Telefónica goes for broke?

Citation

Curwen, P. (2006), "Telefónica goes for broke?", info, Vol. 8 No. 5. https://doi.org/10.1108/info.2006.27208eaf.001

Telefónica goes for broke?

A regular column on the information industries

Telefónica goes for broke?

At the very end of October 2005, Telefónica offered £17.7 billion ($31.4 billion) in cash to buy O₂ in the UK, a mobile operator with a mere quarter share of its domestic market and a few other European holdings. Only a short time previously, in March, it had successfully bought a 51.1 percent stake in Ceský Telecom for $3.6 billion in the face of competition from Belgacom and Swisscom, followed by a partially successful offer to buy out the minorities. These acquisitions did not, on the face of it, make sense given Telefónica’s existing holdings, so what was it trying to achieve? What follows is an attempt to answer this question.

First of all, given that the question involves the mobile telephony market, the distinction must be made between Telefónica and its 92.4 percent-owned subsidiary Telefónica Móviles (hereafter TEM). Table I indicates Telefónica holdings listed according to country. The first section covers Central and South American stakes while the second covers the rest of the world and the third covers the holdings that will be bought from O₂. Secondly, it should be noted that the subscriber numbers are proportionate – that is, they constitute the proportion of the gross subscribers to a network that “belong” to Telefónica in line with the equity stake in that network.

Table I

Telefónica, 31 December 2003, 2004 and 2005

Table I is necessarily rather complicated and it is accordingly desirable for the reader to examine the footnotes with care, but the essence of the situation is that at the end of 2003, Telefónica, either directly or via TEM, derived a significant proportion of its overall subscribers in the home market, a somewhat lesser number from a collection of nine networks in Central and South America and a modest number from Morocco. In addition, its small stake in Portugal Telecom, originally part of a share swap to cement relations between the two in conjunction with their Brazilian joint venture Vivo, produced a modest number of subscribers, some in parts of the world where Telefónica did not operate directly.

For a major European incumbent operator, Telefónica appears historically to have had remarkably little interest in European countries outside the Iberian peninsula. However, that is not strictly true because, in 2000, Telefónica made the decision to enter other European mobile markets via third-generation (3G or UMTS) licenses, subsequently obtaining roaming rights onto one or other of the relevant GSM (2G) networks. To this end, it mostly formed a part of consortia that bid successfully for licenses in Germany (acting as Group 3G in July), Italy (acting as IPSE 2000 in November) and Switzerland (acting as 3G Mobileis in December). These forays proved to be expensive failures. Telefónica had a 57.2 percent stake in Group 3G which paid nearly $7.7 billion for its license. Its partner, currently known as TeliaSonera, rapidly lost enthusiasm – not surprisingly given that roll-out costs were going to run to several billions more – and the license has remained in abeyance ever since. It Italy, Telefónica took a direct 4.0 percent and TEM a 45.6 percent stake in IPSE 2000 which paid $2.7 billion for its license. Once again there was a reluctance to invest in rolling out the network and IPSE 2000 was effectively shut down in October 2002. In early 2005, it seemed as though it would be sold – at a huge loss – to ENEL, but the deal fell through. The future of the company is unclear. Finally, in Switzerland, Telefónica bought a license by itself, but at least this only cost it $30 million. Nevertheless, it has been trying, so far without success, to sell it on.

Under the circumstances, Telefónica/TEM’s preference for investment in Central and South America was understandable although it consumed large amounts of cash during a period when, in the course of, and subsequent upon, the meltdown in telecommunications markets, money was difficult and expensive to come by. Certainly, there was none to spare for further forays into Europe or, indeed, anywhere else in the world. Fortunately, after a period of retrenchment, Telefónica’s finances had stabilized by mid-2004 when it became clear that a wonderful opportunity was about to present itself for Telefónica to consolidate in South America where it was losing the battle for leadership to Mexico-based América Móvil. BellSouth, faced with the problem of paying for its share of the purchase price of AT&T Wireless, decided to sell out its stakes elsewhere, and Telefónica moved rapidly to expand its South American empire, as shown in Table I. This enabled it to leave Telecom Italia trailing in its wake while it jousted with its main rival. Despite some overlaps, the transfer of assets mostly ran smoothly, and by early 2005 it seemed evident to virtually all analysts that Telefónica would thereafter consolidate its holdings and “stick to its knitting” – but they were wrong.

At the time of its acquisition, Ceský Telecom (together with wholly-owned mobile subsidiary EuroTel Praha) had just completed a major overhaul that had turned it into one of the best-run operators in Europe. However, it only had a 3G license plus roughly five million mobile subscribers which, geographically, were totally cut off from Spain, and it was not exactly cheap. Nothing daunted, Chairman Cesar Alierta stated that “we are now looking at the world from a global standpoint when it comes to acquisitions”, adding that China looked interesting. Several days later his interest was transformed into a three percent stake in China Netcom that, at the time, had no mobile subscribers. However, its desire to spread its wings did gain impetus with the successful bid tabled by France Télécom for Amena, its main mobile rival in Spain, presaging much tougher competition in the home market, and analysts began to question whether it would be interested in O₂, although it was assumed at the time that this would only constitute the unwanted assets to be hived off if O₂ was acquired by a Deutsche Telekom/KPN consortium. Alternatively, why not bid for KPN – it had failed to take it over in 2000 but was said to have approached it in 2005 with an unofficial offer in the region of $25 billion – or, indeed O₂ directly?

On the positive side, if it took over O₂, Telefónica would be in a position to attack its main rivals, Vodafone and Deutsche Telekom in the German market. Subsequently, its enlarged balance sheet would potentially enable it to make a move for Bouygues Télécom in France and effectively become a powerhouse in the European mobile space. On the negative side of the equation was the need to pay a premium over the existing share price that had already been inflated by the interest shown by Deutsche Telekom, although it should be noted that the Spanish government subsidies the cost of overseas expansion by making goodwill on foreign acquisitions tax deductible.

In the event the bid was forthcoming in cash, potentially adding 25 million proportionate subscribers (as of the end of 2005 – see Table I). It was argued that Telefónica hoped to learn from the competitive German and UK markets how to defend itself better in Spain, and like O₂, it had begun to roll out i-mode technology. However, the debt rating agencies promptly lowered Telefónica’s debt rating by one notch and mostly threatened to do so again if the deal went through. With €28 billion of debt on the books, and roughly the same again to come with the takeover, this was clearly no trivial matter, yet Telefónica insisted that it would raise the money in the bond markets and not have recourse to asset disposals or equity issuance, thereby effectively guaranteeing that the further credit downgrade would take place. Furthermore, the much-watched ratio of net debt to EBITDA would worsen sharply, thereby putting at risk the prospect of further share buy-backs and dividend growth. As for future acquisitions, there can surely be no more for the foreseeable future – Telefónica had already withdrawn from the auction of a stake in Turk Telecom when the financial markets expressed their disapproval.

In conclusion, it is not altogether clear whether Telefónica is being smart or stupid, and only time will tell. Certainly, there is some industrial logic in its behavior if it seriously wants to be a major player on the European mobile scene, and it must be admitted that it will almost certainly pass regulatory scrutiny with flying colors given the absence of overlaps. But nearly €60 billion of debt harks back to the bad old days of the telecoms bubble, and this debt is going to become increasingly expensive to service. Previous forays into Europe have ended in tears, but will this one provide the fairy story ending?

Peter CurwenVisiting Professor of Telecommunications at the Strathclyde Business School, Glasgow, UK. E-mail: pjcurwen@hotmail.com