Telefónica and the path to consolidation in Europe

Citation

Curwen, P. (2014), "Telefónica and the path to consolidation in Europe", info, Vol. 16 No. 1. https://doi.org/10.1108/INFO.27216aaa.002

Telefónica and the path to consolidation in Europe

Article Type: Rearview From: info, Volume 16, Issue 1

A regular column on the information industries

The rocky path leading towards consolidation among mobile operators in Europe is hardly a new theme for readers of Rearview, but recent M&A activity in the USA may finally have concentrated people’s minds on the awkward but incontrovertible fact that there are too many networks in many European countries. A further matter that may prove influential in this regard is the recent behaviour of Telefónica.

In recent years, the influence of operators based in Europe has tended to ebb and flow. On a worldwide basis, Orange has by far the largest number of holdings followed by the likes of Vodafone, Deutsche Telekom, Telefónica, Telenor, and TeliaSonera. However, only the first four have large numbers of proportionate subscribers (total subscribers multiplied by the relevant equity share) in the 30+ countries forming Western Europe, with Vodafone leading the way by a significant margin. Nevertheless, at roughly one-third, Vodafone is not overly dependent on this region for subscribers and nor is Telefónica, so why is the latter so important to this narrative?

The answer lies in both the absolute and relative size of individual networks. Telefónica has three fairly large networks in Spain, the UK and Germany, but at around 20-25 million subscribers they are not really large enough to yield much profit in the context of a highly competitive environment – it may be noted in comparison that Vivo in Brazil, albeit not wholly-owned by Telefónica, has over 75 million subscribers. Furthermore, given over 100 million subscribers overall in Germany, Telefónica is clearly not a market leader. Hence, one could argue that Telefónica faces a fairly brutal choice in Germany and elsewhere – bulk up or get out. In either event, M&A activity is called for.

Unfortunately, not everyone involved shares the same opinion about such activity. Those in favour include most operators while the regulators in many individual countries in Europe are keen to hold on to their independence by proving to be tough on M&A activity. Until recently, the European Commission appeared to be ambivalent but currently seems to be in favour because it supports a Single Market in telecommunications that it can control from the centre. A number of recent cases broadly lend support to this view. In November 2009, for example, Orange and TDC Switzerland agreed to merge their operations with Orange holding 75 per cent of the joint entity, but the Swiss regulator exercised its veto. Given that the market would have become a duopoly, this may not appear to have been an unreasonable decision, but Switzerland does have a dominant incumbent with over 60 per cent of the market meaning that the other operators are sub-scale.

Next in line was the merger between the third and fourth-largest operators in the UK, T-Mobile and Orange. This was proposed in 2010 and executed in 2012 with both brands left in existence (for internal political reasons) and a common brand (EE) used for 4G. Despite the merger, four operators were left in the market, of which much the smallest, Hutchison (branded as “3”), exerted strong downwards pressure on prices, so regulatory clearances were not a particularly big issue.

At the end of 2011, talks were held with a view to merger between Vodafone Greece and what was then Wind Hellas, a struggling also-ran in a market dominated by OTE. When the talks failed in the face of (inter alia) regulatory concerns, Wind Hellas collapsed, was sold on and eventually ended up in the hands of its creditors. Meanwhile, in Austria, the smallest of the four operators (Hutchison) proposed a merger with another sub-scale incumbent (branded as Orange but not owned by France Télécom) in May 2012. As these small networks faced competition from two much larger rivals, the European Commission was willing to give the go-ahead albeit with attached conditions that increased the (somewhat unlikely) possibility of new entry and the merger was completed in January 2013. Very recently, in June 2013, Telefónica provisionally sold its Irish subsidiary to the even smaller Hutchison network. With only five million subscribers, the Irish market is clearly too small for its current four operators, but Eircom is financially unstable so there is the possibility that only two could remain.

In addition, Hutchison Italy and Telecom Italia decided not to proceed with their proposed merger in July 2013 due to problems over valuations and, given that one operator was already the largest in the market, a general expectation that regulators would not approve even though two large competitors also existed.

