Telefonica German Merger Approval Signals More M&A Deals

The European Union approval of a merger of two national wireless carriers in its biggest economy will give the struggling $230 billion industry a reprieve while setting the stage for a new round of mergers and acquisitions.

The clearance of Telefonica SA’s 8.55 billion-euro ($12 billion) deal to acquire Royal KPN NV’s E-Plus unit in Germany, announced today, ends a year of uncertainty about competition in a country with more than 110 million mobile-phone accounts. It may also set a precedent for future mergers and acquisitions with the elimination of a major European wireless discounter.

The last time two national operators of comparable sizes won approval to merge was in 2010, after Deutsche Telekom AG and France Telecom SA pooled their U.K. mobile assets. European wireless industry revenue has shrunk about 10 percent since that deal was announced, according to data compiled by Bloomberg. Smaller mobile takeovers the European Commission cleared recently include Hutchison Whampoa Ltd.’s purchases of Orange in Austria and of Telefonica’s Irish unit.

“It seems clear to me that after Hutchison/O2 in Ireland and now Telefonica/E-Plus in Germany, there certainly will not be a presumption against a merger from four to three mobile operators, even in large countries such as Germany,” said Emanuela Lecchi, a lawyer at Watson, Farley & Williams LLP in London. “Italy and France in particular are considered jurisdictions ripe for consolidation.”

Wind, Yoigo

E-Plus and Telefonica Deutschland Holding AG, the third-and fourth-largest mobile carriers in Germany, will together compete for market share with Vodafone Group Plc and Deutsche Telekom’s local units. In most other major markets, including Italy, France, Spain and the U.K., four network carriers fight for accounts that often outnumber inhabitants.

Deals that are more likely to take place include a combination of Hutchison’s Three unit in Italy with Wind, owned by VimpelCom Ltd., and takeovers involving TeliaSonera AB’s Yoigo business in Spain and Bouygues SA’s mobile division in France, according to Vincent Maulay, an analyst at Oddo & Cie. in Paris. Today’s approval also sends a much stronger signal to the industry than the consolidation in the U.K. of five carriers into four in 2010, he said.

“Back then the pressure on the industry wasn’t anywhere close,” Maulay said. “It’s clearer now than it was then that you have to mitigate the bottom line.”

Network Investments

Bouygues Chief Financial Officer Philippe Marien told analysts today the company remains open to merger offers for Bouygues Telecom. Spokesmen for Hutchison in Italy and Amsterdam-based VimpelCom declined to comment. A representative for Stockholm-based TeliaSonera didn’t immediately return a phone call seeking comment.

In a statement, the European Telecommunications Network Operators’ Association welcomed the decision, saying it’s a first step toward encouraging network investments and better service quality for consumers.

As telecommunications providers increasingly combine wireless, landline and high-speed Internet offers, Europe has become the only region where industry revenue is sliding even as more people use smartphones and tablets to watch videos, play games and listen to music. Sales fell 1 percent to $409 billion last year, compared with a 3 percent increase in North America and a 3.6 percent gain in Asia, data compiled by Bloomberg show. Wireless accounted for more than half of the figure.

Roaming Fees

As Europe emerges from the debt crisis that crimped demand for expensive phone contracts, a European Union ruling to cut mobile roaming charges across the 28-nation bloc took effect yesterday, further threatening what was once a very profitable business for carriers.

While European carriers on average didn’t increase investments per subscriber between 2011 and 2013, capital spending rose to 18.8 percent from 16.1 percent of revenue per user over the period as sales declined, the GSMA industry group said in a report in May.

A wave of mergers to follow “will improve profitability and support valuations,” said Boris Boehm, who helps manage 2.2 billion euros including Telefonica shares at Aramea Asset Management AG in Hamburg. “What I’d now need to see is how the industry can actually generate growth.”

While the European Commission is right to encourage domestic mergers in Europe, one possible undesired result could be that high share prices and low interest rates will tempt companies to spend on acquisitions rather than on network improvements, Boehm said.

‘Positive Trigger’

Telefonica Deutschland added 3.9 percent to 6.35 euros at 3:53 p.m. in Frankfurt, the biggest winner in the 23-company Bloomberg Europe Telecommunication Services Index. Its parent company slipped 1.6 percent in Madrid. KPN dropped 0.3 percent in Amsterdam.

“It’s a positive trigger for further consolidation in Europe, which is what investors are waiting for,” said Virginie Deterck, an analyst at Paris-based Amundi Asset Management.

Today’s decision is also closely watched by carriers and regulators in the U.S., where the Department of Justice and the Federal Communications Commission have so far opposed a reduction in the number of nation-wide network operators from four to three. In 2011, they shot down AT&T Inc.’s attempt to buy T-Mobile from Deutsche Telekom.

T-Mobile Sale?

That unit is for sale again, with Sprint Corp. in talks to acquire it, people familiar with the matter have said. T-Mobile and Sprint’s owner, SoftBank Corp. of Japan, have been making the case that a merger would benefit consumers by putting pressure on market leaders Verizon Communications Inc. and AT&T.

Today’s approval is conditional on Telefonica committing to selling as much as 30 percent of its German network capacity to one or several operators. The company agreed last week to sell the entire amount to Drillisch AG, one of the smaller resellers with fewer than 2 million customers.

The commission also demanded that Telefonica divest wireless spectrum and other assets that could facilitate the creation of a new network operator. The provider must also allow any interested reseller access to its 4G network and make it easier for those companies’ users to switch to a different network operator, according to the terms.

Bernd Meyring, a Brussels-based partner at Linklaters LLP, said the European Commission will base its future decisions on similar mergers on whether the remedies in Germany could help establish Drillisch as a “serious contender.”

“The main question is this: Does effective competition need a number of independent networks, or can it work when several competitors use the same infrastructure?” Meyring said. “The commission is only starting to find out.”

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