Morgan Stanley – Three UK and O2 Might Try Home Broadband Again

A new note from Morgan Stanley, the financial management firm, has suggested that one by-product of Three UK’s (Hutchison Whampoa) £10.25bn move to buy O2 from Telefonica is that the new combined business may “ultimately decide to explore an entry into UK fixed-line“.. again.

Mobile operator Three UK, which has never had a fixed line broadband and or phone business of its own, entered into an “exclusivity agreement” to buy O2 during January 2015 (here). The move was seen as a response to BT’s similar offer for EE (here), not to mention other movements in the wider market by its rivals.

The above developments are pushing the UK’s telecoms market towards convergence, which in the future will see a greater number of quad-play style offers centred on combining broadband, phone, mobile and TV into a single product. Both Vodafone and Sky Broadband have already announced just such a solution, largely to combat BT’s move, while TalkTalk and Virgin Media already do something similar.

In that sense it’s understandable that Three UK, with the backing of its parent Hutchison Whampoa, wouldn’t want to be left out. But Three UK’s problem is that gobbling O2 merely makes them into a bigger mobile operator (we also get to call them ThreeO2 or just “Throat” for fun) and does not add a fixed line broadband, phone or TV solution.

In fact O2 did use to offer fixed line broadband and phone, which worked quite well for a few years until they began aggressively hiking prices, playing around with the definition of “unlimited downloads” (this drove a lot of subscribers nuts) and ignoring the need to keep pace with rivals by failing to offer an FTTC “fibre broadband” service. In the end O2 had lost so many customers that they sold their fixed line subscribers to Sky instead of trying to make it work (here).

The UK’s fixed line market is aggressively competitive, arguably more so than mobile, and history tends to show that dedicated mobile operators have less success when adding fixed line services to their portfolio (most tend to treat such products and users as a second class citizens) than fixed line operators do with adding mobile; it’s easier to add mobile through an MVNO arrangement than to run your own fixed line network.

All of this places ThreeO2 in a difficult position. O2 failed to make fixed line work and Three UK has never even tried, yet for better or worse the rest of the market is fast going down the quad-play route and ThreeO2 may eventually feel the same pull. But breaking into an already competitive and stagnated market, without any aces up your sleeve, would be very tricky and the road is littered with corpses.

According to Morgan Stanley, ThreeO2’s merged unit should be able to realise significant pro-forma EBITDA uplift, supported by synergies. But that can only get you so far and at some point ThreeO2 may take the difficult step into fixed line, which might create problems with its new MVNO partner Sky Broadband and or their similar arrangements with other ISPs and operators.

In that sense the best approach for ThreeO2 might be to buy an existing ISP, like TalkTalk perhaps.