for European mobile consolidation. In Austria, despite the Hutchison-Orange combination having less than 25% market share, the EC competition authority decided to make an example of what it will do to protect consumers from increasing prices. This included MVNO access obligations, as well as spectrum divestments and new spectrum reserved for a new entrant.
Why the Hutchison-O2 deal in Ireland falls under the EC remit
On pp.44-45 of our note Telecommunications - Mobile consolidation: a reality check, Volume 1: Thematic thinking, we go through the EC approval process in detail.
A combined Hutchison and O2 Ireland will have over EUR5bn of worldwide turnover and over EUR250m in the EU.
In addition more than two-thirds of its EU turnover will reside in Ireland.
As such, it will qualify as a “concentration” with a “community dimension”.
In addition, the combined entity will have a 35% subscriber share, as well as a 61% share of the mobile broadband market and 50% of the postpaid market. This is significantly above the 25% threshold below which the EC does not necessarily need to review the transaction.
A significant increase in concentration
In Exhibit 1, we show the current market shares and HHI (Herfindahl–Hirschman Index) before consolidation in the EC market. This shows that while Vodafone is the market leader for non-mobile broadband subscription, followed by O2, Hutchison is the market leader in mobile broadband. Although there is a decent MVNO in Tesco, it is almost exclusively focused on the prepaid market, which makes up 59% of the Irish market.
In Exhibit 2, we show how concentration would look following the Hutchison-O2 acquisition. Excluding mobile broadband, the combination will be left with a combined 35% market share – still significantly more than Hutchison-Orange has in Austria. Secondly, at 12% penetration, mobile broadband is a relevant market in Ireland. The combined Hutchison-O2 business will have 61% market share, making it highly concentrated. In addition, the combined business will have 50% postpaid share, although this is affected by the mobile broadband market too.
So based on the EC’s substation testing, the high concentration of O2 and Hutchison in the mobile broadband market could flag up issues that the EC seeks to address through remedies.
Telecommunications
Exhibit 1: Irish mobile stats pre-consolidation
Source: Berenberg, Comreg
Subscribers (ex-mobile BB) Subscribers mobile BB Postpaid subscribers Prepaid subscribers Total revenues (€ millions)
Vodafone 1,990 154 770 1,374 173
Telefonica 1,379 149 790 738 101
Eircom 1,007 60 330 738 66
Tesco (O2 MVNO) 186 0 11 174 5
Hutchison 328 180 331 177 38
TOTAL 4,890 542 2,231 3,201 383
27.87764936
Subscribers (ex-mobile BB) Subscribers mobile BB Postpaid subscribers Prepaid subscribers Total revenues (€ millions)
Vodafone 40.7% 28.3% 34.5% 42.9% 45.2%
Telefonica 28.2% 27.4% 35.4% 23.0% 26.3%
Eircom 20.6% 11.1% 14.8% 23.0% 17.3%
Tesco (O2 MVNO) 3.8% 0.0% 0.5% 5.5% 1.2%
Hutchison 6.7% 33.2% 14.8% 5.5% 10.0%
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0%
Subscribers (ex-mobile BB) Subscribers mobile BB Postpaid subscribers Prepaid subscribers Total revenues (€ millions)
Vodafone 1,656 801 1,190 1,842 2,043
Telefonica 795 751 1,253 531 692
Eircom 424 123 219 531 299
Tesco (O2 MVNO) 14 0 0 30 1
Hutchison 45 1,102 219 31 100
Total 2,935 2,777 2,881 2,965 3,135
Q1 2013 data Ireland data points
Q1 2013 data Ireland market share
Q1 2013 data Ireland HHI
Telecommunications
Exhibit 2: Irish mobile stats post-consolidation
Source: Berenberg, Comreg
Subscribers (ex-mobile BB) Subscribers mobile BB Postpaid subscribers Prepaid subscribers Total revenues (€ millions)
