Vodafone: Three UK deal would impede necessary restructuring

Vodafone’s knotty structure already bamboozles investors. Some of them want the UK mobile operator to simplify its sprawling empire. Vodafone’s proposed tie-up with rival Three UK runs counter to that aim.

The deal would create the country’s largest mobile operator. As 51 per cent shareholder, Vodafone would own less of the combined assets than when the units were separate. But that controlling stake means it could eventually absorb the whole unit.

Pity the poor equity salesperson who has to talk that up to an impatient investor in a two-minute call.

Ofcom has noted that neither group makes a decent living in the UK. In February, the watchdog estimated that neither business generated returns on capital above a cost of 9 per cent. That situation cannot have improved much following interest rate rises.

The regulator previously frowned on any consolidation from four to three big UK mobile operators. It stopped Three from merging with O2 — then owned by Spain’s Telefónica — in 2016.

Now Ofcom has had a change of heart.

Some financial balancing would be required. Vodafone UK generates about twice the annual ebitda of Three UK and would contribute around the same ratio of merged assets. A nearly half-and-half share split necessitates a payment from CK Hutchison. If Vodafone injects €10bn (£8.7bn) of assets it could then receive a top up of €5bn of cash from the newco, raised with debt, thinks New Street Research.

Final details must wait until the two sides agree on a combined valuation. What might Three UK be worth? Assume a six times enterprise value to ebitda multiple for Three UK and that puts it on £4.4bn. Vodafone UK would represent another £9.8bn.

Cost benefits from adding Three’s network might lift Vodafone’s share price another 4-5 pence. Vodafone’s smallish share price reaction on Tuesday gave credit for under half that.

Vodafone wants to fix important sub-par markets such as the UK, which accounts for more than 9 per cent of the group’s worth. But shareholders expecting cash from divestments will see assets expand instead and any debt from the newco consolidated on to the balance sheet. The hope is that Three’s additional ebitda keeps the leverage ratio down.

But what of the long-promised Vantage Towers asset sale? Vodafone says it is “in process”. The group is exiting Hungary while acquiring in Portugal. Unknotting Vodafone requires deft sword strokes, not fiddling with loose ends.