Reshaping the UK Telecoms Market Through Acquisitions, Joint Ventures and Partnerships

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1 February 11, 2011 Issue Gary Barton Current Analysis Analyst, Business Network and IT Services The overcrowded and highly competitive UK telecom marketplace suggests that further consolidation is inevitable. However, since mid-2009 there has been very little in the way of acquisitions by business telecoms operators in the UK indeed the biggest move has been BSkyB s decision to sell its business division, Easynet, to investment firm LDC. BSkyB s subsequent acquisition of The Cloud was driven purely to support consumer activities. Partnering has become a distinct theme in the UK market with operators such as Colt and O2 both announcing partnerships. Similarly Vodafone, O2, Orange and Kcom have all partnered with BT Wholesale for fixed network access. However partnering has drawbacks in terms of shared revenues and easy replication by rivals, whilst an acquisition gives a much stronger guarantee of boosting an operator s market position and customer base. With so many operators fighting for a finite number of customers, future acquisitions are a certainty as companies move to assert their market presence. This report will look at major acquisitions, mergers, partnerships and divestments in the UK telecoms market since 2008 observing general trends and the success and market momentum of the respective deals. This report will also discuss the future outlook of the UK business telecoms market and examine areas where future consolidation is more likely to happen. Current Perspective The trend towards consolidation in the UK has slowed down since The economic slowdown has undoubtedly played a large part in this with banks less willing or able to provide the necessary financing, and companies less willing to risk large capital expenditure until the economy shows signs of recovery. However the forces that drive acquisitions are still very much in play and as a result partnering has become increasingly common as telcos make moves to become holistic service providers (i.e., fixed/mobile/it). Partnering offers notable advantages over acquisition. The financial exposure is much less so it is easier to take a chance on a new or unproven product or company if things don t work out, then the partnership can easily be abandoned. Acquisitions driven by the need to bring a certain product or service to a company can be fraught with peril if the market does not move towards adopting that technology or service, an acquisition risks the buyer being stuck with a less valuable asset. However partnering can also lead to a lack of exclusivity and can often be easily replicated. Exclusivity is often fickle on a deal-by-deal basis and where exclusivity exists it often has a time limit. Acquiring a company gives the buyer sole control of the product or service. Partnering also tends to offer reduced Europe +33 (0) Or visit our Web site: 1

2 payoffs as revenues are split. The divide in the UK between fixed and mobile operators has also lead to a series of partnerships between Vodafone, O2 and Orange and BT Wholesale as a means to supporting their respective overture towards the FMC/UC and fixed markets. Kcom has also partnered with BT to expand its UK presence and, like Orange with its LLU assets, Kcom has transferred the operations of its own network footprint to BT to reduce operating costs. These deals with BT have all been positive for the respective operators, but they also underline that partnerships are easily replicated. The table below asses a number of significant acquisitions, joint ventures, partnerships and divestments in the UK market over the last three years. Significant UK Telecom Market Acquisitions, from 2008 to Present Acquisition / Divestment / Merger / Partnership O2 UK partners with 2e2 (January 2011) Colt Partners with Unisys (October 2010) Easynet sold by BSkyB to investment firm LDC. (GBP 100 million, July 2010) (Includes Easynet Global Services and Easynet Connect) Orange UK and T-Mobile UK merge to form Everything Everywhere joint venture. (March 2010) TalkTalk splits from Carphone Warehouse (CPW) (March 2010) Annual Revenues Market Segment(s) Market Momentum 2e2 generated GBP 200 million in revenues for the FY Following the acquisition of Morse Plc., 2e2 has pro forma 2009 revenues of GBP 430 million. Colt total FY 2009 Colt revenues: EUR billion, UK revenues: EUR million. Easynet reports FY 2009/10 revenues of GBP 203 million. Everything Everywhere reported pro forma 2009 revenues of GBP 7.57 billion. The CPW group FY 2009/10 revenues of GBP billion. TalkTalk Business contributed GBP 327 million of revenues. For H1 2010/11 The new TalkTalk Group posted revenues of GBP 887 million. 