Europe Telecom Giants Call the Shots Again as M&A Picks Up
Published on: 4th May 2008
Note -- this news article is more than a year old.
As the global financial crisis nears its one year anniversary, Europe's top telecom operators are rediscovering an appetite for deals and preparing to pounce on vulnerable rivals, armed with solid balance sheets and needled by a rising threat from newcomers like Google and Apple.
The past two months have seen a surge in activity. First out of the starting blocks was Europe's largest operator, Deutsche Telekom, which in March offered 2.5 billion euros ($3.9 billion) for a 20% stake in Greece's largest phone company, Hellenic Telecommunications Organization, or OTE.
A month later its closest rival, France Telecom, set its sights on Nordic player TeliaSonera. Last week shares of Dutch carrier KPN climbed on a report that Spain's Telefonica might make a bid, though no official word on deal talks has been released. Other moves have included Vivendi's offer for Neuf Cegetel and Freenet's acquisition of Debitel in Germany.
Tepid growth and falling market share at home, rebuilt balance sheets, weak valuations and the gnawing of a slew of new competitors at their home turf have jolted the big guys into action. So-called incumbents, former national monopolies that now face competition, are seeking scale to ward off attack and gain access to markets where mobile phones aren't commodities yet.
"The large incumbents seem to have worked up quite an appetite for smaller incumbents lately," said Neil Rickard, vice president in the telecoms practice of research firm Gartner.
Deutsche Telekom, France Telecom, Telefonica and Britain's Vodafone Group are the big beasts of the European sector and unlikely to be swallowed.
"The rest are all potential targets," said Windsor Holden, principal analyst at Juniper Research.
Industry observers say the telecom industry is getting more confident about completing deals. They cite lower valuations, the potential acquirers' stronger balance sheets and the virtual disappearance of competition from private-equity firms.
"It's actually encouraging for telecoms firms because they're not so concerned about private equity coming in and the price going up in a bidding war," said John Delaney, principal analyst at research firm IDC.
The big incumbents' financial position has improved markedly over the past few years, with debt levels nowhere near where they were at the beginning of the millennium. Between 2000 and 2006 France Telecom reduced its net debt- to-EBITDA ratio from 5.6 to 2.27. While in 2002 the group's debt was equal to 100% of its assets, in 2007 it was just 55%.
"The big players like France Telecom have substantially written down their debt. They're not talking of borrowing billions of dollars," Delaney said.
Even then, they still need to reassure investors wary of large complex deals at a time when the economic environment is unstable and credit conditions tight.
On a conference call with journalists after France Telecom revealed its interest in TeliaSonera, Chief Financial Officer Gervais Pellissier stressed there would be no going back to the "reckless" merger-and-acquisition strategy that marked the start of the millennium and saw the group spend $55 billion on Orange, the U.K. operator it then struggled to integrate.
The race for scale
From a strategic point of view, the rising threat of cable, Internet and media companies has convinced many telecom operators they need to add scale to hold their own in the new ultra-connected, always-on world.
"To some extent there is a scale game going on there," Gartner's Rickard said. Being bigger means an operator can negotiate better prices with equipment vendors such as Ericsson and Alcatel-Lucent and phone makers such as Nokia. It also gives the carrier opportunities to re-use equipment and technologies in new regions, resulting in economies of scale.
Scale, however, shouldn't be pursued for its own sake, and acquirers need a clear idea of what they want to do with their "new toy," said Holden of Juniper Research, stressing that there can be "a bit of keeping up with the Joneses" among the top players, particularly given the recent decline in valuations. The European Dow Jones Stoxx 600 telecoms index has lost 13% over the past three months.
Political interference is also less of an issue than it used to be and governments all over Europe are putting stakes in incumbent players -- including TeliaSonera, OTE and the Ukraine's Ukrtelecom -- up for sale.
The pursuit of growth in new markets
Access to new markets is the other main strategic reason why operators do deals.
As growth has slowed at home, where there are sometimes more mobile phones than people, Western European carriers have been increasingly lured to emerging markets in Central and Eastern Europe, Asia and China. The most striking example of such a move was Vodafone's acquisition of India's Hutchison Essar for $11 billion last year.
France Telecom has been pursuing a similar strategy, albeit on a smaller scale, acquiring several assets in the Middle East and Africa over the past two years, but consistently shrugging off bigger targets in Western Europe.
A purchase of TeliaSonera, which holds a strong position in well developed and fiercely competitive Scandinavian markets, would thus mark a strategic shift for the French group, several financial analysts noted with alarm.
While TeliaSonera would offer some degree of exposure to Russia and Turkey via its minority stakes in Turkcell and Megafon, they said these assets would be difficult to get control of and should therefore not form the main rationale for the deal.
In defense of its strategy, France Telecom has said expanding into new regions can yield benefits other than access to a fast-growing subscriber base.
By enlarging its geographical footprint a carrier can serve its international business users at a lower cost, for instance, as it will no longer need to pay a fee to use another operator's network there, said IDC's Delaney.
Still, investors reacted negatively to news of France Telecom's interest in TeliaSonera, sending the shares down 11% in the two sessions after it surfaced.
Juniper's Holden said the reaction reflects the general nervousness gripping investors at the moment and making them less receptive to what they may perceive as a risky deal.
Chances are that it may not happen anyway. J.P. Morgan earlier this week said its analysis shows an offer for TeliaSonera would have to include a cash consideration of 60% for it to be cash-flow neutral for France Telecom. Considering that the French group must refinance 9.5 billion euros of debt this year, such a level of borrowing could be difficult to achieve in the current market conditions, the broker said.
And although a private equity firm is unlikely to rain on France Telecom's parade with a rival bid, Telenor could well decide to. The newspaper Svenska Dagbladet this week reported that the Norwegian operator had hired two banks to look into a merger.
While most analysts agreed a new wave of consolidation is about to sweep through the industry, they said all the top players are likely to remain in place.
"You need three or four very powerful operators competing with each other in each national market," Holden said. "We are not going to get to a point where France Telecom makes an offer for Deutsche Telekom."
Beyond those already in the news, attractive targets include second-tier players in major markets, such as Hutchison Whampoa's 3 in the U.K, Holden said, noting he is not convinced there is room for five players in that market.
In Eastern Europe, the Ukraine's UkrTelecon is being wooed by Comstar UTS and Sistema , Bear Stearns analysts told clients earlier this week.
The market for business services could also see some action this year, with Deutsche Telekom and AT&T particularly likely to make acquisitions as they put renewed emphasis on their international business operations.
Potential targets in the sector include U.K.-based Cable & Wireless , and Colt Telecom , Global Crossing and Level 3 Communications for instance, Gartner's Rickard said.
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