Concessions Seen for Telefonica-KPN German Merger

Telefonica SA and Royal KPN NV’s bid to combine their German assets has become an acid test for a telecommunications industry anxious over whether regulators will allow deals carriers say they need to spur growth.

Already Germany’s phone regulator has given Telefonica’s O2 and KPN’s E-Plus units two weeks to turn over details of wireless frequencies so it can determine they’d be “efficiently used,” and that the merger won’t hamper competition, according to a July 25 letter from the Bonn-based agency.

The letter raised the prospect of a surrender of some airwaves, which could water down the benefits of the 8.1 billion-euro ($10.8 billion) transaction and by extension inhibit other carriers from attempting similar consolidation moves, which regulators have said are key to rationalizing the 28-nation European Union market. Approval of the deal will probably come with conditions such as asset disposals, according to competition lawyer Paul Hughes.

“You’re looking at a reduction in the big players from four to three,” said Hughes, European competition counsel at Steptoe & Johnson LLP in Brussels. “No doubt, there will be remedies required in the form of making available access to wholesale network for virtual mobile telephony companies, for making spectrum available to other players.”

Price Differences

The EU telecommunications market is inundated with carriers spread over 28 countries. That creates a sevenfold difference in the price of a domestic mobile call between the priciest and cheapest markets across a region less than half the size of the U.S., according to a statement yesterday from Neelie Kroes, who is in charge of the digital agenda for the European Commission, the EU’s executive arm in Brussels.

“It is critical for the whole EU to move quickly to build a real single market,” Kroes said.

The combination of O2 and E-Plus, two of Europe’s fiercest competitors, sets up the likelihood of more deals in a region where phone companies struggle to keep up profitability and need to boost investments in faster services. With earnings under pressure, carriers from EE in the U.K. and Vivendi SA’s SFR in France to Telecom Italia SpA and Spain’s Yoigo are considering partnerships or share sales.

Combining forces in markets like Germany, Europe’s largest economy, will help competition, not thwart it, Telefonica Chief Operating Officer Jose Maria Alvarez-Pallete said last month.

‘Play Scale’

“There are too many players in Europe that if Europe as a whole, as a region, wants to play scale, it needs to consolidate,” he said on a July 25 conference call. “The consolidation of the third and fourth should create an infrastructure-based player that is going to accelerate competition” in Germany with market leaders Deutsche Telekom AG and Vodafone Group Plc.

Telefonica Deutschland spokesman Albert Fetsch and Stefan Simons, a spokesman at KPN, declined to comment on the reviews. Alvarez-Pallete said on the call he expects it will be approved.

Telefonica fell 0.7 percent to 10.71 euros at 9:43 a.m. in Madrid, while shares of its German unit, Telefonica Deutschland Holding AG, slipped less than 0.1 percent to 5.10 euros in Frankfurt. KPN dropped 0.6 percent to 1.97 euros in Amsterdam.

EU Competition Commissioner Joaquin Almunia has indicated that he sees consolidation in the industry could be helpful, saying earlier this year the fragmentation “preoccupies” him.

“Our merger control in this sector therefore becomes especially important,” said Almunia in a speech in February. “We have to ensure that the market structures that result from the mergers we control remain competitive.”

‘Diligent Review’

The day before the German regulator’s letter, Andreas Mundt, head of the Federal Cartel Office, said to German newswire DPA that antitrust approval was “anything but a shoo-in” and requires “a diligent review.” Kay Weidner, a spokesman for the cartel office, declined to comment on the proposed merger, referring to Mundt’s remarks to DPA.

It remains to be seen how that will translate into the EU review of the merger. Madrid-based Telefonica and KPN, based in the Hague, Netherlands, haven’t notified the regulator of the deal and there is no rule on how soon they must put in their application. Once they do, it triggers a 25 working-day countdown for the commission to approve it or start an in-depth review, known as phase two, that lasts about 90 working days. Companies with significant deals often propose their own fixes to the competition concerns they foresee in a bid to head off a deeper look.

Irish Review

Hutchison Whampoa Ltd.’s 1.3 billion-euro takeover of wireless carrier Orange Austria last year faced intense scrutiny. Hutchison, owned by Hong Kong billionaire Li Ka-shing, received EU antitrust approval after agreeing to divest radio spectrum and offer network access to new rivals. Li, which agreed in June to take over Telefonica’s Irish assets, also needs regulatory approval for that deal.

“Phase two isn’t a death knell anymore,” said Peter Alexiadis, an EU competition lawyer in Brussels with Gibson, Dunn & Crutcher LLP. O2’s tie-up with E-Plus has “phase two written all over it only because of the enormity of the market and the level of consolidation.”

Almunia has blocked four deals since taking the post in 2010, including the 5.16 billion-euro bid by United Parcel Service Inc. for TNT Express NV. Vodafone withdrew its attempt to merge with a rival in Greece last year in the face of commission opposition to creating a market with two operators.

Inevitable Tension

Part of the challenge is that EU merger rules look at markets on a country by country basis given the lack of an EU-wide market for mobile telephony, Steptoe & Johnson’s Hughes said.

“There will inevitably be tension between industry and the competition regulator in Brussels,” he said. “The merger regulation evaluates them on a national basis at a time when they’re being told to become pan-European.”

Chantal Hughes, a spokeswoman for the European Commission, declined to comment on how the deal might fare before the competition authorities.

“If regulators allow the E-Plus deal, it will send a clear message that similar M&A deals can happen and will be a huge positive for the much-needed telco consolidation in Europe,” said Espen Furnes, who helps oversee $75 billion at Storebrand Asset Management.

“Regulators are now the biggest risk to the E-Plus deal,” Furnes said, adding that it will probably be approved at the end. “We’re likely to see more inner-market deals in the larger mobile markets if this one goes through.”

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