Telefonica to Buy KPN’s German Unit for $10.7 Billion

Telefonica SA agreed to buy the E-Plus German wireless unit of Royal KPN NV in a cash-and-stock deal valuing the unit at 8.1 billion euros ($10.7 billion) to become the country’s biggest mobile-phone operator by customers.

The Dutch phone company will get 5 billion euros in cash and a 17.6 percent stake in the combination of E-Plus and Telefonica Deutschland Holding AG, the Spanish carrier’s German unit, which uses the O2 brand, KPN said today.

The purchase would let Telefonica’s O2 surpass Deutsche Telekom AG and Vodafone Group Plc as stiffening competition in the German wireless market forces carriers to cut prices and seek mergers. Still, the elimination of a carrier by combining the third- and fourth-largest operators will face scrutiny from antitrust regulators.

“The deal is very positive for Telefonica from a business perspective while it doesn’t affect its debt position,” Borja Mijangos, an analyst at Interdin Bolsa in Madrid, said by phone today. “My biggest concern down the road is potential regulatory issues that may delay the transaction or request some conditions to the agreed deal.”

The deal, which the companies expect to complete in the middle of 2014, will result in cost savings and revenue “synergies” of 5 billion euros to 5.5 billion euros, the companies said. Telefonica, Europe’s most indebted phone company, reiterated its goal to reduce net financial debt to less than 47 billion euros by the end of 2013.

KPN rose 3 percent to 1.85 euros at 3:42 p.m. Amsterdam time. Telefonica gained 2.7 percent to 10.33 euros in Madrid, while shares of the German unit fell 5.3 percent in Frankfurt.

German M&A

The deal is the biggest in Europe’s telecommunications industry since Vodafone agreed to buy Kabel Deutschland Holding AG in June, according to data compiled by Bloomberg. The agreement values E-Plus at 9 times estimated full-year earnings before interest, tax, depreciation and amortization, KPN said.

Germany has become the hottest battleground for telecommunications assets in Europe as demand for video and music delivered wirelessly and over the Internet increases, while voice revenue declines. Vodafone agreed to pay 7.7 billion euros for Kabel Deutschland, the country’s largest cable company, as it combines phone, Web and TV services to increase customer loyalty and stabilize prices.

Rights Issue

Telefonica Deutschland will help finance the purchase through a 3.7 billion-euro rights issue underwritten by its parent. The Spanish carrier said it will subscribe to 2.84 billion euros of new shares as a proportion to its current stake of 76.8 percent. Telefonica’s stake in the new company will be 65 percent.

O2 and E-Plus’s combined customer base at the end of March would leapfrog Vodafone’s 32.4 million and Deutsche Telekom’s 37 million, according to data compiled by Bloomberg Industries. Counting wireless-service revenue, E-Plus-O2 remained smaller than Vodafone and T-Mobile.

“The transaction we announced today has been contemplated for a long time,” Telefonica Deutschland Chief Executive Officer Rene Schuster said on a conference call with journalists. “Both parties have realized the outstanding value creation potential to join forces for many, many years, and I’m glad that we finally found a common ground.”

Shrinking the number of carriers in Germany to three will “create a more balanced playing field, allowing the combined business the opportunity to exploit the economies of scale enjoyed by the existing incumbents,” Giovanni Reichenbach, an analyst at Fitch Ratings, said today in a note. Fitch affirmed Telefonica’s BBB+ rating with a negative outlook and Telefonica Deutschland’s BBB rating and stable outlook.

Regulatory Issues

As Neelie Kroes, the EU commissioner in charge of the digital agenda, pushes reform in favor of a single European telecommunications market, carriers have become more emboldened to pursue deals. They are seeking to share expenses to build so-called fourth-generation networks to cope with rising demand for faster data connections.

“This is a very important step in consolidation in Europe,” KPN Chief Executive Officer Eelco Blok said on a conference call. “We are clearly of the view that scale in this very competitive market on the one hand and the investment wave driven by 4G spectrum will drive consolidation.”

Competition regulators at the European Commission and in Germany would be interested in reviewing a potential merger of E-Plus and O2, a person familiar with the matter said last year. Germany’s Federal Cartel Office won’t in principle rule out a reduction in market participants, another person said at the time, when KPN and Telefonica were holding talks about a merger of the assets.

More Consolidation

It’s too early to comment on whether the deal will be approved, Ryan Heath, a spokesman for Kroes, said today in an interview on Bloomberg Television. Still, EU regulators are “keen to see more cross-border consolidation,” he said.

Antoine Colombani, a spokesman for Competition Commissioner Joaquin Almunia, declined to comment.

For Telefonica, the agreement follows several transactions globally as the company seeks to sell assets to reduce its debt load. The company recently agreed to sell its Irish business to Hong Kong billionaire Li Ka-shing’s local unit called Three.

Morgan Stanley, Citigroup Inc. and HSBC Holdings Plc advised Telefonica, while KPN was assisted by Goldman Sachs Group Inc. and JPMorgan Chase & Co. Telefonica Deutschland was advised by Bank of America Merrill Lynch and UBS AG.

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