The global telecoms “land grab”

Telefonica's £17.7bn bid for UK mobile group O2 is the latest in a flurry of recent merger and acquisition activity in the European telecoms sector.

Telefonica, Spain's biggest telecoms group, this week broke free from a pack of potential bidders for O2 with a £17.7bn offer for the UK's second-largest mobile operator, says the Financial Times. The deal will make Telefonica the world's second-largest listed international telecoms group, behind the UK's Vodafone. It will also gain 24.6 million clients in the UK and Germany to Telefonica's 90 million-strong, mainly Spanish and Latin American, subscriber base. This bid should not only spice up competition for market share in Spain, but is likely to spark further acquisitions in the sector across Europe.

For O2 shareholders, it's a "fantastic" result, says The Daily Telegraph: they get a premium of 22% above Friday's closing price of 164.25p. Indeed, at 200p a share the deal is probably "a good 50p" beyond what the Spanish group could justify paying in the normal course of events. But these are not normal times: mobile operators are partaking in a "rapid land grab". Revenues per subscriber are falling and the big players are worried. And even though Deutsche Telekom and T Mobile have said they won't bid, the deal isn't done yet.

Telefonica's bid is the latest in a flurry of recent merger and acquisition activity in Europe and another sign of the changing landscape in European telecoms, say Andy Reinhardt and Esha Bandhari in BusinessWeek. The very same day that Telefonica announced its O2 bid, Norway's Telenor agreed to buy Vodafone's Swedish wireless operations for $1.2bn. And in July, France Telecom bought Amena, the number three wireless operator in Spain, for $7.7bn. The merger mania looks "far from over". Two private equity firms are circling Denmark's TDC, and Telecom Italia may start looking, as it's made no major acquisitions in Europe. Potential victims include France's number three mobile operator, Bouygues Telecom.

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Outside Europe, the race to grab control of fast-growing markets is underway too, with Vodafone set to be the first telecommunications group to act on India's recent relaxation of foreign direct investment limits, says the FT. And if industry pundits are correct, "it will not be the last". Vodafone's acquisition of a 10% stake in India's largest mobile phone operator, Bharti Tele-Ventures, potentially gives it exposure to a huge honey pot, since India is the third-largest mobile market in Asia, behind China and Japan.

Vodafone is a rare UK success story, but all this cross-border activity in telecoms leaves the UK a bit like Wimbledon: the world's best players on display, but few starring roles for the Brits, says Anthony Hilton in the Evening Standard. The O2 takeover means Vodafone is the only one of the five mobile networks in the UK that is British owned. Of the others, T-Mobile is owned by Deutsche Telekom, Virgin runs on the T-Mobile network, Orange is part of France Telecom and 3 is owned by Hong Kong-based Hutchison. And now there's Disney a potential newcomer to the UK market, which plans a virtual network akin to Virgin's. How have we come to this? It's because many other countries have found ways of blocking foreign bids and UK managements are becoming increasingly short termist, motivated by massive share options and incentive schemes.

The best bets in the sector

Fundamentally speaking, the O2 bid is not a bad deal for Telefonica, says Luis Prota, telecoms analyst at Morgan Stanley. However, even if the numbers stack up, the company's credibility has taken a knock. Top management repeatedly denied that they were going to buy an operation on the scale of O2 and this might "become an issue" for investors concerned about future acquisitions.

The real winners should be shares in the sector's remaining minnows, which should rise, says Lex in the FT. (Shares in Virgin Mobile (VMOB) for instance, have been strong since the Telefonica announcement.) Yet if scale in the industry is what everyone is after, then the best company to buy may yet be Vodafone (VOD). Its stock price already reflects the "punishing cost of expansion".

Another way investors might benefit as telecoms companies compete for new customers is to invest in firms providing mobile phone technology. Bango (BGO) is likely to do well out of people using their mobiles to watch news, play games or receive pictures, says The Daily Telegraph. The company only floated in June and is loss making, although it generated revenue of £3.4m last year. A capitalisation of £51m "looks punchy", but chairman Lindsay Bury has recently bought shares, which is positive. It is a "buy", but a risky one.