By Belén Carreño and Pamela Barbaglia
MADRID/LONDON (Reuters) - Spain's Telefonica SA (MC:TEF) is in talks with billionaire John Malone's Liberty Global Plc (O:LBTYA) to explore a merger of its British mobile operator O2 with Liberty's Virgin Media cable network company, two sources familiar with the matter said.
Telefonica has been weighing options for the mobile business since 2016 when a previous 10.3 billion pound deal takeover of O2 by Three UK, controlled by CK Hutchison Holdings (HK:0001), was blocked by European antitrust regulators, banking sources said.
A combination of O2 and Virgin Media would reshape Britain's telecoms industry, leaving Hutchison and Vodafone (L:VOD) stranded without their own fixed-line consumer networks.
If successful, the deal would end uncertainty around the fate of one Britain's biggest mobile operators after it was repeatedly touted as a possible candidate for a sale or a stock listing in recent years.
It would also offer Telefonica a way to partially cash out from O2 while retaining a presence in Britain, which the company sees as one of its "core markets" along with Spain, Germany and Brazil.
Malone, who transformed the pay-TV sector in the United States, combined Liberty's Dutch operations with Vodafone's in 2016 in a joint venture deal which could offer the blueprint for a merger of O2 and Virgin Media, one of the sources said.
He added that discussions between Telefonica and Liberty were focusing on creating a joint venture equally owned by the two firms.
Shares in Liberty were up 8.75% at $21.12 on the news.
Telefonica's overriding goal to reduce its debt load - which stood at 37.74 billion euros at the end of last year - would likely shape the deal, Jefferies analysts wrote in a note after Bloomberg first reported news of the talks.
A cash acquisition would be within reach for Liberty, they said, but a joint venture structure could still satisfy Telefonica's pressing need to cut its leverage.
DWINDLING PROFITS
Telefonica has been active in Britain since 2006 when it took control of O2 and made it the first British network to offer Apple (NASDAQ:AAPL)'s iPhone in 2007, a deal that attracted more high-value customers to the brand.
O2, led by boss Mark Evans, had 25.8 million contracts and pre-paid mobile subscribers at the end of 2019.
Telefonica's UK business, which includes O2, generated 7.11 billion euros in revenue in 2019, around 14.7% of the group's total, and had 34.5 mobile connections on its network.
But faced with dwindling profits, Telefonica announced in November a turnaround plan to bring in 2 billion euros a year in extra revenue by hiving off part of its Latin American business and focusing on its core markets including Britain.
At the time, Chief Executive Jose Maria Alvarez-Pallete said the company was open to reviewing possible merger options.
Liberty Global, which has controlled Virgin Media since 2013, sold its cable networks in Germany and central Europe to Vodafone in a $22 billion deal which was finalised last year, reigniting talk among analysts of a deeper tie-up in Britain.
The firm is expected to plough the cash from the Vodafone sale into the O2 deal, said the source who commented on a possible blueprint for a merger, cautioning no final agreement had been reached.
Virgin Media competes with UK pay-TV market leader Sky, owned by Comcast (O:CMCSA), in pay-TV, and with BT (L:BT), Sky, TalkTalk and others in broadband. It had 6 million cable customers and 3.3 million mobile customers as of the end of 2019.
Despite its sizeable mobile business, Virgin Media has never owned its own wireless network. It instead pioneered the MVNO model, whereby an operator piggybacks on an existing network, 20 years ago with a partnership with the forerunner of BT's EE.