Regulatory Risks Loom as O2, E-Plus Owners Consider Deal
Telefonica SA (TEF) and Royal KPN NV (KPN), weighing a $20 billion merger of their German businesses, would probably face protracted regulatory scrutiny delaying any savings and restricting potential stock gains.
A combination of Telefonica’s O2 and KPN’s E-Plus would cut the number of network operators in Germany to three and create the country’s largest wireless-service provider by customers. An antitrust review could drag into 2013, with possibly different outcomes depending on whether the European Commission or the German Federal Cartel Office takes on the case, said Frederik Wiemer, an antitrust lawyer at Heuking Kuehn in Hamburg.
When the European Commission approved a merger of Deutsche Telekom AG (DTE) and France Telecom SA (FTE)’s U.K. units in 2010, there was little rivalry between the two operators, both had declining market share and neither was among the cheapest providers. E- Plus and O2 compete for lower-priced subscriptions, and both are growing faster than Vodafone Group Plc (VOD) and Deutsche Telekom, said Javier Borrachero, an analyst at Kepler Capital Markets.
“In the U.K. this was a relatively easy case to make, with T-Mobile underperforming and the France Telecom unit not delivering either,” said Madrid-based Borrachero, who has a “buy” rating on Telefonica and “hold” for KPN. “In Germany that’s not obvious at all. I wouldn’t take this scenario as a reason to recommend either Telefonica or KPN.”
KPN and Telefonica are exploring the German combination, as well as an initial public offering of the joint carrier, among various strategic options, people familiar with the matter said this month. The Hague, Netherlands-based KPN, seeking to fend off an unsolicited 2.6 billion-euro ($3.3 billion) offer for a stake by Carlos Slim’s America Movil (AMXL) SAB, estimates a merger would generate 4 billion euros in synergies.
The enlarged company would have a value of 16.2 billion euros, including savings, Sanford C. Bernstein & Co. analyst Robin Bienenstock wrote in a June 8 note. Madrid-based Telefonica, America Movil’s main competitor in Latin America, is separately pursuing IPOs of its German and Latin American assets to help reduce net debt of more than 57 billion euros.
A deal this large would have to be reviewed by the Brussels-based European Commission. The German antitrust office is likely to ask the EU watchdog to turn the case over to it, said Joerg Karenfort, head of Salans LLP’s competition-law practice in Berlin.
Both the Commission and the German regulator would be interested in reviewing a potential merger of E-Plus and O2, according to a person familiar with the matter. Germany’s Federal Cartel Office won’t in principle rule out a reduction in market participants, another person said, adding that it’s too early to provide a detailed assessment.
KPN and Telefonica may face greater resistance from the European Commission than German regulators, said Wiemer, the lawyer at Heuking Kuehn, who estimates the review process may take seven months.
“Whereas the Commission may prohibit the merger if it leads to a significant impediment of effective competition, the Federal Cartel Office must find the creation of a market dominant position of the merged entity,” he said. “Apparently, there is no single dominant player in Germany. The flood of new offers by service providers or retailers in recent years may also work in favor of an approval.”
O2 and E-Plus would have a combined mobile-phone customer base of 41.7 million, which would leapfrog Vodafone’s 36.5 million and Deutsche Telekom’s 35.1 million. Based on wireless- service revenue in the first three months of this year, a combined E-Plus and O2 remains smaller, with about 1.53 billion euros, compared with Vodafone’s 1.7 billion euros and 1.66 billion euros for T-Mobile.
Representatives for the Commission and the German regulator declined to comment, as did spokesmen for Telefonica and KPN.
Niek Jan van Damme, who leads Deutsche Telekom’s German unit, said a merger of E-Plus and O2 is a “valid option.”
“I’ve myself experienced similar consolidation in the Dutch market from five to three network operators,” he said in an interview today in Cologne. “Prices have remained under pressure and have come down.”
Through yesterday, KPN shares had gained 20 percent since May 7, the day America Movil announced its bid. The stock added 0.3 percent to 7.79 euros at 11:25 a.m. Amsterdam time, trading below the 8 euro-a-share offer that ends June 27. Telefonica rose 2.1 percent to 9.89 euros and has dropped 11 percent since May 7.
America Movil, which has offered to increase its KPN stake to as much as 27.7 percent, said yesterday it had accumulated a 7.3 percent holding in the carrier.
A number of telecommunications mergers have faltered in the face of regulatory opposition. Vodafone in February abandoned its attempt to combine its Greek unit with Wind Hellas. European regulators were concerned about creating a market with only two operators, a person said at the time.
Last year, AT&T Inc. (T) and Deutsche Telekom gave up on the U.S. carrier’s proposed $39 billion purchase of T-Mobile USA as authorities opposed a deal that would have reduced the number of nationwide players to three from four.
Switzerland’s regulators in 2010 rejected France Telecom’s plan to merge its Swiss operations with those of TDC A/S. (TDC) In February this year, antitrust authorities approved Apax Partners LLP’s purchase of France Telecom’s local Orange unit. That deal didn’t decrease the number of operators.
E-Plus’s first-quarter mobile-service revenue rose 4.2 percent to 767 million euros from the year-earlier period, as it added 2.3 million customers. O2’s wireless-service sales rose 11 percent to 758 million euros and its customers increased 7.1 percent. That exceeded growth at Vodafone and Deutsche Telekom.
Germany’s mobile market is already less competitive than the U.K.’s, Exane BNP Paribas analysts say, citing the Herfindahl-Hirschman Index, a measure of market concentration that it says antitrust authorities are likely to reference. A merger would take the measure to 3,300 from 2,900, exacerbating its high market concentration. The creation of Everything Everywhere moved the U.K. market to 2,800 from 2,300 as the number of network operators shrank to four.
“An E-Plus and O2 merger would be considered to increase market power and could be blocked or come with substantial remedies,” the analysts wrote in a June 6 note.
Regulators may observe that E-Plus has been keeping other operators on their toes with low-cost offers. The KPN unit in April introduced a 20-euro flat rate for mobile voice and data connections under the Yourfone brand, undercutting its rivals by more than a third.
In addition to an antitrust review, Germany’s Federal Network Agency would have to review the network infrastructure and spectrum holdings of a combined entity. E-Plus and Telefonica would probably be required to sell some of those assets to their peers, according to Bernstein’s Bienenstock.
“The antitrust authority will probably weigh whether a merged business can better stand up to the market leaders than individual providers could,” said Salans’s Karenfort. But they “will carefully review whether this creates an oligopoly of three, which would be problematic from an antitrust control point of view.”