Vodafone 1,990 154 770 1,374 173
Eircom 1,007 60 330 738 66
Tesco (O2 MVNO) 186 0 11 174 5
Hutchison 1,707 329 1,120 915 139
TOTAL 4,890 542 2,231 3,201 383
Subscribers (ex-mobile BB) Subscribers mobile BB Postpaid subscribers Prepaid subscribers Total revenues (€ millions)
Vodafone 40.7% 28.3% 34.5% 42.9% 45.2%
Eircom 20.6% 11.1% 14.8% 23.0% 17.3%
Tesco (O2 MVNO) 3.8% 0.0% 0.5% 5.5% 1.2%
Hutchison 34.9% 60.6% 50.2% 28.6% 36.3%
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0%
Subscribers (ex-mobile BB) Subscribers mobile BB Postpaid subscribers Prepaid subscribers Total revenues (€ millions)
Vodafone 1,656 801 1,190 1,842 2,043
Eircom 424 123 219 531 299
Tesco (O2 MVNO) 14 0 0 30 1
Hutchison 1,218 3,672 2,521 817 1,318
Total 3,313 4,596 3,930 3,220 3,661
Q1 2013 data Ireland HHI
Q1 2013 data Ireland data points post deal
Q1 2013 data Ireland market share
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As well as subscriber concentration, we also care about spectrum concentration. In Exhibit 3 we look at this both pre- and post-consolidation. For the adjusted spectrum share, we apply an adjustment to reflect the different quality of spectrum and thus the differing price of spectrum bands. This is based on Ofcom data and takes account of anomalies in spectrum share, such as one operator having a particularly high share of sub-1GHz spectrum.
Prior to consolidation, there is a relatively balanced spectrum portfolio, although Hutchison is weaker than its competitors when it comes to sub-1GHz spectrum. After consolidation though, the combined business will have 45% of spectrum in the market, and 43% on an adjusted basis. This is before applying any remedies.
In Exhibit 4, we plot European 4-player markets, prior to consolidation, based on spectrum HHI on one axis and revenue HHI on the other. This shows that, while currently there is a high degree of spectrum fragmentation in the Irish market (similar to Germany and the UK), the market looks relatively uncompetitive in terms of revenue share. This is not a surprise given that i) MVNOs only have a low market share, and ii) Vodafone has such a high revenue share of the market at 45%. This would thus indicate that non-spectrum remedies could form a meaningful component of the way the EC addresses competition through Irish consolidation.
Exhibit 3: Post-2015 spectrum share (pre- and post-consolidation)
Source: Berenberg
Pre-deal specturm
Post 2015 800 900 1800 2100 2600 Total Share HHI
Vodafone 20 20 50 30 120 30% 900
O2 20 20 30 30 100 25% 625
Eircom 20 20 30 30 100 25% 625
Hutchison 10 40 30 80 20% 400
Total 60 70 150 120 400 100% 2,550
Spectrum adjustment 1.0 1.0 2.0 2.5
Post 2015 800 900 1800 2100 2600 Total Share HHI
Vodafone 20 20 25 12 77 30% 926
O2 20 20 15 12 67 26% 701
Eircom 20 20 15 12 67 26% 701
Hutchison 0 10 20 12 42 17% 276
Total 60 70 75 48 253 100% 2,604
Post deal spectrum
Post 2015 800 900 1800 2100 2600 Total Share HHI
Vodafone 20 20 50 30 120 30% 900
Eircom 20 20 30 30 100 25% 625
Hutchison 20 30 70 60 180 45% 2,025
Total 60 70 150 120 400 100% 3,550
Spectrum adjustment 1.0 1.0 2.0 2.5
Post 2015 800 900 1800 2100 2600 Total Share HHI
Vodafone 20 20 25 12 77 30% 926
Eircom 20 20 15 12 67 26% 701
Hutchison 20 30 35 24 109 43% 1,856
Total 60 70 75 48 253 100% 3,484
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Exhibit 4: Pre-consolidation, Ireland has a low adjusted spectrum HHI, but a high service revenue HHI
Source: Berenberg
In Exhibit 5, we show the same chart but assuming the most likely consolidation in each EC 4-player market. For the Irish market this comes with some very interesting conclusions.
