Telefónica's (TEF ) Oct. 31 bid for London-based cell-phone provider O2 PLC (OOTFF ), if it goes through, will be one for the record books. The $31.4 billion price tag ranks the deal as the second-largest all-cash offer in telecom history, after Cingular Wireless LLC's purchase of AT&T Wireless. It also would be the largest British acquisition since 2000 and the second-largest proposed takeover this year in Europe after Gas Natural of Spain's (GASNF ) $51.7 billion bid for electricity giant Endesa (ELE ), according to market tracker Dealogic.
The Spanish phone giant's bold bid is the latest in a flurry of recent merger-and-acquisition activity in Europe. Dealmaking in the first nine months of this year topped $763 billion in the Old World, and third-quarter deals outpaced U.S. activity by 50%. It's also a sign of consolidation in the European telecom sector, where resistance to cross-border mergers is wearing down, and smaller, independent carriers are falling prey to globe-straddling giants.
The same day Telefónica announced its O2 bid, Norway's Telenor (TELN ) agreed to buy Vodafone Group PLC's (VOD ) Swedish wireless operations for $1.2 billion. Two private equity firms are circling Danish telecom TDC A/S (TLD ). Ireland's eircom (EIRGF ) said on Nov. 2 that it's being pursued by an unidentified buyer. And France's No. 3 mobile operator, Bouygues Telecom, continues to be seen as a potential target (DCM ).
O2, spun out by BT Group PLC (BT ) in 2001 in an $11 billion "demerger," has been a rumored takeover target for years because it is dwarfed by rivals such as Vodafone, Deutsche Telekom's (DT ) T-Mobile, and France Telecom's Orange. What caught analysts off guard was the buyer. Telefónica, which has 145 million wired and wireless subscribers worldwide and 68 million mobile customers outside Europe, has long favored acquisitions in emerging and Spanish-speaking markets. The company has spent $50 billion on Latin American telcos since 1990 (BLS ).
But all that changed this year when Telefónica beat out Swisscom in a last-minute bidding war for Czech operator Cesky Telecom. Suddenly, Telefónica's dormant interest in European expansion reawakened. Now, with $36.4 billion in 2004 revenues, up 6.8% from the year before, and first-half 2005 revenues 20% ahead of last year's, Telefónica is outperforming many European peers. More important, it's a cash cow, spinning out almost $3.4 billion in free cash flow in the first half.
Telefónica's move for O2 also may have been defensive. Like other fixed-line operators, it sees a huge long-term threat from Internet telephony, which could savage prices for conventional phone calls. By picking up O2, with its 25 million customers in Britain, Ireland, and Germany, Telefónica gets quick access to two top mobile markets. "O2's integration in the Telefónica group will enhance our growth profile," said Chairman César Alierta Izuel in a statement, "[allowing] us to gain economies of scale and balance our exposure across regions."
Financial analysts were generally positive on the acquisition. Brokerage Dresdner Kleinwort Wasserstein (AZ ) figures that the takeover will add to earnings and cash flow. It says "Telefónica got a fair deal," despite paying 18.4 times O2's projected 2006 earnings. Still, Telefónica's shares fell 4.7% on the Madrid bourse in the days following the bid, and its New York-traded American depositary receipts dropped 5.4%, to $47.37.
If Telefónica succeeds in closing the O2 deal, Alierta and his team will have their hands full. The biggest question is whether Telefónica knows how to win in cutthroat markets such as Britain and Germany. "Telefónica is used to being the leading player in the markets where it's present," says Mark Newman, chief research officer for researcher Informa Telecoms & Media in London. "It may not know how to play catch-up." That's a challenge the Spaniards are ready to tackle.
By Andy Reinhardt, with Esha Bhandari in Paris