Euro Telecom: Survival Of The Biggest

The regions titans get set to partner up

Executives at KPN Mobile, the Netherlands' largest wireless-phone company, were shell-shocked. They'd entered the bidding for Britain's new, third-generation mobile-phone licenses with high hopes, only to drop out when the bidding had soared seven times higher than expected, reaching a total of $35.5 billion. "After the British auctions, we took a deep breath and saw we couldn't go it alone anymore," says one KPN insider. No kidding: In a quick turnabout, the company dropped plans for a $9 billion flotation and instead started negotiating a sellout to Spain's Telefonica.

If Telefonica and KPN tie the knot on the $134 billion deal, it will be the first merger of Europe's former telephone monopolies. It won't be the last. Just in the last few weeks, the cost of staying in the Great European Telecom Race has grown exponentially. At stake is the Old World's ability to continue to lead the world in mobile-phone innovations as well as catch up in fixed-line services. Now big mergers may be the only way to amass the firepower needed to roll out the latest New Economy data services. The mating dance may eventually involve mighty British Telecommunications and France Telecom, companies whose executives probably thought they would never have to merge with anyone.

FRENZIED BIDDING. At the root of the upheaval is the powerful technology behind the next generation of mobile phones. The 3G wireless networks will transform the industry and challenge the PC as the main entryway to the Net.

But this highway to the future involves expenses never seen before in telecom. First, there's the cost of licenses. The frenetic bidding in Britain has encouraged other governments, including Germany, Italy, and the Netherlands, to plan similar auctions. This means it may cost a company up to $30 billion to get licenses--and $60 billion more to build infrastructure across Europe.

Facing such costs, it's no wonder companies are looking for partners. "If you are going to stay in the major leagues, you have to do something quick to bulk up," says Philippe Kiewiet de Jonge, an analyst at ABN Asset Management in Amsterdam.

The outlines of Europe's future major leagues are already emerging. "I believe we will only have six telecom giants in a few years, two from Europe, two from Asia, and two from America," says Jack McMaster, CEO of KPN Qwest, a data communications venture.

To get there, more deals will happen fast. For starters, there's the question of who will get Orange, Mannesmann's subsidiary. To acquire Mannesmann, Vodafone AirTouch agreed to divest Orange, the British cell-phone operator Mannesmann had purchased last fall. With buyers already lining up, Orange's estimated selling price has nearly doubled in six months, to almost $50 billion. "KPN and Telefonica wanted to get together to go after Orange," says Sean Johnstone, a telecom analyst at SG Securities in London. France Telecom, desperate to expand outside of France, also looks set to make a bid.

A wild card in the looming battle could come from outside Europe. MCI WorldCom Inc. will probably join the Orange frenzy. BellSouth Corp., meanwhile, has an alliance with KPN in a German mobile network. Insiders suggest it may want to take over both Telefonica and KPN. DoCoMo, the Japanese mobile giant, may also jump in.

A super combination among KPN, Telefonica, and an outsider would put more pressure on Deutsche Telekom. Hemmed in at home by Vodafone and KPN, DT could counterattack by bidding for KPN or even Telefonica. As for other former monopolies, a logical partner for Britain's BT is AT&T, with which it already has a joint venture.

The need for consolidation can only increase. The European Commission announced on Apr. 27 that incumbent local operators must open their last mile of wire to competitors at reasonable prices. The upshot? Even tougher competition. Ring up another reason for bigness.

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