Firstly, this chart shows the EC precedent of what we have seen with the Austrian deal. As a result of the 2.6GHz spectrum to be given to a new operator, and the 800MHz spectrum reserved for the same new entrant, spectrum remedies will see the adjusted spectrum HHI fall from 3,297 to 2,904 – should these remedies be successfully implemented.
With regard to Ireland, the resulting spectrum concentration of 3,484 puts it marginally above the average, but also comfortably above the concentration seen in Austria. With a 43% adjusted spectrum share, the combined Hutchison-O2 business will likely face Austrian-style spectrum divestments.
However, what really stands out in the Irish market is the service revenue HHI, which after consolidation would be the highest of all the potential consolidation opportunities in Europe. Clearly, remedies will not stop at spectrum as this position would leave market revenues particularly highly concentrated.
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Exhibit 5: Post-consolidation, Ireland has the highest service revenue HHI
Source: Berenberg
The remedies the high concentration indicates
Following the above work on concentration, we would expect remedies in Ireland to take three forms. Firstly, the spectrum share will be addressed, possibly by requiring spectrum divestments to a new entrant. Secondly, given the immature MVNO market, access obligations will form another meaningful component. Finally, the high concentration in the mobile broadband segment could in our view mean divestments if the EC’s substitution tests capture it.
Spectrum: If we take the Austrian precedent, to get to an adjusted spectrum HHI of 2,904, the Irish consolidated entity would have to divest just over 20MHz of premium sub-1GHz spectrum to a new entrant. Outside spectrum auctions, Comreg has indicated little in terms of new auctions to come. 2.6GHz spectrum is currently being used by UPC and is unlikely to be auctioned until 2016, while the 700MHz band needs to be harmonised, which could be five years away. Comreg is however likely to launch an auction consultation for the 1500MHz band next year, and this could be used as a medium for reallocating any spectrum to a new entrant.
MVNO access: The O2/Tesco JV MVNO will likely have its share protected. Given limited MVNO share, the EC may try and boost this.
Divestments: Although not formally required by the EC, Hutchison did divest its Yesss! brand as part of its Austrian consolidation. The combined O2 and Hutchison in Ireland will have a 61% market share in mobile broadband, and a 50% market share in postpaid; thus we would not be surprised to see divestments in Ireland.
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Adjusted spectrum concentration vs market concentration (with consol.)
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How effective will remedies be in Ireland?
When looking to score markets on consolidation potential, we did it according to how effective we thought remedies might be. This was based on the following criteria.
Pricing levels/bundles: Put simply, we assume that where prices are already low, consolidation, even with remedies, may stand a better chance of resulting in market repair as low price levels will deter new entrants.
MVNO presence: Where MVNOs are already a powerful force in the market, there will be less scope for regulators to use MVNO remedies to counterbalance consolidation. Where MVNOs with strong distribution channels are not already present, the introduction of MVNOs could present a good counterbalance to consolidation.
Herfindahl-Hirschman Index (HHI) (pre- and post-MVNOs): Where HHI is low, the market would appear to already be very competitive. Hence the consolidation of two players may be more acceptable, and may leave little scope for new entrants to make an impact, or for the introduction of more consumer-friendly MVNO privileges.
Extent of network-sharing: Where network-sharing is prevalent, there should be less scope for regulators to enforce access to shared infrastructure as a remedy. However, too much network-sharing, or arrangements that are too complex, could act to prevent operators pursuing full consolidation. Also, network-sharing without consolidation at the point of sale to the customers (to remove actual competitive tension in the market) should serve simply to allow operators to extract efficiencies. These will then just be passed onto consumers in the form of lower prices, sustaining competitive tension. This can be particularly important where smaller operators share infrastructure (as in Sweden and Denmark) to gain enough scale to compete with the incumbent.
