Telefonica (Market Capitalization as of 27/09: €52.5bn)
Telecom Italia (Market Capitalization as of 27/09: €10.6bn)
Recent news regarding Telefonica’s interest in Telecom Italia (“TI”) came to no surprise. The deal fits into the recent revival of dealmaking within the TMT sector and culminates months of speculation surrounding Telecom Italia.
M&A Revamp in Telecommunications
If 2013 will be considered a good year for M&A, it will be mostly due to heightened activity within TMT, especially within telecoms where the largest deal in a long time is unraveling (Verizon – Vodafone, discussed below). The sector has increased 38% Y-o-Y, more than any other, and it has inflated the current deal activity figure to $1.57 trn, up $70 bn with respect to last year. It is important, however, not to jump to conclusions regarding the health of the investment banking industry: without the Vodafone megadeal, in fact, 2013 would still lag behind in volume compared to 2012.
Many companies in the telecom sector have been pushed to pursue external growth given the highly competitive market environments typical of Western countries as well as the lack of growth in most of these very same countries. Acquisitions have thus been seen as the best way to deploy the large cash cushions that companies have built to tide over the crisis and to consequently deliver the returns demanded by their shareholding’ base. In a Darwinist-like scenario, strong companies like Telefonica and Carlos Slim’s America Movil have come to the fore of this acquisition wave taking advantage of companies in need, like the overleveraged Telecom Italia.
Telefonica had started making moves already in the summer to create the largest mobile operator in Germany, in a complex transaction valued at ca. € 8bn where its German subsidiary Telefonica Deutschland acquired E-Plus from KPN. It is now moving over to Italy, where it wants to increase its stake in TI to create value for its shareholders and protect its Brazilian interest (where it operates through the market leader Vivo).
Telefonica – Telco
The Italian move of Telefonica is seen by operators as aimed at increasing its exposition to Southern Europe as well as trying to control competitive pressures in Brazil where both the Spanish and the Italians hold an interest.
On the 24th of September, Telefonica secured a deal of €861 mln($1.2 bn) cash and stock transaction, which will allow the company to boost its stake in Telecom Italia. At first, the Spanish company will pay €324 mln to increase its ownership from in Telco from 46% to 66%, the holding company controlling 22.4% of Telecom Italia. Thus, a Telecom Italia share is valued at €1.09, so nearly twice the current market price (€0.58 on 27th September 2013), representing de facto a hefty control premium paid to the existing shareholders. In order to momentarily avoid antitrust issues, Telefonica will maintain only 46% of voting shares of Telco.
The second stage, subject to regulatory approval, consists of Telefonica’s increasing its control over Telco to 70% while keeping its voting stake unchanged.
On 1st January 2014 Telefonica could exercise a right to convert preferential shares into ordinary ones, a move that would increase its voting power to 65%.
Moreover, Telefonica will use some of its shares to pay down some of Telco’s debt and then, it will gradually become the sole owner, through acquiring additional shares from the other Telco’s shareholders, such as Italian banks, Mediobanca, Intesa San Paolo and Generali. The latter group obtains then an exit opportunity in June 2014 or in February 2015.
The proposed transaction wouldn’t’ generate any benefits for the minority shareholders since, according to the current Italian takeover law, the threshold for mandatory takeover bids is set at 30% and Telco owns only 22.4% of Telecom Italia. However, the Italian Government is considering lowering the limit of 30% to force the Spanish company to acquire the rest of Telecom Italia at €1.09 per share, an ad-hoc measure apparently
“Telecom is the most delicate structure of the country, through which all Italian citizens’ communication goes”, said Giacomo Stucchi, president of Copasir. Cgil, Cisl and Uil are putting pressure on the Governmentas well, because this deal will cause a negative impact on the country’s level of employment, as nearly 12,000 workers are likely to lose their position. Moreover, unions’ representatives insist that a foreign control on a strategic asset like telecommunication, will limit its investment opportunities and future development.
For the debt-laden company Telefonica’s acquisition of an extra 20% of Telco comes alongside to the sale to other strategic buyers, the disposal of assets and/or a rights issue. With ca. €30bn net debt, TI’s management led by CEO Bernabè has been exploring different deleveraging options with the intent of putting the company back on track to carry out the necessary infrastructure investments and avoid the potential downgrade of their debt to junk status. Bernabè is expected to present a business plan at the board meeting which will be held on the 3rd of October, same meeting during which it has been rumoured that Bernabè will resign after having lost the support of the company’s biggest shareholders.
Possible strategic partners who have over time displayed interest in TI or parts of TI are the American telecommunications giant AT&T, Egyptian tycoon Naguib Sawiris and Hong Kong-based Hutchinson Whampoa.
The most discussed option definitely consists in the disposal of one of TI’s assets, with public interest focusing mainly on TIM Brasil and on TI’s fixed line network. According to many analysts, Telefonica’s recent move to gradually buy out Telco is part of its plan to force TI to sell its Brazilian business and to avoid a capital increase to raise cash. Telefonica is likely to be interested in buying at least part of the business alongside other Brazilian telecoms operators owned by America Movil and Portugal Telecom. The four groups all control roughly a quarter of the Brazilian market, with Telefonica’s market leading Vivo accounting for only marginally more customers than TIM Brasil. A potential deal to reduce the level of competition would be welcomed by all the companies, but will most likely attract the scrutiny of the country’s competition regulator. This finds Telefonica in deep disagreement with TI, which sees the Brazilian operations as one of its crown jewels and as such not for sale. TI is more willing to consider the disposals of some real estate assets or the possibility of splitting its fixed line network into a separate operation that could be opened to investors. The latter asset has attracted a lot of public debate, and in particular the government seems to be pushing for an investment by the Cassa Depositi e Prestiti in order to “protect national security” and keep this strategic asset in national hands. Many scepticals see this as a move to dump TI’s obsolete fixed line network on CDP’s balance sheet, helping TI to raise a decent enough sum to allow it to reduce its exposure to Italian banks. However, the possibility of a rights issue seems to be TI’s favourite option so far under the claim that it is the only option which would allow it to raise money quickly enough to avoid an impending credit downgrading. What we must wait to see is whether the board will push for the rights issue regardless of Telefonica’s opposition, which at least in theory could happen as such a resolution can be passed with just two-thirds of shareholder support.
It will be very interesting to follow up on the successive stages of this transaction, given its complexity and the clashing of multiple diverging interests.