2e2 provides ICT lifecycle management services. Large enterprise, mid-market Managed Hosting, Workspace Management; Enterprise, SME Data WAN, Fixed Voice, IP PBX, UC, Access Services. Mid-market, SME Large Enterprise, SME. Fixed and mobile voice, data and networking services. SME focused Access Services, data WAN, fixed and mobile voice, mobile broadband, SIP. Moderate Outlook 2e2 is a good partner for O2 as it has a growing reputation in the UK and Europe. It is too early to judge the success of the partnership, but O2 Unify will put O2 in a strong position to compete in the UK managed services market albeit in a heavily crowded market. This is a new partnership and agreements between telcos and IT services providers have a reputation for not always going smoothly. Colt has been a little vague with its roadmap for the partnership and will need to publicise a few big customer wins to fully convince. The provider is making the most of its new independence announcing a string of new customer wins both in the UK and in Europe following its split from Sky and it is continuing to expand its portfolio (e.g., hosted PBX). The Everything Everywhere JV has created the UK s largest telecoms company in terms of customer numbers (27.9 million at Q3 2010) with the scale to be a very powerful player in the UK market. Initial integration progress has been positive, whilst new product launches (e.g., Orange Pocket Landline) have continued. Doubt remains over the JV s future branding strategy, which may hamper marketing activities and questions over future product development as Orange and Deutsche Telekom remain in competition elsewhere. However, overall the future looks bright for Everything Everywhere. The move away from CPW has been a positive for the TalkTalk Group as a whole and for the newly branded TalkTalk Business (formerly Opal) in particular. Distancing itself from CPW s retail activities has given TalkTalk stronger credibility as a telco. Rebranding Opal as TalkTalk Business is a refl ection of the growing strength of the TalkTalk brand. Continued Europe +33 (0) Or visit our Web site: 2

3 Significant UK Telecom Market Acquisitions, from 2008 to Present (Continued) Acquisition / Divestment / Merger / Partnership TalkTalk buys Tiscali (GBP 236 million, May 2009) Vodafone UK buys Central Telecom (GBP 18.5 million, February 2009) Cable&Wireless Worldwide buys THUS (GBP 329 million, October 2008) Daisy s major acquisitions since 2009 NEG (GBP 23.5 million, December 2010) Spiritel (GBP 27.5 million, November 2010 ) Redstone Telecom (GBP 17 million, August 2009) Eurotel (GBP 13.5 million, August 2009) Vialtus (GBP 13 million, July 2009) Reverse takeover of Daisy by Freedom4 (Freedom4 rebrands as Daisy. GBP 30 million, Jul 2009) Annual Revenues Market Segment(s) Market Momentum In December 2008, Tiscali UK s gross assets were 457m and profi t before tax was 9.7m Central Telecom s revenues were reported to have been between GBP million. THUS reported FY 2008 Revenues of GBP million. Daisy delivered revenues for the 15 months ending March 2010 of GBP million SME, DSL and VPN services Outlook The acquisition of Tiscali instantly positioned TalkTalk as the UK s number two broadband provider, behind BT, and allowed TalkTalk Business to push on with its transition from being primarily a voice provider, to now being an established SME broadband and data WAN provider. TalkTalk Business has the UK s largest LLU network, with ADSL2+ at more exchanges than BT. IP Voice, PBX, UC The acquisition Central can fairly be seen as a big step in Vodafone s move in to the UK UC market. Central was quickly integrated into Vodafone and has played a key in supporting the launch in September 2009 of Vodafone One Net, Vodafone s fl agship SME UC solution which now has more than 10,000 users in the UK across more than 1,000 organisations SME focused Data WAN, Fixed Voice, IP PBX, UC, Access Services SME focused Data WAN, Fixed and mobile Voice, mobile broadband IP PBX, UC, ADSL2+, Healthcare ICT Negative Moderate THUS has struggled under its new ownership. Its network has been absorbed in to C&W s and its largest customers have also been transferred to its new owner. A signifi cant fall (20%) in C&W s mid-market revenues between H1 2009/10 and 2010/11 suggests all is not well. Daisy has been one of the most aggressive consolidators of value added resellers (VARs) in the UK. The company has acquired an impressive skill set, portfolio and customer base through its acquisitions. Daisy has independently acquired 28, ten of which have been in the last 18 months. However, many of