Telefonica: Takeover Escape Artist?

It's fending off predators with spin-offs that boost market cap

The TV show is called Big Brother, and it may well be the biggest rage in Holland since the tulip craze in the 1600s. The idea is simple. Nine young people live inside a house for 100 days, surrounded by microphones and cameras, and totally blocked out from the rest of the world. They eat, talk, read, and scuttle off to the bedroom from time to time, and an entire nation watches. It's the "real-life" drama taken to an extreme, and one of the biggest fans is Juan Villalonga, chairman of Spanish phone kingpin Telefonica. On Mar. 17, the Spaniard agreed to dish out $5.4 billion in stock for Endemol Entertainment, the Dutch TV company that produces Big Brother.

Count on Villalonga to buck a trend. His competitors in Europe are hurrying to buy phone companies. Size, they believe, is the key to survival in a continent dominated by mighty Vodafone AirTouch PLC. But the 47-year-old Villalonga, a former Bankers Trust executive and McKinsey & Co. partner, is pursuing a far different strategy. He's reorganizing Telefonica into a portfolio of a half dozen businesses, from a media group to Latin Internet behemoth Terra Networks, and he's spinning them into the stock market.

BIG SPENDERS. The idea is to create a stable of stock market stars and drive up Telefonica's market cap--its rampart against takeovers. The key to Villalonga's scheme is content. Without it, he believes, phone companies risk becoming simple commodity pipelines. That's why, while the rest of Europe's phone giants shop for networks, he buys a TV studio.

The question is whether Villalonga can hold off the predators in Europe long enough to carry out his restructuring. Already, Deutsche Telekom and British Telecommunications PLC are eyeing the Spanish star, analysts say. No doubt Telefonica would be a lot to swallow. Its stock price has quintupled in the past four years, and the $13.5 billion company, with 1999 earnings of $1.8 billion, has a market capitalization of $84.7 billion. But that's not enough to fend off suitors these high-spending days. A recent spurt, for example, has driven Deutsche Telekom's market cap to $267 billion.

For now, Villalonga is racing ahead with big projects. This spring, he's issuing some $22 billion in new stock to consolidate his grip on Telefonica's Latin America jewels in Argentina, Brazil, and Peru. This should permit him to split off the valuable pieces of those companies, including mobile-phone and Internet businesses, and package them with Telefonica's spin-offs. At the same time, he's bidding for next-generation mobile-phone licenses in Europe. And he's continuing to launch IPOs. Next up, in May, is Telefonica's media group, including TV, radio, and cable operations in Spain and Latin America and 5% of British publishing group Pearson PLC.

And where does Endemol fit in? If Villalonga has his way, into nearly every pipeline and radio wave that Telefonica controls. The Dutch group, with 1999 sales of $480 million, produces more than 300 television programs. The next step, says CEO John de Mol, will be to follow Telefonica into Latin America. "We were running out of room for growth in Europe," he says.

But what heightens Endemol's appeal is its link to the Web. In its Big Brother series, for example, die-hard viewers keep up with the televised household on the Net during all the hours the TV isn't broadcasting. As the show spreads across Europe and into the U.S. later this year, Villalonga will look for it to feed his Internet businesses. And he maintains that Telefonica is trolling for more media buys.

BANKER FRIENDS. While media fits into Villalonga's vision, most of Telefonica's growth is coming from the mobile-phone markets. In Spain, Telefonica's mobile business grew by 85% last year, while Latin America raced ahead 125%. "They're especially good at winning the business markets, since they tie all their services together," says one disheartened competitor in Spain. The cellular boom was the main reason for the 10.5% increase in Telefonica's sales last year.

Despite this success, Villalonga cuts a controversial figure in Spain. In the middle of the recent election campaign, papers reported that Villalonga was in position to rake in stock options worth $15 million. This created problems for Aznar, who had given his old schoolmate the top job at Telefonica when it was still state-controlled. It played into the Socialist opposition's claim that Aznar's privatizations were pouring fortunes into the pockets of cronies.

In response, Villalonga hurried to extend limited stock options to Telefonica's 120,000 workers worldwide. At the same time, he protected his flank by signing an e-banking joint venture, featuring cross-shareholding, with Banco Bilbao Vizcaya Argentaria, Spain's largest bank. "If the President wants his head, Villalonga will have the bankers as allies," says one telephone executive in Madrid.

Bank allies could also help if European raiders come knocking. For now, Villalonga is building his media and Net operations, trying to make Telefonica too rich to be eaten. But in Europe's phone wars, as Mannesmann boss Klaus Esser learned, price is little object. If Telefonica is going to survive on its own, Villalonga may have to put aside content for a month or two and go giant hunting.