Strength of competition in distribution: Where the customer has lots of choice at the point of sale, there should be less scope for remedies to make a difference. The presence of strong reseller/retail distribution channels (such as Carphone Warehouse in the UK) should add to the impression that the consumer already has a broad choice of alternatives. Likewise, if the consolidation of operators can also reduce the level of competition at the point of sale without being offset by regulatory remedies, this should be good for market repair.
Spectrum balance among competitors: Where there is an equal distribution of spectrum among competitors (post-consolidation), there is less scope for regulators to enforce spectrum reallocation remedies. Likewise, where there is a significant imbalance between operators’ share of subscribers and spectrum, the scope exists for one or more residual competitors to price disruptively, possibly irrespective of consolidation. We ask whether consolidation could remove potentially disruptive excess capacity from the market, and whether spectrum divestments could create such an opportunity for a new entrant (eg for MVNOs’ ongoing own-network, or for wireline competitors looking to enter mobile).
The opportunity cost of no consolidation: Maybe consolidation will not result in a more rational market, but perhaps it could result in a less disruptive one – it is all relative. Can we identify which markets have a
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high opportunity cost of not pursuing consolidation? Put another way, there may be markets where consolidation is worth pursuing, even with significant remedies, simply because the current competitive environment is so irrational that any level of improvement would be welcome. We compare recent mobile market service revenue growth trends with our medium-term expectations for growth in order to assess which markets face a high opportunity cost from not seeing consolidation.
We have already addressed many of these factors in the previous section. We use this section to look at pricing, MVNOs, network sharing, distribution and the opportunity cost of not seeing consolidation, to look at the prospects for whether remedies will be effective.
Pricing
When we look at pricing in the Irish market, it appears close to the average for a mid-end postpaid subscriber, and at the high end for the important prepaid market.
Exhibit 6: On postpaid medium user pricing, Ireland is close to the average
Source: Berenberg, OECD
Exhibit 7: High-end pricing is closely bunched
Source: Berenberg
All rates are in € O2 Vodafone
emobile
(Eircom) 3 Tesco
€5 usage
Package name O2 open RED Unlimited Ultimate flex na
Voice calls (in min) unlimited unlimited unlimited unlimited unlimited
Data Mb pcm 1GB 1GB 15GB unlimited unlimited
SMS umlimited umlimited umlimited umlimited umlimited
Period (months) 1 1 18 1 na
Monthly Flat rate tariff (base) 40.0 40.0 64.0 39.8 na
Monthly Flat rate tariff (promotion) 40.0 40.0 32.0 39.8 na
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Exhibit 8: Prepaid users, who represent 60% of the Irish market, show it to be expensive
Source: Berenberg, OECD
Exhibit 9: Unlimited voice/SMS packages are expensive
Source: Berenberg
In our view, favourable MVNO contract terms, imposed by the regulator, could disrupt the pricing environment in both the prepaid market and the high value market. In the low value segment, Ireland is 0.9% more expensive than the benchmarked country average. In the mid-value market, Ireland is 16.2% cheaper than the European benchmark average.
MVNO presence
The MVNO market in Ireland is immature. Back in 2010, Ofcom noted that the MVNO market in Ireland was non-existent. However there are now six MVNO agreements in Ireland, of which two are owned by the MNOs. Tesco is the largest MVNO in the market, and is a 50:50 JV between O2 UK and Tesco PLC.
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Who could benefit from an imposed MVNO offer?
In terms of fixed broadband subscribers’ market shares, Eircom has 40% share, followed by UPC (28.1%) and Vodafone (17.1%). Imagine and Digiweb have 3.7% and 2.5% respectively.