the VARs have been struggling financially. The challenge for Daisy is to successfully consolidate all of its acquisitions and deliver sustained organic growth and profi tability. An operating loss of GBP 17.5 million in 2009/10 and a GBP 8.6 million operating loss for H1 2010/11 suggest this is still some way off. Daisy is not the only SME reseller to have made such a large number of acquisitions. For example, Cheshire bases Chess Telecom has made 47 acquisitions in six years. Future Outlook Although consolidation in the UK market has slowed, the merger of Orange and T-Mobile underlines the fact that as voice and data margins continue to contract, economies of scale will be increasingly necessary to stay competitive and profitable. The sheer intensity of competition in the UK strongly suggests that over the next few years the number of operators must reduce either through strategic acquisitions and mergers, or simply by natural wastage as weaker players are picked off for their customer bases. BT remains the UK s most powerful business provider; however its lead is constantly being eroded. O2 and Everything Everywhere for example have already passed BT for total customer numbers in the UK (consumer and business). Large multinational competitors such as Cable&Wireless, AT&T, Verizon, Telefonica and Orange Business Services are a threat in the UK, and it is not inconceivable that any of them might seek to expand their UK presence through acquisition. Indian operators such as Tata and Reliance have the money to Europe +33 (0) Or visit our Web site: 3

4 gain market presence through acquisition, as Reliance has already done once through Vanco. The mobile operators are also attacking BT s market share (and indeed the share of all fixed operators) in the SME and consumer spaces. Acquisition may provide the best route for the likes of Vodafone and O2 to make real strides into the UK fixed market. The companies listed below are some of the UK s strongest challenger operators, both at the MNC/large enterprise level and in the SME market. There is no suggestion that the companies listed below are actively seeking or would welcome takeover attempts. However, if consolidation resumes at the larger end of the UK market, it is companies such as these that are more likely be acquired or, in some cases, be the acquirer. Cable & Wireless Worldwide s annual revenues of more than GBP 2.2 billion make it one of the UK s largest telecoms operators and underline that it is far from being an easy takeover target, either logistically or financially. However, speculation remains and a depressed share price has only fanned the flames of rumours of a potential takeover. The separation of Cable&Wireless Communications and Cable&Wireless Worldwide instantly made Cable&Wireless Worldwide (UK and global business telecoms operations) a more attractive takeover target. At flotation, C&W Worldwide and C&W Communications had a combined share price of 148 pence. C&W Worldwide s share price has continued to decline since March 26, 2010, and now stands at pence (January 31, 2010) a further 20% reduction in C&W s Worldwide s market capitalisation. So a market capitalisation of GBP 1.9 billion makes C&W Worldwide a possible target for a few potential suitors (either for partial or complete acquisition), and the asking price has fallen significantly. C&W would make a mobile operator such as Vodafone or O2 arguably stronger than BT in the UK and Asia. C&W Worldwide has one of the UK s strongest and most advanced networks and a strong portfolio of services. The company also has an impressive list of large enterprise, MNC and public sector customers. Vodafone s recent $900 million investment in Ghana Telecom shows that there is money out there (although primarily targeted at emerging mobile markets). There is no suggestion that C&W Worldwide s shareholders are actively seeking a buyer and a recent recovery in share prices from a low of 63 pence to above 70 pence may make shareholders wait to see if prices rise as the economy recovers. Risking and financing such a large takeover in the current economic climate seems unlikely, although certainly not impossible. THUS is also an interesting part of the C&W Worldwide puzzle. Combined with its parent company, it adds a competitive SME portfolio and customer base to C&W s large enterprise and MNC expertise. THUS depressed recent performance suggests that it is far from being C&W s primary concern. C&W s own depressed share performance and concerns around its public sector business may also make it more willing to release capital through a selloff of its SME division now that network integration is complete. However, THUS value