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Morningstar | Vodafone Agrees to Wholesale Cable Network to Telefonica Deutschland Pending Liberty Deal Closure

On May 7, Vodafone announced it had reached an agreement to wholesale fixed-line telephony, broadband, and pay TV services to Telefonica Deutschland across its combined Kabel Deutschland and Unitymedia footprint if regulators approve Vodafone’s agreed acquisition of Liberty Global’s operations in Germany, Romania, Hungary, and the Czech Republic. We have been sceptical of this deal closing, primarily because previous attempts to combine Kabel Deutschland and Unitymedia have been struck down by German regulators. However, with the Telefonica agreement, which would enable Telefonica to sell fixed-line services--and with faster broadband speeds than Deutsche Telekom--we think the likelihood of approval has increased. Telefonica has been wholesaling capacity from Deutsche Telekom but slowly bleeding customers, as it didn’t have a way to differentiate its service. We believe using Vodafone’s faster broadband network will likely increase Telefonica’s ability to compete, which will be looked on favourably by the EU regulators that will rule on Vodafone’s acquisition of Liberty’s assets. We have previously built a tentative Vodafone model incorporating the acquisitions, which produced a valuation similar to our GBX 250 per local share fair value estimate. Thus, we don’t expect any significant change to our fair value estimate if the deal closes. There is also no change to our narrow moat rating.

However, if the Liberty Global deal closes, Vodafone’s debt level will increase to above 3 times EBITDA. This will remove a lot of the firm's financial flexibility and puts the dividend at risk. That said, the wholesale agreement with Telefonica would provide some additional cash flow to help fund the dividend. Our base case is still that Vodafone maintains the dividend, but we believe the risk of a cut increases if the deal goes through.