April 28 (Bloomberg) -- Freenet AG agreed to buy rival Debitel AG for 1.63 billion euros ($2.6 billion), forming Germany's third-largest mobile-phone company and fending off a takeover from United Internet AG.

Buedelsdorf, Germany-based Freenet will buy Debitel from buyout firm Permira Advisers LLP, it said in a statement last night. United Internet AG, Germany's second-largest Web provider, had made a 16-euro-a-share tentative bid for Freenet. United Internet Chief Executive Officer Ralph Dommermuth said April 4 he wouldn't buy Freenet if it acquired Debitel.

Freenet, the German mobile-phone and Internet company that merged with Mobilcom AG last year, plunged as much as 11 percent in German trading. Drillisch and United Internet joined forces last year to bid for Freenet and break up the company. Drillisch wanted to buy Freenet's mobile unit and United Internet wanted the Internet and fixed-line operations. Smaller providers are trying to combine as the cost of attracting customers rises.

``Consolidation is inevitable as the land-grab phase is over'' for digital subscriber-line broadband providers ``and margins slow on rising customer acquisition costs,'' said Pete Nuthall, an analyst at Forrester Research NV in Amsterdam. ``Customer acquisition costs have reached unsustainable levels for smaller providers.''

Permira Stake

Freenet will issue 32 million new shares to give Permira a 24.99 percent stake in the merged company and receive a 132.5 million-euro loan from the buyout firm.

Freenet dropped as much as 1.23 euros to 10.03 euros, and traded at 10.62 euros as of 11:36 a.m. in Germany.

Permira paid 640 million euros in 2004 to buy Stuttgart, Germany-based Debitel, which sells services of wireless network providers including Deutsche Telekom AG and Vodafone Group Plc.

Freenet is paying 7.7 times earnings before interest, tax, depreciation and amortization for Debitel. This compares with 6.6 times reported Ebitda paid by Debitel in June for TDC A/S's German wireless division.

Freenet said it will assume financial liabilities of 1.14 billion euros as part of the Debitel deal and won't pay a dividend for 2008.

``The deal is incredibly value increasing,'' said Joeri Sels, an analyst at DZ Bank in Frankfurt with a ``buy'' rating on Freenet shares. The transaction is also a ``poison pill'' against United Internet's interest, he said.

United Internet fell 6 cents, or 0.4 percent, to 14.12 euros at 11:37 a.m. in German trading, while Drillisch fell 3 cents, or 0.7 percent, to 4.32 euros.

Deal Rationale

``Short-term, the rationale of Freenet's management is clear,'' Christian Ludwig, an analyst at Berenberg Bank in Hamburg, wrote in a note April 18. Permira's 24.99 percent stake in Freenet would dilute the stake of MSP Holding, the joint investment vehicle of United Internet and Drillisch AG ``to less than 20 percent.'' Ludwig rates the stock ``hold.''

Focusing on mobile services is better for Freenet as its DSL business ``isn't very successful,'' said Boris Boehm, a management board member at Aramea Asset Management AG in Hamburg, before the announcement. Boehm's firm has the equivalent of $1.1 billion under management. ``If a buyer for the DSL appendix can be found, dealing with this failure would be less painful.''

Forrester predicts 3.5 million German DSL customers will change their DSL provider this year, driven by deals including multimedia packages. Deutsche Telekom is Germany's largest Internet provider.

Protracted Approach

United Internet said in a letter to Freenet CEO Eckhard Spoerr yesterday it may bid as much as 16 euros a share for the rival. Eight institutional shareholders holding 32.6 percent in Freenet are willing to sell their stakes to United Internet, CEO Dommermuth wrote in the letter.

On April 4, Dommermuth said he ``could imagine'' paying 12.80 euros a share for Freenet. ``Under certain conditions we could imagine raising the price to up to 14 euros a share,'' Dommermuth wrote in a letter to Spoerr posted by Berlin-based newspaper Die Welt on its Web site April 14.

Paschalis Choulidis, the CEO of Drillisch, a major Freenet shareholder, said March 26 that he estimates synergies of such a merger to be about 100 million euros a year.

To contact the reporter on this story: Andreas Hippin in Frankfurt at ahippin@bloomberg.net

Last Updated: April 28, 2008 05:41 EDT