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Vodafone merger talks with Chinese-owned rival trigger alarm over undersea cables

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Vodafone is preparing the biggest test yet of takeover laws meant to protect national security with plans to merge its British operation - including its sensitive undersea cables - with a Chinese-owned rival.

The FTSE 100 telecoms empire on Monday confirmed it is in talks to combine Vodafone UK with Three, the challenger network owned by CK Hutchison of Hong Kong, to create a giant with 27 million customers.

The multibillion-pound deal, which will involve no cash changing hands, will seek to extract higher returns from both businesses by cutting costs such as equipment and staff. Competition authorities will also investigate whether reducing the number of mobile operators in the market from four to three risks price rises for customers.

However, the combination is also likely to face intense scrutiny under the National Security and Investment Act, introduced last year to address rising official concern about the influence of hostile states in the British economy, including China.

Vodafone, which has been negotiating the merger with Hutchison for many months amid disagreements over valuations, was quick to emphasise that it would retain control with a 51pc stake in the combined business. Yet ministers now have powers to block deals that result even in minority stakes.

So far the nine-month-old laws have been used to block a Chinese takeover of a Bristol computer chip design company and to prevent a Beijing company from striking a deal with the University of Manchester. A review of the takeover of a Welsh microchip factory by a Chinese-owned company is ongoing.

Telecoms infrastructure has been subject to growing national security scrutiny in recent years, highlighted by the high-profile eviction of Huawei from Britain's 5G network in 2020. The ban came after intense pressure from the US, with then Secretary of State Mike Pompeo saying the Chinese Communist party did not have “a technical back door to Huawei. They have the front door.” Huawei has always denied any untoward relationship with Beijing.

Parts of Vodafone UK are deemed particularly sensitive by security sources, especially the former Cable & Wireless undersea cables it acquired in 2012, which are viewed as a potential target for hostile state eavesdropping or sabotage. It has interests in networks passing through key geopolitical flashpoints such as the Persian Gulf, West Africa and the Europe-Persia Express Gateway which links Oman to Frankfurt via Tehran.

Sir Iain Duncan Smith, who has led Conservative calls for a more hawkish approach to China, said that “the Government must call this in”.

The former Tory leader, who was sanctioned by Beijing last year for criticising human rights abuses against Uyghurs, added: “These plans have clear implications for Chinese access to sensitive UK data and the Business Secretary must intervene.”

A national security intervention would mark a significant shift in approach to Hutchison, which is one of the largest foreign owners in British assets with tens of billions of pounds invested. As well as Three, among other assets it owns the retail chain Superdrug, the rolling stock leasing company Eversholt Rail, the electricity distribution infrastructure UK Power Networks and Northumbrian Water.

A combination of Three with Vodafone UK would be Hutchison’s biggest and most sensitive UK deal since China tightened its grip over Hong Kong and its economy. The loss of democratic freedoms saw the imposition of a controversial national security law in 2020, granting its authorities exceedingly broad access to corporate information.

Hutchison, which is controlled by the family of 94-year-old billionaire Li Ka-shing, has been exploring options for Three for years, having racked up billions of pounds of losses since it entered the market as a latecomer in 2003.

On Monday Vodafone claimed a combination would boost Britain’s digital infrastructure and access to the latest 5G mobile network upgrades, at a time when investment by businesses is in short supply. The mobile pioneer has focused its energies and money in other territories such as Germany in recent years, while its UK business endured a series of customer service crises and lost market share to EE and O2.

Vodafone, which rose 2.6pc on the news, said: “The UK Government rightly sees 5G as transformational for the economy and society and critical to the UK becoming more competitive in an increasingly digital world.

“The conditions to ensure thriving competition in the market need to be nurtured, otherwise the UK is at risk of losing the opportunity to be a 5G leader.”

“By combining our businesses, Vodafone UK and Three UK will gain the necessary scale to be able to accelerate the rollout of full 5G in the UK and expand broadband connectivity to rural communities and small businesses.”

Similar arguments were advanced by O2 and Three when they attempted to merge in 2015 but rejected when that deal was blocked by EU competition authorities, on advice from their UK counterparts.

James Robinson, an industry expert at Assembly, said: “While the parties might view consolidation as a way to improve returns and unlock shareholder value, we expect the CMA would be eager to protect against the risk of consumer price rises - particularly in light of the current cost of living crisis.”

Three declined to comment.

A Department for Business spokesman said: “The Business Secretary has powers under the National Security and Investment Act to intervene in transactions on national security grounds where necessary.”