Time for Vodafone to revisit a Virgin Media deal?

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Vodafone is shelving plans to launch a pay TV offering in the UK, saying: "Our focus in the UK is on broadband, where we're seeing good growth. We will look at launching TV in the UK when we deem it necessary and commercially appropriate." CEO Vittorio Colao said that the company has decided to put it on hold indefinitely, although the service could be launched "within weeks".

The plans were initially revealed in May 2015, when Vodafone launched its revamped home broadband service, promising a pay TV offering later in the year. Few details of the pay TV plan have been revealed, but it's understood the failure to reach a deal with BT Sport to carry its channels was a major factor in the service being shelved.

Vodafone struggles to gain UK broadband market share

The very modest success of Vodafone's home broadband (ADSL) offering has undoubtedly dampened the telco's desire to further expand into the competitive UK fixed line market. While the service has gained some traction, it had gained just 183,000 subscribers by the end of 2016 - a market share of less than 1%, and a far cry from Vodafone's achievements with fixed offerings in Germany, Italy and Spain, which are well into the millions. Vodafone's UK fixed line revenues fell nearly 21% in 2016, although a lot of this can be attributed to the fall in the value of the pound since the Brexit vote (Vodafone reports its revenues in euros).

Barriers to success in the UK fixed-line market

So, what are the barriers to building share in the UK fixed line market?

The main barrier is that there are four mature competitors in the fixed-line sector in the UK: the "big four" of BT, Sky, Liberty Global's Virgin Media and TalkTalk. Virgin and TalkTalk both also have established MVNOs, whilst Sky has recently launched its own mobile offering in response to BT buying UK mobile giant EE (itself a joint venture between Orange and Deutsche Telekom).

The UK's mobile and fixed sectors are unusual in Europe in that they have largely developed separately, particularly after BT spun off its mobile arm Cellnet in 2001, which became Telefónica's O2.

This trend was reversed somewhat by BT buying EE, which was cleared by the UK competition regulator in 2015, and which we believe has strengthened BT's position. The tie-up has handed BT 35% of the mobile consumer market to add to its similar share of the UK's consumer fixed broadband business. The deal was approved on the basis that BT had very little in the way of mobile business, while EE had some 950,000 broadband customers, this was not thought to be enough to have a detrimental effect on competition in either sector. While BT has stated it plans to maintain EE as a separate brand for the time being, it is already leveraging its consolidation with EE customers being offered 3 months' free live sport on the BT Sport app.

The beginning of consolidation in the UK

The merger of BT and EE has created a powerful new player in the UK multiplay sector. This has already caused Sky to renter the market with a mobile proposition, and as these fixed-line giants move into mobile this puts more pressure on Vodafone to improve its fixed offering.

Vodafone has been attempting to improve its fixed presence across Europe in the past decade with key cable acquisitions in Germany and Spain and Cable & Wireless Worldwide in the UK. Elsewhere it has formed a joint venture with Liberty Global's Ziggo in the Netherlands, sparking rumours of a combination with Virgin in the UK. The Netherlands deal was largely an effort to challenge the fixed and mobile dominance of incumbent KPN, and Vodafone now faces a similar threat from BT/EE in the UK.

Vodafone has repeatedly denied any plans to merge with Virgin in the UK, with CFO Nick Read saying there were no talks with Liberty beyond the Netherlands, although he admitted they are seeing some price pressure from EE and O2 in enterprise in the UK. The main barrier to any tie-up with Virgin is that the cableco has over 3 million mobile subscribers to its MVNO service, which would undoubtedly cause regulatory issues (Vodafone Netherlands was forced to sell its 150,000 fixed subscribers to T-Mobile to facilitate the Ziggo merger).

Time for VodaVirgin?

Following the approval of the awkwardly named JV "VodafoneZiggo", Vodafone must be seriously considering a cable tie in the UK. The telco has fallen some way behind mobile market leaders O2 and EE, and at one point risked being pushed into a very distant third by the merger of O2 and CK Hutchison's 3 UK (which was blocked by the European Commission).

So, BT and Sky are ramping up their mobile game, further increasing competition in an already cutthroat sector. Plus, Vodafone's strategy of cable partnerships with Liberty is bearing fruit elsewhere in Europe, meaning a combination with Virgin is one obvious answer in the UK - although the two companies must be prepared to jump through some serious regulatory hoops to gain approval for such a deal.