as a separate entity is limited now that it has lost its network assets and its major appeal would be its SME customer base. Colt has managed to weather the financial storm with relatively flat revenues, whilst its profits have continued to grow and the organisation is now debt free. For the full year 2009, Colt reported revenues of EUR billion (of which million were generated in the UK) with a net profit of EUR million (up EUR 57 million vs. 2008). Colt s historical focus on low latency Ethernet connectivity and strong European data centre footprint has put it in a strong position to respond to the growing enterprise demand for cloud-based services and broader ICT requirements. Colt has successfully partnered with companies such as Unisys and VMware and can already point to Carphone Warehouse and Fidelity Investment Managers as reference customers for its new hosted services. Colt s European network assets, data centres and customer base, particularly in the finance sector, would give any potential buyer a strong foothold in Europe. However, Colt seems an unlikely takeover target for UK/European operators, and interest would most likely be from large Asian or American operators looking to move into Europe. Europe +33 (0) Or visit our Web site: 4

5 Easynet s sell off by BSkyB leaves the operator as an oddly detached virtual network operator, and one with a proven and growing track record of success in the UK and European mid-market. Easynet Global Services has posted a number of contract wins with companies based in countries such as the UK, the Netherlands and Spain requiring multinational support. The company has an expanding managed services portfolio (e.g., IP PBX) and it also has Cisco Managed Services Master Certification. Easynet is privately owned and has only just been sold by BSkyB in July However, the GBP 100 million LDC gave to Sky for Easynet represents good value for a company with more than GBP 200 million of revenues and a healthy recent track record of growth. As a private investment firm, LDC may well be tempted to make a quick profit if it gets the right offer. Easynet s standalone status and attractive customer base make it an interesting takeover target. Global Crossing UK (GCUK) has traditionally been one of the Global Crossing (GC) group s strongest performing divisions. However, GCUK reported a loss of GBP 8 million for H and although it posted a profit GBP 11 million in 2009, this followed a GBP 28 million loss in Similarly its revenues fell 14% year-on-year to GBP million in 2009/10. GCUK has adopted a new strategy with managed and cloud services at the heart of its plans for growth (e.g., applications and platform as-a-service). It is still early days for the strategy, but a profitable Q gives initial signs for optimism. The company s recent win with FirstGroup was a positive, although it is in the transport sector a traditional area of strength and the deal is for WAN services, rather than a success for its new cloud strategy. GCUK s network assets, expertise and customer base would make it a valuable acquisition to anyone looking to gain a strong foothold in the UK fixed market and Global Crossing s overall financial troubles may make it responsive to the right offer. However, although GCUK is essentially a profitable operator, it also has around $430 million of debt levied against it, which may well sour its appeal. Kcom has successfully adjusted to its new situation following its network outsourcing deal with BT Wholesale a deal that has now been expanded to include SIP trunking services. Kcom s recent change in strategic direction has allowed it to change a GBP million loss in 2008/09 to a GBP 17.7 million profit in 2009/10 (with revenues of GBP million). Kcom s deal with BT has also largely dispelled criticism that it is a regional operator in the Yorkshire area and the provider has also added BT s new fibre broadband service to its SME ISP Eclipse s portfolio and is working with the incumbent to develop the access service as part of its large enterprise access portfolio. Kcom s network assets, although operated by BT, remain its own, but the company s limited network footprint was a key part of its decision to partner with BT Wholesale and is therefore unlikely to attract potential buyers. However, Kcom s deal with BT closely model arrangements O2, Orange and Vodafone have with BT in the UK for wholesale fixed network access which suggests that they would not have too much difficulty absorbing Kcom s business model. The operator has successfully developed a reputation as a provider of integrated telecoms solutions linking fixed and mobile elements with a competitive UC portfolio which may also