In-market consolidation – more critical than crossing borders

European telecom operators are today facing multiple challenges – economic recession, regulatory pressure, price wars that erode ARPUs, low financial returns, to name just a few. It is also known that Europe has fallen behind the US in LTE investments and has lower LTE coverage and number of LTE connections. Therefore, some argue (including the EU telecom commissioner Neelie Kroes) that European operators need bigger scale, achieved through cross-border consolidation, in order to become global players and increase their ability to invest and expand.

Consolidation through M&As seems inevitable in Europe, but before greeting potential cross-border consolidation, it appears that in-country consolidation is the next (and more viable) step, much to the objection of telecom regulators or competition authorities. The reason is that with four players per market (the current state in many European countries), the profit margins and maneuverability are so small that there is no justifiable business case for an operator to expect high returns by expanding into new countries, even when factoring in the potential benefits of scale. True, some scale benefits can be achieved by centralizing certain functions such as procurement, financing, IT or product development. But to be also realistic – group operators are not known as the most efficient, and common processes and centralized operations can result in administration overhead due to mirroring of functions as well as losing agility to respond quickly to local market changes. European countries are much more diverse than the states that form the US in terms of economic development, cultures, languages etc. to expect that Europe can leverage scale as well as the US.

Therefore, whatever scale benefits there are on paper will be largely offset by the added complexity in reality, and the main problem still remains that four-player markets do not offer healthy business conditions for telcos. Operators are already indicating their ambitions to move from four to three players per market. Austria has taken the step through the completed merger of Hutchison 3G Austria with Orange Austria. Hutchison has followed this strategy in Ireland where 3 Ireland has proposed to acquire rival O2, a transaction, which the EU Commission has expressed objections about and is expected to address in a final decision in April. The concerns are well known – fewer players would mean less competition and higher prices for consumers. But if the third and fourth players are so far behind the market leader(s), their merger can result in a third player with financial strength and spectrum assets to preserve competitive market dynamics. Germany is a key market where the proposed €8.6bn merger of E-Plus with Telefonica Deutschland can become a turning point and a catalyst for change. If approved by the EU Commission, and there are indications that this will probably happen (given certain remedies), we will likely witness more such activity in the near future.

Consolidation in Europe is inevitably due to happen and as we see more three-player markets emerge, there is hope that Europe can again take a lead in mobile communications.

/Galina

Galina is a Senior Consultant at Northstream

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