O2 Germany and E-Plus To Merge (Yet Again)? Some Thoughts on Benefits and Tech Background

About twice a year there are rumors in the German mobile industry that O2 and E-Plus are about to merge one way or other. This time, it's more than a rumor as O2 has actually made an official offer of around 5 billion Euros in cash + 17% of O2 stock for Dutch telecom incumbent KPN, who owns E-Plus. The total sales prices is thus around 8.1 billion Euros according to the WSJ. I wonder how this makes sense from a financial point when considering the significant sum of money involved and the drastic network changes likely to be required to form a single network!?

On the financial side KPN has always touted that E-Plus is its cash cow, generating an annual EBIDTA of 1.353 billion Euros out of a total revenue of 3.236 billion Euros in 2011 according to their Wikipedia entry. O2 Germany has a similar EBIDTA from a total revenue of 5.21 billion Euros in 2011 (see here and here). So both companies are profitable and with a market share of around 20% each that still grows are far from being the lame ducks of the German mobile network industry as some market commentators suggest. But financial numbers can be interpreted in many ways and I am not a monetary expert so I won't dig deeper into this part of the story.

Let's have a look at some technology related implications of such a deal. "Die Zeit" reports that O2 Germany's CEO estimates potential cost savings of the deal of 5.5 billion Euros but no timeline was given for realizing those savings. At the beginning I think it is likely that a massive amount of money has to be spent on forming a single network. Obviously it makes no sense for a single company to run two overlapping networks. As the majority of both networks overlap today, one has to be switched off and base station installations have to be removed. Quite a bit of work and cost involved to remove 19.000 base station sites. I wonder if there's a market for second hand network equipment where some money can be made or if the equipment, which is unlikely to be the latest kit, will just have to go to the bin. In the long run this will of course reduce base station site rental costs. As many base station sites are shared and owned by another company I wonder if the rental prices for other companies at those sites will go up as a result of the reduced number of companies that rent tower space?

Obviously, switching off one half of the network requires increasing capacity on the other network as otherwise it would go into overload with the additional traffic. O2's network seems to be already stretched in many areas so increasing capacity will incur significant cost that would otherwise not be necessary. Binning half the network and increasing capacity on the other half, I wonder what the cost of this would be!?

From a timing perspective the deal comes at an interesting point in time. The current GSM licenses are due to expire in 2016 and are set to be re-auctioned. An interesting time to cease operation, E-Plus would have made a very good use of their expenditure for their initial spectrum. Also it's likely that there will be little delay on the forecast spectrum auction in the 2016 timeframe, which will also include new spectrum in the 700 MHz band for the so called Digital Dividend 2 spectrum. Only three players, and I assume there won't be more as building up another network when one has just ceased operations is unlikely to happen, would reduce competition and thus spending on the network operators part. Here's definitely savings I can see for O2 on the horizon.

On the downside, if the deal went ahead, O2 would not be able to keep E-Plus spectrum that runs beyond 2016 which includes the UMTS spectrum and newly acquired spectrum during the 2010 spectrum auctions. E-Plus currently holds five chunks of 5 MHz in the UMTS 2.1 GHz spectrum, two from the initial auction and three from the 2010 auction. This is more than any other operator holds in this band and would go back into the pool for the next frequency auctions scheduled for 2016 together with the spectrum acquired in the 2.6 GHz range for LTE. A massive loss of investment!

Let's summarize: O2 would pay the equivalent of 8.1 billion Euros for E-Plus, get no network, has to shed all frequency licenses and has to invest massively into its own network to absorb E-Plus customers. Also it's likely that the other two network operators would jump at the opportunity and try to get some of E-Plus and O2 customers onto their networks that might not be happy with how the network performs during the switchover. In other words, the only thing O2 would get out of such a deal is E-Plus' subscribers but nothing else, no assets whatsoever. O2's CEO estimates that cost savings could be 5.5 billion, but coming from a CEO who wants to push a deal it has to be assumed this is an optimistic number. Spending 8.1 billion and perhaps getting 5.5 billion back over a longer timeframe!? Does that make financial sense? One has to wonder… So taking those numbers O2 would have to spend 2.6 billion for perhaps 24 million customers. That's 108 euros per customer (not including interest, overly optimistic cost saving figures, etc.). That, on the other hand, does not sound very expensive.

So much for now. Another thing that has to be considered, though, is the impact of such a deal on competition, i.e. what would change for consumers. That's for another post, however.