On May 11, Margrethe Vestager, the EU competition commissioner, rejected CK Hutchison's 3 UK's proposed acquisition of Telefonica's U.K. division O2 UK. We had thought the odds of approval were about 50%, so we aren't surprised by the rejection. We think this makes approval of CK Hutchison's 3 Italia's proposed merger in Italy with VimpelCom's Wind division highly unlikely. Competition is much lower in Italy, as evidenced by fewer mobile virtual network operators and much higher EBITDA margins.
It would have provided fuel for the fire of politicians in favour of Brexit
However, the Italian deal has two advantages. First, the U.K. deal was complicated by 3's network-sharing agreement with EE, and by O2's network-sharing agreement with Vodafone. Allowing 3 and O2 to merge without changing the network-sharing agreements could have potentially provided the combined firm with a network advantage. Second, the deal became tied up with Brexit, as both Ofcom, the U.K. telecom regulator, and the U.K. Competition and Markets Authority came out strongly against the deal.
If the EU had approved a deal that the local regulators were against, it would have provided fuel for the fire of politicians in favour of Brexit. Owing to the political sensitivity of this issue, we don't expect Hutchison to appeal the ruling until after the U.K.'s vote on Brexit on June 23.
Despite the deal's rejection, we are not changing our fair value estimates or moat ratings on any of the companies involved. We still believe Telefonica is undervalued and it has other means of raising cash to reduce debt. These include looking for another buyer of O2, possibly Liberty Global, or spinning off part of it.
We also believe the firm can sell some of its other long-term financial assets, as well as possibly listing Telxius, the company it recently created to hold some of its telephone tower portfolio. We also assume it will pay a significant portion of its €0.75 per share dividend in shares rather than cash. Paying 50% in shares would save it €1.85 billion.