Germany appears superficially to be a different kettle of fish because the market is the largest in Europe and the two biggest operators (T-Mobile and Vodafone) control roughly 70 per cent of it. This means that regulatory decisions there have more far-reaching implications for the future structure of mobile in Europe than the examples previously cited. However, the underlying issue – how smaller networks can survive against much bigger rivals in competitive markets – remains essentially the same. Hence, the response to the proposed takeover of KPN’s E-Plus network by Telefónica (branded as O2) in July 2013 should provide a clear signal as to the attitudes to M&A activity in Europe likely to be seen in the near future.

In fact, discussions between Telefónica and KPN had previously taken place in 2012 at a time when E-Plus was valued at roughly €8.5 billion. What is particularly interesting about this proposal is that KPN has basically trundled along for many years as a minor player in the European mobile space. For now, it has three networks of note, of which E-Plus (with 23 million subscribers) is much the largest – indeed, it constitutes roughly two-thirds of KPN’s total subscribers, so if shed in its entirety it would have left KPN as little more than a dominant player in its home market. This helps to explain why the deal currently on the table (in July 2013) constitutes a cash payment of €5 billion plus a 17.6 per cent stake in the enlarged Telefónica Deutschland. The deal is equivalent to €8.1 billion ($10.7 billion) reflecting a general deterioration in the German market. If it is allowed to proceed, the merged entity will become the biggest in Germany in terms of subscribers but not necessarily in terms of mobile revenues.

But does Telefónica have the necessary resources to proceed with further M&A activity? In 2012, Telefónica was downgraded by Standard & Poor’s and Moody’s and decided to start rolling back the empire built by the previous CEO. The Irish sale was part of this but it also involved disposing of a 40 per stake in the Central American holdings and reducing its stake in China Unicom from 9 to 5 per cent. Somewhat ironically, given the previous discussion, it also reduced its stake in Telefónica Deutschland to 76.8 per cent. Despite all of this, the amount of net debt remained close to the not immodest sum of €50 billion – the target is €47 billion by end-2013 – so a willingness to lay out even the cash element of the E-Plus purchase clearly indicates the urgent need to grapple with the scale issue in Europe.

It is necessary to speculate as to how regulators will react to this deal. The previous examples do not paint a clear picture – the closest analogy would seem to be the merger allowed in the large UK market creating EE but that still left four competitive operators which will not be the case in Germany. There is considerable debate, which the outcome of this takeover may at least partly resolve, as to whether a large European market should have three or four operators – France, for example, only has three – but it is self-evident that four is too many for a market with, say, fewer than 30 million subscribers, yet many such markets still exist. But independent regulators cannot seemingly be seen as subservient to Brussels, so they may decide to dig in their heels even though the evidence is beginning to emerge that – as Rearview has long argued – a number of sub-scale operators that are unable to merge will simply go bust and disappear.

A final point is that, by and large, it has long been assumed that consolidation in Europe would depend entirely on the attitudes of European operators. However, there is the odd indication that this may no longer be entirely the case since the biggest operator in Latin America, Carlos Slim’s América Móvil, recently acquired stakes in both Telekom Austria (23.7 per cent) and, interestingly, KPN (29.8 per cent). It may seem rather odd that anyone should be seeking growth within Europe at the present time and América Móvil’s investments have hardly been a success so far – the current price per share is very considerably below that paid by América Móvil for its stake in KPN (initially €8 per share). KPN tried hard to fend off América Móvil in 2012, even proposing some kind of deal with Telefónica. Now América Móvil has decided to proceed by way of an offer for the rest of KPN at €2.4 per share.

At the takeover bid price the whole of KPN is worth €10.3 billion yet Telefónica has offered €8.1 billion just for KPN Deutschland, which is rather odd. Furthermore, it raised the value of its bid to €8.55 billion in late August – a bid supported by América Móvil even though it reiterated its intention to pursue its own bid. Obviously, regulators at national and EU level will now want to have their say. The interesting question is whether América Móvil’s experience will induce or put off further interest in European M&A from outside the region.

About the author

Peter Curwen
Visiting Professor of Telecommunications at the Department of Management Science, Strathclyde University, Glasgow, UK. Peter Curwen can be contacted at: pjcurwen@hotmail.com