As Vodafone Group PLC weighs M&A options in Western Europe, analysts say the U.K. offers its best opportunity to consolidate the mobile business.

This is in large part due to a slightly more favorable regulatory environment and a shrinking pool of possible targets in other markets where Vodafone wishes to expand.

Asked about the company's progress toward striking a deal on a May 17 earnings call, Vodafone CEO Nick Read said the company is engaged in many "active conversations" in its previously identified target markets of Germany, Spain, Italy and the U.K. Later in the call, he also spoke of the potential to work with U.K. regulators.

"I'm not saying all combinations will be treated in the same way, but I think we have an opportunity in the U.K.," Read said in response to a question about mobile consolidation in that market.

The mid-2021 merger of Liberty Global PLC's Virgin Media and Telefónica UK Ltd.'s O2 to form a new joint venture operating the O2 brand signaled to many that U.K. regulators were more willing to consider large mobile deals.

"Many regulators had seen the maintenance of four players [as] crucial to having a healthy market, but that view looks to be changing," said Mohammed Hamza, principal analyst at Kagan, a media research group within S&P Global Market Intelligence.

In the U.K., Vodafone is the third-largest mobile player after O2 and British Telecom. Vodafone's U.K. mobile subscriber base fell from a peak of 18.1 million in the quarter that ended in December 2019 to 17.1 million two years later.

The U.K. business has shown some small gains in the most recent two quarters. Executives also pointed to improved churn and commercial momentum in the market.

The U.K.'s Office of Communications, or Ofcom, said in an emailed statement to S&P Global Market Intelligence that its "stance on a potential merger would … be informed by the specific circumstances of that particular merger, taking into account how markets are evolving."

The regulator will be more focused on how effective the surviving market competitors will be as opposed to how many are in competition, an Ofcom spokesperson said.

"I think right now the best political-regulatory conditions for decreasing the number of competitors in the mobile market from four to three [are in] the U.K.," said Massimo Comito, an independent TMT investment adviser.

On the earnings call, Vodafone's Read pointed to the T-Mobile and Sprint merger in the U.S. as an example of a consolidation deal that helped spur an increase in infrastructure investment from T-Mobile US Inc.'s remaining competitors.

"At this time when governments are looking for strong, resilient and secure networks, is it better to have three strong networks that are resilient with scaled industrial players? I think, increasingly, governments, politicians [and] regulators are understanding the benefits of that and the vulnerabilities of fragmentation," Read said on the call.

Vodafone faces pressure to make a move from some of its shareholders, who want to see a return on the big investments made in 5G infrastructure in recent years.

The company's leverage grew over the past five years, and its 2.9% return on capital lags that of peers such as Orange SA, Telefónica and Deutsche Telekom AG.

Ahmed Essam, CEO of Vodafone UK, said at an Enders Analysis conference May 13 that regulatory reform needs to focus on giving companies "an incentive to invest in these expensive new networks and technologies." The executive pointed to high spectrum license fees and restrictive net neutrality regulations as barriers to further investment.

"At the moment it feels like we're working with 3G regulation in a 5G world," Essam said.

Vodafone may pull back on some underperforming markets as it looks to shrink its debt load, though Vodafone CEO Read has indicated a preference for forming joint ventures as opposed to outright asset sales. In Italy, for instance, the company recently rejected a takeover offer for Vodafone Italia from France's Iliad, but Read told analysts on the earnings call that there are too many players and unsustainable pricing in the Italian market.

"Things will have to change. People are going to have to ... collaborate, combine ... and we are very pragmatic and open," Read said. "We remain actively engaged with players to find better routes to more sustainable returns in that market."

Meanwhile, Vodafone is at risk of falling further behind the competition in Spain after the country's second- and fourth-largest mobile operators, Orange and MásMóvil Ibercom SA, agreed to consider a joint venture.

Should Vodafone pursue a deal in the U.K., potential targets include Hutchison 3G UK Ltd., which is rumored to be among the entities already in talks with Vodafone. Kagan's Hamza agrees that Hutchison's Three brand is a likely target.

"There are few strategic moves left in the U.K.," said Paolo Pescatore, a TMT analyst at PP Foresight. "Vodafone will need to move quickly to avoid losing further ground."