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Last updated: October 31, 2005 7:51 pm

Spanish group stirred into action

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Telefónica’s audacious bid for O2 will leave investors wondering what direction the Spanish group is taking.

After building up an impressive array of Latin American assets, which was rounded off by the $5.855bn acquisition of BellSouth’s operations in the region last year, it also gained a toehold in the vast Chinese market, paying €240m ($287m) for a 3 per cent stake in China Netcom this year, subsequently lifted to 5 per cent.

But the company’s main focus was to establish a presence in Europe, outside its home market, following a number of disastrous forays earlier in the decade via licence auctions in Germany, Italy and Switzerland, which ended with all of them being written down.

A move for Cesky Telecom, which cost an initial €2.7bn this year, was seen as the precursor of further deals, with the focus on integrated players – operators with both fixed and mobile business – in emerging markets. But, as recently as September, the Spanish company was forced to deny interest in O2 after comments from Cesar Alierta, chairman and chief executive, caught the eye of the Takeover Panel in the UK.

Privately, senior Telefónica executives had reinforced this message, insisting O2 was of no interest because it did not offer a fixed-line business.

Instead, management ran the rule over a number of medium-sized incumbent operators in Europe but appeared to have decided there were too many hurdles involved in any of the deals.

And the move by France Telecom for Amena, Spain’s third largest mobile operator, for €10.6bn was a decisive moment in Telefónica’s decision to pursue the UK operator, according to people familiar with the deal.

With Vodafone already proving a tough rival in the highly-competitive Spanish market, the entry of France Telecom’s Orange, another aggressive player, stirred Telefónica into action. The consequent merger of Ono and Auna, two fixed-line and cable operators in Spain, was also a wake-up call.

“The UK and Germany are two of the most advanced markets in Europe. O2 has managed to defend its position well whilst operating in highly-competitive environments. [This is] something Telefónica could learn from, especially now that it faces increasing competition from Vodafone and Orange in its home market,” says Marta Muñoz Méndez-Villamil, an analyst at Ovum.

“One could even say that it is a defensive move, with Telefónica drawing attention out of the Spanish market and forcing its competitors in Spain – Vodafone and Orange – to focus their attention elsewhere [Germany and UK],” she says.

However, Telefónica is now facing a credibility issue with investors. In a note on the deal yesterday, Chris Hoare, telecoms analyst at Dresdner Kleinwort Wasserstein, wrote: “Telefónica has denied interest in O2 in the past so there are credibility issues, strategically it seems questionable; and it is not in Telefonica’s area of expertise – emerging markets.”

Telefónica was keen to talk up the extra scale it would give the company and the ensuing synergies. The deal gives the Spanish company a total of 116m mobile subscribers worldwide, which, excluding the two big Chinese operators, cements the group’s position as number two globally, behind Vodafone’s 165m.

But analysts pointed out synergies were limited because there was no overlap between O2’s business and the rest of Telefónica’s mobile portfolio. Management identified just under €300m in annual savings yesterday but insisted there was potential for much more.

While Telefónica investors might be left pondering exactly what management believes the future holds, O2 investors are celebrating. If an offer of 200p a share isn’t enough to sway them immediately – the shares were trading at just more than 120p at the start of the year – they can sit back and see if anyone else is prepared to try to trump the offer.

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