Could Voda fail if ACCC wins the TPG merger case?

The Australian Competition and Consumer Commission, in opposing the proposed merger of Vodafone and TPG Telecom, has focused on the implications for competition if TPG doesn’t build the fourth mobile network. Perhaps it should have paid more attention on the implications for Vodafone if it did.

As it happens, TPG, after the federal government banned the use of Huawei’s equipment in 5G networks, ditched its plans and wrote off $228 million it had already invested.

It has essentially said that, without access to the cheapest technology for its original small-cell based 4G network and an upgrade path to 5G that only Huawei could have provided, there is no credible business case for it to realise its initial ambition.

The ACCC, however, opposed the merger on the basis that, if it blocked it, TPG might change its mind and reactivate the plan.

On Friday, Vodafone filed a statement of claim with the Federal Court seeking a declaration that the merger would not have the effect, or be likely to have the effect, of substantially lessening competition in any market.

In essence, it is asking the Federal Court to over-rule the ACCC’s judgment and conclude that the combination of two businesses that don’t compete today won’t result in a substantial lessening of competition in future.

It raises another layer to the counter-factual to the ACCC’s position.

In making the case for the merger of Vodafone’s mobile business and TPG’s fixed line operations, the merger partners have argued that, givent TPG has abandoned its plan to build its own network, the combination would strengthen competition in both the wireless and fixed markets by creating a stronger competitor to Telstra (the dominant player in both markets) and Optus.

It would give the combined business a bigger customer base and a strengthened financial position to fund the increasing capital requirements in the mobile telecommunications sector as Telstra and Optus roll out 5G networks.

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It would also generate economies of scale to offset the margin squeeze occurring for fixed line resellers like TPG as the national broadband network nears completion of its rollout.

They haven’t previously argued that the merger might be not just an escape route for TPG from that squeeze on its existing fixed line business but the salvation of a Vodafone business that has been chronically unprofitable.

Friday’s filing doesn’t make that case explicitly but the factual base for it is laid out.

Vodafone has been operating in this market since 1993, initially alone. In 2009 it merged its Australian business with Hutchison Telecom’s.

It is doubtful that Vodafone Australia has ever been profitable but since 2015, at least, it has been technically insolvent –its total liabilities ($9.11 billion) exceed its total assets ($8.19 billion). It survives because its debts are either guaranteed or provided by its two shareholders.

Over the past five years, according to its filing, they have invested about $4.6 billion in the business while incurring losses totalling $1.63 billion. The ACCC appears to believe that, absent the merger, they would continue to fund those losses and guarantee Vodafone Australia’s debt indefinitely.

To remain competitive with Telstra and Optus, Vodafone will have to upgrade its network to 5G.

Its existing 4G network also uses Huawei technology and it had planned to use Huawei’s leading edge 5G equipment to upgrade the network to 5G.

The government’s ban on the Chinese vendor means the upgrade, supposed to start last year, has been significantly delayed and will cost materially more, even as the relentless increases in the volumes of data carried on its 4G network continue to increase congestion.

Over the past five years, the average data downloaded onto mobile phones has increased roughly five-fold and data inclusions in mobile plans have soared even as average revenues per user have fallen.

Vodafone needs to make very large investments in 5G to be competitive with Telstra and Optus but there is no meaningful incremental return on those investments in prospect, at least in the near term.

With a co-parent, Vodafone Plc , whose share price is trading at its lowest levels for nearly a decade and which has been exiting some markets (most recently New Zealand, where it was the market leader in mobiles), to focus on its European operations there is no guarantee that Vodafone and Hutchison will keep writing large cheques for a business that doesn’t make money.

If the merger were allowed, not only would the merged entity have a bigger and stronger balance sheet , greater customer mass and some operational synergies, it could use TPG’s spectrum holdings and the small cells that it has deployed to ameliorate its network congestion and expand its coverage.

The Vodafone challenge is unlikely to be heard until late this year but will be a test of the ACCC’s ability to regulate market structures that don’t exist today but which it believes (despite, in this case, TPG’s strong assertions to the contrary and the commercial logic that underpins them) might exist in future.