Members of the Czech Republic's coalition government were not the only people losing sleep as their leader faced a vote of no confidence last week.

As political crisis cast doubt over cabinet approval for Telefónica's €2.7bn ($3.5bn) bid for the state's stake in Cesky Telecom, executives from the Spanish company spent most of Friday anxiously awaiting news from Prague.

Despite surviving the censure motion, the Czech government may yet collapse, but not before its cabinet votes on the acquisition possibly on Wednesday. This means that Telefónica can get on with the difficult task of buying out the remaining 49 per cent of the Czech company's shares while convincing its own investors it got a good deal.

On the face of it, say analysts, the Spaniards overpaid to gain their foothold in eastern Europe. Their Kc502-a-share bid was 25 per cent above the closing price before the submission of bids, more than the government had hoped for.

Taking Cesky off the stock market will probably cost it another €2.7bn, which will put more debt on to an already heavily leveraged balance sheet, a point not missed by Standard & Poor's the credit ratings agency, which put the company on CreditWatch.

Telefónica officials, however, point out that they only paid 4 per cent above what Swisscom, the Swiss operator, had been prepared to stump up, and that the strategic value of positioning itself towards the centre of the enlarged European Union easily will offset the initial outlay. In spite of the relatively small earnings contribution expected from Cesky, the move into the Czech Republic marks an important diversification for the world's third largest global telecommunications group by market capitalisation.

With furious competition, particularly in mobile telephony, tight margins in Spain, and nothing left to buy in Latin America, investors are looking out for new growth stories.

“Latin America has been our focus over the last 10 years or so,” said a highly placed executive. “But the fundamental business plan remains unchanged look for opportunities wherever they arise. We believe these will come principally from the enlarged European Union for some time.”

Morgan Stanley, in a recent research note, appears to back the strategy. “If Telefónica manages to end up with a nice portfolio of assets in eastern Europe and the southern Mediterranean region in the following two to three years, it might end up being the right strategy,” it said.

In the meantime, dividends from the Czech business, which enjoys healthy cash flow and operating margins, will allow Telefónica to recover acquisition costs quickly, officials argue.

The company has also promised to maintain its generous dividend payout, although analysts wonder if the value-adding share buy-backs that have so enamoured investors over the past two years can continue.

As there is no overlap between Telefónica and Cesky, the deal presents no obvious synergies. More importantly, say analysts, there is little immediate fat to cut at a company which has in two years lifted lines per employee 17 per cent, to 383, while reducing headcount by 19 per cent.

Telefónica's difficulties in its mature domestic market, where it is losing mobile customers to the UK's Vodafone and Amena, an unlisted business, should prepare it for the rigours of the Czech Republic, which boasts mobile penetration of more than 100 per cent.

Cesky, through its Eurotel wireless telephony business, will also have to take on the dynamic UK operator, which has just taken control of Oskar, the third mobile operator, with number portability about to be introduced.

Eurotel's market share declined slightly last year, to 42.6 per cent, as ebitda dropped 4 per cent to Kc13.6bn ($583m). As a legacy carrier, Cesky like Telefónica dominates the fixed-line market, though subscribers are abandoning traditional telephony in favour of wireless communications. At the same time, Czech regulators are forcing down interconnection charges while capping consumer tariffs.

Having battled these dynamics at times in the courts in Spain and Latin America, Telefónica has spent heavily on broadband infrastructure and the marketing of bundled services, a strategy with potential in the Czech Republic.

At the same time, it has retrained its focus on core businesses. This year Telefónica bought out minorities in Terra, the internet service provider which, itself, last year divested itself of Lycos.com, the lossmaking US portal.

Telefónica now plans to partially list Endemol, the production company which created the Big Brother television sensation. Telefónica was forced to heavily write down the book value of the company after paying €5.5bn during a heady dotcom spending spree.

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