Vodafone, which is the second-largest mobile operator, is also the key alternative DSL operator in Ireland.
Neither Digiweb (unbundled operator) nor UPC (main cable operator) has a mobile offer.
In our view, UPC may be best placed to benefit from an MVNO agreement in the Irish market. However, it is interesting that as an MVNO in Austria, UPC has done little thus far to disrupt the market.
Network sharing
O2 and Eircom have a network-sharing agreement signed in 2011; this includes cooperation on site equipment, power supply, technology and transmission sharing. Where possible, existing sites of both operators will be consolidated and new sites will be jointly built. The sharing arrangement does not include spectrum, however.
In addition, Vodafone and Hutchison have a network-sharing agreement, based on 2,000 sites – although both companies continue to run their radio equipment and spectrum independently.
This does provide a complicating factor to the agreement between Hutchison and O2, although this has likely been thought through as part of the current agreement.
Opportunity cost
This is where consolidation looks particularly appealing. O2 makes only a 20% margin in the Irish market, Eircom made a 7% mobile margin last quarter, while Hutchison is still losing money in Ireland. Margins have been affected by competition as well as the very difficult macroeconomic backdrop. This is likely to be a key driver to consolidation, and the low margins in the market will likely deter any new entrant opportunity.
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Please note that the disclosures, historical price targets and rating changes reflect the status of the most recently published comments or reports on the companies.
Valuation basis/rating key
The recommendations for companies analysed by the Bank’s equity research department are either made on an absolute basis (“absolute rating system”) or relative to the sector (“relative rating system“), which is clearly stated in the financial analysis. For both absolute and relative rating system, the three-step rating key “Buy”, “Hold” and “Sell” is applied. For a detailed explanation of our rating system, please refer to our website at
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NB: During periods of high market, sector or stock volatility, or in special situations, the rating system criteria as described on our website may be breached temporarily.
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General investment-related disclosures
The Bank has made every effort to carefully research all information contained in this document. The information on which the research note is based has been obtained from sources which the Bank believes to be reliable such as, for example, Thomson Reuters, Bloomberg and the relevant specialised press as well as the company which is the subject of this research note. Only that part of the document is made available to the issuer, who is the subject of this analysis, which is necessary to properly reconcile with the facts. Should this result in considerable changes, a reference is made in the research note. Opinions expressed in this research note are the Bank’s current opinions as of the issuing date indicated on this document. The companies analysed by the Bank are divided into two groups: those under “full coverage” (regular updates provided); and those under “screening coverage” (updates provided as and when required at irregular intervals). The functional job title of the person/s responsible for the recommendations contained in this report is “Equity Research Analyst”, unless otherwise stated on the cover.
The following internet links provide further remarks on the Bank’s financial analyses:
http://www.berenberg.de/research.html?&L=1&no_cache=1
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This document has been prepared by Joh. Berenberg, Gossler & Co. KG. This document does not claim completeness regarding all the information on the stocks, stock markets or developments referred to in it. On no account should the document be regarded as a substitute for the recipient procuring information for himself/herself or exercising his/her own judgements. The document has been produced for information purposes for institutional clients or market professionals. Private customers, into whose possession this document comes, should discuss possible investment decisions with their customer service officer as differing views and opinions may exist with regard to the stocks referred to in this document. This document is not a solicitation or an offer to buy or sell the mentioned stock. The document may include certain descriptions, statements, estimates, and conclusions underlining potential market and company developments. These reflect assumptions, which may turn out to be incorrect. The Bank and/or its employees accept no liability whatsoever for any direct or consequential loss or damages of any kind arising out of the use of this document or any part of its content. The Bank and/or its employees may hold, buy or sell positions in any securities mentioned in this document, derivatives thereon or related financial products. The Bank and/or its employees may underwrite issues for any securities mentioned in this document, derivatives thereon or related financial products or seek to perform capital market or underwriting services.
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