attract the mobile operators. Kcom seems an unlikely takeover target, but it has developed a loyal customer base of SME, large enterprise and public sector customers that would make it an interesting, left-field choice. TalkTalk/TalkTalk Business was subject to rumours of a potential takeover approach by BSkyB at the time of its split from Carphone Warehouse in March TalkTalk s 4.2 million broadband customers and 2,000 ADSL2+ enabled unbundled exchanges make it a serious competitor to BT (with a larger ADSL2+ footprint) and would make a company such as BSkyB the UK s leading broadband provider. TalkTalk is a company with real momentum and it is expanding its business portfolio at an impressive rate (boosted by the Tiscali acquisition). However, it is not long since that Opal was primarily a business fixed voice provider and TalkTalk Business portfolio remains primarily an SME data WAN/access portfolio and less advanced than those of Europe +33 (0) Or visit our Web site: 5

6 competitors such as Kcom and Easynet. The TalkTalk Group had pro forma 2009 revenues (i.e., separated from CPW) of GBP billion (with business revenues of GBP 327 million), a profit of GBP 95 million and market capitalisation of around GBP 1.45 billion which greatly reduces the number of organisations able to afford such a large takeover. TalkTalk also has a newly signed MVNO agreement with Vodafone UK, which may present a problem for mobile operators other than Vodafone. Finally, there is also a regulatory question. It is uncertain whether the UK regulator Ofcom and the Competition Commission would allow the UK s second largest broadband operator to be bought out by one of its largest competitors. When TalkTalk bought Tiscali it was the third largest broadband ISP, buying the fifth largest at a time when BT was a runaway leader and Tiscali was in financial trouble, neither of which applies to any potential takeover of TalkTalk. TalkTalk has made two major acquisitions in recent years (AOL and Tiscali) and it is seems more likely to be a driver of consolidation rather than a target. Virgin Media Business is in competition with C&W Worldwide for the title of the number one challenger to BT for fixed network services. The company has fibre coverage across more than 80% of the UK and a strong set of local government and medium to large sized enterprise customers. Virgin Media also has the UK s strongest broadband portfolio. However, the rebrand from ntl:telewest Business to Virgin Media Business has all but killed off speculation concerning Virgin Media s intentions for its business division. Virgin Media Business GBP 580 million turnover makes it an expensive target and the business division would not come with Virgin Media s network. Virgin Media Business is more likely to make acquisitions than be sold off, although both currently seem unlikely. Recommended Vendor Actions Operators need to have a clear strategy in mind when looking to make an acquisition, essentially this involves asking the question, Why are we buying X? Acquisitions made to boost customer base are logical enough, but companies should look at whether transition of those customers is likely to be a smooth process TalkTalk s acquisition of Tiscali and particularly AOL were ultimately positive, but churn has been a constant thorn in its side. Similarly, do the customers fit the buyer s current business model? Part of the criticism of C&W s acquisition of THUS is that C&W had at the time been going through a process of focusing solely on its largest customers and exiting the smaller end of the market. When looking to expand into new product/service areas, operators should consider partnering as a good first step. Partnering provides a risk free and CapEx-lite way of entering a new part of the telecoms/ict market. Colt has done this to good effect partnering with companies such as Unisys. Similarly O2 s joint venture with 2e2 will bring it a level of ICT support expertise that would have been difficult to develop independently. O2 in particular also has the option of attempting to acquire 2e2 in the future should the partnership prove successful. Service providers should note the success of Vodafone in the UK unified communications market since its 2009 acquisition of Central Telecom. Central Telecom cannot be cited as the only reason for Vodafone s success. The strength of Vodafone One family of UC services is the primary reason. However the UC expertise and particularly the UC sales experience gained through taking over Central Telecom have undoubtedly enhanced its development of the product in the UK in its efforts to better compete against fixed operators. Europe +33 (0) Or visit our Web site: 6