Liberty Global Doubles Down in the U.K.

Mike Fries, Liberty Global CEO, believes the Vodafone deal will pass regulatory muster. Others are skeptical.

Mike Fries, Liberty Global CEO, believes the Vodafone deal will pass regulatory muster. Others are skeptical.

The deal by John Malone’s Liberty Global to sell off some of its European assets to rival Vodafone is another step in the international cable giant’s strategy to focus more on its U.K. cable and mobile operations, which after years of investment appear to be turning the corner.

The Vodafone deal will give Liberty Global nearly $23 billion in cash and stock for its cable assets in Germany, the Czech Republic, Romania and Hungary. The deal officially scrubs Malone and Liberty from the German market, Europe’s second-largest, which it had tried for years to dominate. Now that market will be left to Vodafone, already Germany’s largest cable operator, and that country’s No. 2 player, telco Deutsche Telekom.

With the deal, Vodafone will widen the cable TV gap between it and Deutsche Telekom, but the phone company will retain its broadband dominance. After the Liberty deal is closed, Vodafone would have about 14 million cable customers, compared with 3.2 million for DT. According to company reports, Deutsche Telekom controls about 13.4 million broadband customers in Germany, while Liberty and Vodafone will have a combined 10 million.

Some analysts believe the deal will have a rough time obtaining approval, but Liberty Global CEO Mike Fries said it should pass muster with the European Union in about a year.

Related: Regulators Likely to Block or Restrict Vodafone-Liberty Global Deal: Analyst

In an interview with CNBC, Fries said the German market is “screaming for consolidation and a real national challenger.” Germany has been a growing, profitable market for Liberty Global — revenue rose 8.7% in the first quarter and operating cash flow was up 11.8% — although its pay TV subscriber growth has slowed. Still, the properties attracted a hefty multiple.

Fries told CNBC prior to Liberty Global’s Q1 earnings announcement that the decision to sell to Vodafone was simple, as the price was right.

At $22.7 billion, the Vodafone deal values the assets at about 11.5 times 2018 estimated cash flow, a huge premium to Liberty Global’s current trading multiple of about 7 times.

“It’s a premium valuation,” Fries told CNBC, adding that this isn’t the first time Liberty Global has sold assets, noting the 2006 sale of its French properties to Altice N.V. “We’re trying to be agile, smart and see the playing field clearly. Long-term, this is going to be a great transaction.”

But this deal has the potential to be transformative for all parties involved. Vodafone gets another arrow in its quad-play quiver of video, voice, data and wireless services. Liberty Global gets a great payday, but is essentially shedding one-third of its business.

With the Vodafone deal and a pending transaction to sell its Austrian operations to Deutsche Telekom for $2.3 billion (expected to close in the second half of this year), Liberty will pare the number of countries it operates in from 11 to six and its total customers from 22 million to 11 million.

No Brexit Here

With those deals, Liberty Global’s Virgin Media U.K. operations become even more strategically important, as they will represent more than half of Liberty’s total cash flow. And while Virgin Media has struggled in the past — subscriber growth has been sluggish, and with 5.9 million video customers it is a distant No. 2 to top pay TV service provider Sky (23 million) — it has started to turn the corner, at least financially.

Revenue growth at Virgin Media has soared in the past five quarters, from 1.7% in Q1 2017 to 5.2% in Q1 2018. At the same time, operating cash flow has grown from about 1% in Q1 2017 to 5.5% in Q1 2018, Liberty reported.

Liberty is also pumping money into the U.K. business. It rolled out its new advanced set-top for cable customers, V6, to 500,000 households in Q1; the product is currently in 41% of Virgin Media’s homes. And in 2014 it started building a fiber network, called Project Lightning, that is expected to reach 4 million homes by the end of 2019 at a cost of about $3.9 billion.

The buildout has hit some snags and last year was revamped because of delays and problems with independent contractors in some communities. But the project is ongoing, and with $13 billion in cash from the Vodafone sale, Virgin could have the resources to accelerate Project Lightning and perhaps build out its own mobile network.

Mobile is beginning to emerge as a growth area for Virgin, which has about 3 million customers through a Mobile Virtual Network Operator agreement with U.K. wireless company BT. Virgin added 69,000 post-paid mobile subscribers in the U.K. and Ireland in Q1, Liberty Global said, 89% higher than the previous year. Overall, mobile revenue growth has turned from a negative 8% in Q1 2017 to positive 5% in Q1 2018.

In a research note, Pivotal Research Group CEO and senior media & communications analyst Jeff Wlodarczak praised the deal for its robust multiples. For Liberty, he added, the task will be to sustain its financial growth, but there could be room for other deals.

“Like most of the rest of the cable industry, Liberty Global likely remains mainly about sizeable cash flows (and deployment of those cash flows) in 2019,” Wlodarczak wrote, adding that Virgin Media could be a possible target of Comcast, should Comcast’s bid for U.K. satellite company Sky fail.

Fries was encouraged by Virgin’s performance, but also left the door open should a similar opportunity arise.

“We have a really strategically complete business today in the U.K.,” Fries told CNBC. “We’re happy with it, we’re going to create great value over the long term. If somebody comes up and says they have to own it, we’ll pick up the phone, of course. But at this point, we’re happy.”