Telefonica Faceoff in Brazil Portends GVT Bidding War: Real M&A

Aug 27, 2014 7:26 am ET

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Aug. 27 (Bloomberg) -- The chance to gain control of one of Brazil’s fastest-growing Internet providers has former European phone allies Telefonica SA and Telecom Italia SpA preparing for a bidding war.

Telefonica’s lower debt burden relative to profit, higher credit rating, and greater market value may give the Madrid- based carrier more financial flexibility than Telecom Italia as it looks to purchase Vivendi SA’s Brazilian broadband unit GVT. Telefonica, which this month offered 6.7 billion euros ($8.8 billion) for GVT, is considering an even higher bid before a potential counterproposal from Milan-based Telecom Italia, according to a person with knowledge of the matter.

“It will be Telecom Italia that will have to give up if Telefonica is aggressive enough to increase the bid,” Erhan Gurses, an analyst at Bloomberg Intelligence, said in a phone interview. Telecom Italia “has a really high debt level so obviously they want to have a stock-based offer to avoid raising so much debt.”

Telecom Italia is preparing a counterbid valued at as much as 7 billion euros to merge GVT with Tim Participacoes SA, its Brazilian division, people with knowledge of the plan said last week. Telecom Italia’s board is scheduled to discuss its GVT bid today.

Telefonica and Telecom Italia, which joined forces seven years ago and have since grown estranged amid a management fallout, are vying for GVT to strengthen their positions in one of their biggest markets amid flagging revenue at home. Telefonica’s improved offer could potentially value GVT at as much as 8 billion euros, representing a premium to the average profit multiple paid in comparable deals in the past five years, according to data compiled by Bloomberg Intelligence.

‘Valuable Player’

“GVT is a valuable player,” said Cyrus Mewawalla, director of research at London-based CM Research. “It offers broadband, cable television and telephone services,” helping an acquirer gain scale in a number of related markets.

Telefonica may present a revised bid for GVT ahead of Vivendi’s scheduled board meeting tomorrow, said the person with knowledge of the matter, asking not to be identified because the deliberations are confidential. No final decision has been made, and Telefonica’s board could decide to stick with its current offer, the person said.

Representatives for Telefonica, Telecom Italia and Paris- based Vivendi declined to comment.

Oi’s Role

Brazil’s wireless carriers are pursuing combinations as intense competition weighs on call and data prices. Oi SA, the country’s smallest network operator, said separately it’s working with Banco BTG Pactual SA on a potential acquisition of Telecom Italia’s stake in Tim. Shares of Portugal Telecom SGPS SA, which is merging with Oi, jumped as much as 8.2 percent in Lisbon. Telecom Italia rose 3.2 percent to 86.3 cents at 1:26 p.m. in Milan.

Telefonica has an indirect stake in Telecom Italia through its holdings in Telco SpA. The investment vehicle was formed in 2007 to take a stake in Telecom Italia, thwarting a takeover bid from AT&T Inc. and Carlos Slim’s America Movil SAB.

Telefonica, which has spent billions since 2000 in Latin America, approached GVT in 2009 and lost out to Vivendi. This month, it offered the French company 6.7 billion euros, mostly cash, in a proposal to combine Telefonica’s Brazilian unit with GVT.

Vivendi said on Aug. 5, after Telefonica’s bid, that none of its units are for sale, though its board would consider Telefonica’s offer.

Splitting Tim

The Spanish carrier’s offer followed an attempt to split Telecom Italia’s Tim among three operators to address regulatory concerns stemming from its stake in the Italian carrier. Brazil’s antitrust watchdog has ordered Telefonica to resolve the conflict of interest, either by reducing its own local holdings, including through a sale of its Telecom Italia stake, or by persuading Telecom Italia to divest its own operations there.

While Telefonica pressured Telecom Italia to consider the latter option, Chief Executive Officer Marco Patuano prefers to keep Tim and expand it by combining with GVT, people familiar with the matter said in May. Now the stage is set for the two companies to go head to head in the quest for control of GVT.

As part of its GVT bid, Telefonica offered Vivendi a right to buy a stake of about 8 percent in Telecom Italia, which would bring Telefonica’s holding in the company close to zero.

Telecom Italia and Vivendi also have an indirect link, through Vivendi Chairman Vincent Bollore. The magnate also heads France’s Bollore Group, a stakeholder in Mediobanca SpA, which in turn is one of the four partners in Telecom Italia’s largest investor group Telco.

Debt Load

Telecom Italia’s 3.56 ratio of net debt to earnings before interest, taxes, depreciation and amortization is the highest among Western European peers with a market value greater than $10 billion. Telefonica by contrast has a leverage ratio of about 2.6 and is assigned a credit rating of Baa2 by Moody’s Investors Service, two levels above Telecom Italia at Ba1.

Given its debt level, Telecom Italia will be pushed to finance an offer with its own stock, while Telefonica has cash available to pay for the deal, according to Daniel Isidori, a fund manager at Threadneedle Asset Management Ltd.

“I think that what will happen is that Telefonica will look at Telecom Italia’s balance sheet and based on that decide how much to offer,” Isidori said in a phone interview. Isidori said the fund doesn’t currently hold Brazilian phone operators.

Acquiring GVT would offer Telefonica a larger stake in the fixed-line broadband market in Brazil and strengthen its ability to compete with America Movil and Oi SA in so called bundle packages -- subscription packages that include fixed- and mobile-phone, pay-TV and Internet.

Other Bidders

GVT also could attract interest from AT&T after the U.S. carrier agreed to acquire DirecTV in May, Deutsche Bank AG analysts said in a note in May. DirecTV has more than 5 million pay-TV subscribers in Brazil.

Even as the Brazilian broadband market booms, competition there is also intensifying, meaning an acquirer paying too much will fail to earn a return for the investment. Seeking a deal in Brazil through a bidding war is part of an aggressive strategy that may not be in investors’ best interests, said Daniel Lacalle, a senior portfolio manager at Ecofin Ltd.

“Sometimes companies become obsessed with being present in a market just to position themselves and grab income,” Lacalle said in a phone interview from London. “This can be risky.”

Still, a Telefonica acquisition would shield it from renewed competition with Telecom Italia, which doesn’t have a broadband presence in the sector currently even though it is the second-largest mobile-phone operator in Brazil.

“Brazil offers growth perspectives, it’s an emerging market,” said Gurses of Bloomberg Intelligence. “If the market moves to convergence, whereby you sell products in bundles, then this will be bad” for Telecom Italia.

--With assistance from Manuel Baigorri in London, Brooke Sutherland in New York and Ville Heiskanen in Helsinki.