Vodafone plays offense and defence with Kabel Deutschland

Vodafone’s determination to buy Kabel Deutschland represents both an offensive and defensive strategy as it looks to strengthen its position in its leading European market.

Last week, the UK company had a €7.7bn bid accepted by the board of the German cable group. The deal will catapult Vodafone to become the largest pay-TV provider in Germany with 7.6 million direct TV customers and the second-largest fixed broadband provider with a further five million. It already has 32.4 million mobile customers. In a statement, Vodafone said it believes the integrated company could generate annual revenue of €11.5bn. The deal is expected to close in 4Q13.

The most obvious benefit of the deal is that it will enable Vodafone to tap into additional sources of revenue.  It will look to leverage its strong brand and extensive distribution to cross-sell services to both sets of customers. New revenue is hugely significant for European telcos, which remain under pressure from regulation, strong competition and the continued decline in usage of traditional services such as voice and SMS. Germany is Vodafone’s most important European market and accounted for more than 25 per cent of its European service revenue in the quarter ending March 2013. However, it has seen a deteriorating trend over the past three quarters, with service revenue falling by 3.5 per cent year-on-year during this period.

Vodafone sees strong growth potential given Kabel’s low penetration of broadband (16 per cent) and pay-TV services (12 per cent). Further, it believes there is significant upside potential in ARPU, which at €16.3 per month is much lower than most other European cable operators, notably Virgin Media (€65.7) and Telenet (€46.8).

But Vodafone’s move is as much about protecting itself from the ambitions of Liberty Global, Deutsche Telekom and Kabel Deutschland as it is generating new income. Like other European telcos, it has found itself increasingly threatened by cable and fixed-line providers which are strengthening their position through bundling mobile services into their portfolios. Some are also investing in content to enable them to offer attractive pay-TV services. Continuing to offer services based predominantly on mobile would almost certainly see Vodafone lose substantial ground in such highly competitive market.

In fact, given that Vodafone already has a significant fixed-line position in Germany, having taken full-ownership of Arcor in 2008, the move highlights just how seriously it considers this threat.

As Kabel’s network extends to 13 out of the 16 federal states in Germany, the move reduces its reliance on using Deutsche Telekom’s network in the long term. However, a deal struck with the German incumbent in May 2013 complements the Kabel deal as it enables Vodafone to reach out to the remaining territories.

The trend to offer triple or quadruple-play services should enable operators to keep customers for a longer period of time as they more tightly ‘lock them in’ to a single provider. Consumers like to pay a single company for bundled services as such deals typically represent better value than if bought separately. Vodafone says that it sees more than €1.5bn of revenue synergies from cross-selling and improved customer loyalty. As more consumers elect to watch content on a variety of devices, this trend will only continue.

Vodafone’s bid could still be subject to a counter offer from Liberty Global, which recently acquired UK provider Virgin Media. Such a move would complement the US company’s existing German assets, but would be more likely to face significant regulatory hurdles.

Vodafone’s decision to acquire Kabel Deutschland is its most significant move yet in a strategy aimed at bolstering its limited standing in the fixed-line market in Europe. CEO Vittorio Colao has repeatedly outlined a flexible, market-by-market approach to strengthen its position to offer converged services. It intends to do this through wholesale agreements, deployment of its own infrastructure or acquisition of existing providers.

These comments suggest that Vodafone could well be considering replicating its strategy in Germany in other European markets. It has been rumoured to be interested in acquiring Italian fixed-line operator Fastweb, while Spanish cable company Ono could be another target. Such moves could become more likely should Vodafone cash in on its profitable stake in US carrier, Verizon Wireless. CCS Insight believes that were Vodafone to receive a satisfactory offer, it should seriously consider exiting the US market. This would release funds for greater investment in fixed-line infrastructure and help it shore up its under-performing European networks.

Earlier this year, Vodafone announced a deal with Orange to jointly invest €1bn in a fibre-optic cable network in Spain. The partnership aims to reach 6 million households and workplaces across 50 cities by September 2017. Spain is seeing strong demand for triple and quadruple play services as hard-up consumers look to make cost savings. Telefonica’s Fusion, which launched in October 2012 and bundles mobile, fixed, TV and broadband, reached 1.7 million customers in 1Q13. Its positive start prompted Mr Colao to candidly admit that Vodafone was “losing strength and credibility” against its main competitor in Spain on a recent call for analysts.

The agreement with Orange follows two fixed-line acquisitions by Vodafone in 2012. It bought Cable and Wireless Worldwide for slightly over £1bn in April and followed this up with the purchase of TelstraClear in New Zealand for £429 million.

Should Vodafone successfully complete the deal to buy Kabel Deutschland, all eyes will be on its next move in its increasingly important strategy around converged services.

Kester Mann, Senior Analyst, Operators, CCS Insight