If the deal goes through, it will be one for the record books. Madrid-based Telefónica (TEF), which has the third-highest market capitalization of any telco in the world, said on Oct. 31 it will buy London-based O2, a pure-play wireless carrier with 25 million customers in Britain, Ireland, and Germany.
The $31.4 billion price tag -- a 22% premium over O2's Oct. 28 share price -- ranks the deal as the second-largest all-cash offer in telecom history, after Cingular's purchase of AT&T Wireless. It's also the largest British acquisition since 2000 and the second-largest proposed takeover this year in Europe, according to figures from market tracker Dealogic.
Telefónica's bold bid was only the latest in a flurry of recent merger-and-acquisition activity in Europe, where total dealmaking in the first nine months of this year topped $763 billion and where third-quarter deals outpaced U.S. activity by 50% (see BW, 10/24/05, "Hey, Let's Buy Something Big").
CONTINENTAL SHOPPING. It's also yet another sign of consolidation in the European telecom sector, where long-held resistance to cross-border mergers is wearing down and smaller, independent carriers are falling prey to globe-straddling giants (see BW, 4/25/05, "Europe's Dealmakers Are Dialing Again").
The same day Telefónica announced its O2 bid, Norway's Telenor (TELN) agreed to buy Vodafone's (VOD) Swedish wireless operations for $1.2 billion. And in July, France Telecom (FTE) bought Amena, the No. 3 wireless operator in Spain, for $7.7 billion -- a move that may have prompted Telefónica's retaliatory move into Britain, a stronghold for France Telecom's Orange wireless unit.
The merger streak reshaping Europe's telecom landscape looks far from over. Two private-equity firms are circling Denmark's TDC (TLD). Telecom Italia (TI) may have to get into the act, having made no major acquisitions in Europe.
STRATEGIC PLANNING. And France's No. 3 mobile operator, Bouygues Telecom, continues to be seen as a potential target. It's one of the Continent's few remaining independents and, like Telefonica and O2, a user of the i-mode wireless Web technology created by Japanese giant NTT DoCoMo (DCM). That would make it a good fit for Telefónica, which doesn't operate in France. Bouygues owners have so far refused all buyout offers, and Telefónica says it isn't planning more European acquisitions, though it may pursue deals in Tunisia and Colombia.
Telefonica's latest conquest could also pave the way for closer cooperation with DoCoMo. Though eight European carriers offer i-mode, the technology has generally failed to catch on there. But with Telefónica's new heft -- the third-largest wireless player in Europe, after Vodafone and France Telecom's Orange -- it could become an important strategic partner for DoCoMo. That could result in money and marketing support from the Japanese.
It was hardly a surprise that O2 got snatched up. Spun out by British Telecom (now BT Group (BT)) in 2001 in an $11 billion "demerger," O2 has been a rumored takeover target for years because it was dwarfed by rivals such as Vodafone, Deutsche Telekom's (DT) T-Mobile, and Orange. In August, word leaked out that Deutsche Telekom and Dutch incumbent telco KPN (KPN) were teaming up to buy O2, but the deal never happened. "O2 was clearly going to be bought by somebody," says senior analyst Marta Muñoz Méndez-Villamil of telecom researcher Ovum in London.
CASH COW. What caught analysts off guard was the buyer. Telefónica, which has 20 million wired and wireless subscribers in Spain and 34 million customers in Latin America and elsewhere, has long favored acquisitions in emerging and Spanish-speaking markets. The company has spent $50 billion on Latin American telcos since 1990, including a crucial $5.85 deal in 2004 for BellSouth's (BLS) wireless properties in 10 South American countries.
But all that changed this year, when Telefónica beat out Swisscom (SCM) in a last-minute bidding war for Czech operator Cesky Telecom. Suddenly, Telefónica's apparently dormant interest in European expansion reawakened. Telefónica had tried to expand its European footprint in 2000 by buying fixed-line and mobile operator KPN, but dropped the deal amid shareholder objections. The same year, it won an $8 billion license in conjunction with Finland's Sonera to run a third-generation (3G) mobile network in Germany. But after technology delays and spiraling costs, the companies bailed out and wrote down the investment in 2002.
Now with $36.4 billion in 2004 revenues, up 6.8% from the year before, and first-half 2005 revenues 20% higher than a year earlier, Telefónica is outperforming many European peers. (It was ranked No. 16 in BusinessWeek's 2005 annual IT100.) More important, it's a cash cow, spinning out almost $3.4 billion in free cash flow in this year's first half. That wealth has fed its latent desire for acquisitions closer to home. In early October, Telefónica was reported to be close to a deal to buy KPN for $24 billion, but it never came to fruition.
SPREADING THE RISK. Telefónica's move for O2 also may have been defensive. Like other fixed-line operators, Telefónica sees a huge long-term threat to its business from Internet telephony, which could savage prices for conventional phone calls. The combination of that danger and ample cash likely prompted the O2 bid, says Mark Newman, chief research officer for Informa Telecoms & Media in London.
"Telefónica is diversifying its risk across a broader range of markets, not just Latin America," Newman says. Added motivation may have come from the stiff competition posed in that region by Mexican telecom entrepreneur Carlos Slim, who has also considered setting up shop in Spain (see BW, 3/29/05, "The Telecom King of Latin America?").
By picking up O2, Telefónica gets quick access to two of the world's top mobile markets. "O2's integration in the Telefónica group will enhance our growth profile," says Telefónica Chairman César Alierta Izuel in a statement, "[allowing] us to gain economies of scale…and balance our exposure across regions."
CUTTING THE WIRES. Ovum figures the German market, where O2 ranks fourth behind T-Mobile, Vodafone, and KPN's E-Plus, generates $25 billion in revenue annually. Britain is even larger, at $28 billion, thanks to greater use of wireless-data services, and O2 is the No. 3 player in a market nearly evenly split among four fierce rivals. "Telefónica had to do this deal," says Ovum's Muñoz. "It would have put them in a very weak position if they hadn't."
The acquisition will transform Telefónica into more of a wireless company, making it less dependent on fixed-line. In that sense, it will become more like Vodafone, the world's largest mobile operator (see BW, 7/28/05, "Can Anyone Answer Vodafone?"). Ironically, as Telefónica is turning its attention back to the developed world, Vodafone is moving in the opposite direction: On Oct. 27, it announced plans to buy 10% of Indian mobile giant Bharti for $1.5 billion.
Financial analysts were generally positive on the deal. Brokerage Dresdner Kleinwort Wasserstein figures the acquisition will add to earnings and cash flow, and says "Telefónica got a fair deal," despite paying 18.4 times O2's projected 2006 earnings.
NEW GAME. Still, Telefónica's shares fell 2.6% on the Madrid bourse on Oct. 31, and its New York-traded American depositary receipts fell 3.5%, to $47.95. The big unknown is whether other bidders will step up, as many analysts expect. The most likely candidate is Deutsche Telekom, which would eliminate a T-Mobile rival in both its home market and in Britain by swallowing O2. But Dresdner thinks Deutsche Telekom would find it difficult to counteroffer in cash, and a stock purchase would require a price 15% to 20% higher, which would be difficult to justify on the numbers.
In the event Telefónica succeeds in closing the O2 deal, Alierta and his team will certainly have their hands full. The biggest doubt is whether Telefónica knows how to win in saturated, cutthroat markets like Britain and Germany. "Telefónica is used to being the leading player in the markets where it's present," says Informa's Newman. "It may not know how to play catch-up." That's a challenge the Spaniards better be ready tackle.
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With Esha Bhandari in Paris Reinhardt is BusinessWeek's European technology correspondent in Paris
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