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Private equity circling distressed European telcos

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Private equity firms stand to benefit from the misfortunes of Europe's major telecom operators as they snap up mobile assets being sold off by incumbents who need to pay down debt and focus on their core markets.

After years in which they focused more on buyouts of cable firms, private equity funds like Apax, Carlyle and Providence are among those now on the prowl for telecom deals.

With the sector's valuations beaten down by Europe's economic crisis, tough competition, and regulatory pressure, some of these assets are at their cheapest for a decade and so within reach of private equity funds despite tight debt markets.

"For the first time in many years, there is a good supply-and-demand dynamic right now," said Gabriele Cipparrone, a partner at Apax, which recently won a bidding war among half a dozen private equity funds for France Telecom's Swiss unit.

"We expect to see maybe three to five of these opportunities in the coming year and a half."

The funds believe they can run these mobile businesses better by stripping out costs and adopting more aggressive approaches than the incumbents that now own them.

Meanwhile, telecom majors like Deutsche Telekom and Telefonica are under pressure to generate cash to maintain generous dividends even as revenues and profits fall, pushing some to rethink their commitment to markets where they are not leaders.

It is a far cry from a decade ago when European telcos flush from the Internet boom went on buying sprees in pursuit of growth, planting flags in eastern European and Asian countries far from home, often with minority stakes and local partners.

Today many are refocusing on the countries where they have critical mass. Vodafone, the world's largest telecom operator by revenue, shed more than 20 billion euros in assets last year in a portfolio cleanup that saw it sell minority stakes in mobile operators in Poland, France, and China.

France Telecom's own review led it to sell Orange Switzerland, the number three player, to Apax late last year for 1.6 billion euros. Funds like EQT, Providence, and Doughty Hanson competed for the prize despite tight debt markets that made financing the deal more expensive.

Further opening the door for private equity is the fact that competition regulators are increasingly stepping in to block mergers among big telecom operators in the same country so as to protect consumers from higher prices.

France Telecom had earlier tried to sell its Swiss unit to local competitor Sunrise, the second biggest player, but was shot down by antitrust regulators. Deutsche Telekom's planned $39 billion US sale of T-Mobile USA to AT&T was also blocked.

Private equity firms see mobile operators as good candidates for leveraged buyouts because of their predictable revenues and steady cash flows, which can then be used to service the debt taken on to buy the company.

They then seek to improve the operations via cost cuts, network sharing, and new commercial strategies to build value before exiting via a sale or public listing after 4-5 years.

"A big incumbent telco is not usually the best placed to do restructuring or make significant operational improvements on its existing assets," said Thierry Baudon of Mid Europa Partners, which has done such deals in Central Europe.

Apax's Cipparrone said that when it took part in a consortium of six private equity firms that took over Danish operator TDC in 2005, the funds improved margins by ten points in five years by reducing staff, making purchasing more efficient, and exiting foreign markets.

The $15.3-billion TDC deal, which was Europe's biggest leveraged buyout at that time, proved profitable for the six funds involved. They exited via selling shares on the stock market in chunks starting in 2010 and ceded control last month.

UNITS IN FOCUS

Investment bankers and private equity investors predict that Telefonica, which is struggling to reduce debt as its home market of Spain heads towards recession, may soon unload some European units that it deems not core to its strategy.

Private equity firms recently approached Telefonica about buying its 69-percent stake in Cesky Telecom, according to one banker, but were rebuffed because the Spanish incumbent had not decided yet what it wanted to do.

Bankers said Telefonica could consider selling its Irish mobile operator, which as the second player in the market might be the right size to attract a private equity buyer.

Private equity funds are also monitoring Deutsche Telekom and Dutch operator KPN for signs they might sell assets.

For Deutsche Telekom, the failure of its recent attempt to sell its U.S. business has touched off speculation it might try to exit the Netherlands, Austria, or even its 50-50 joint venture with France Telecom in Everything Everywhere, the UK's biggest operator.

"I would be surprised if private equity firms were not pitching Deutsche Telekom on Everything Everywhere," said a banker specialized in telecoms. "They'll try to drum it up but it would be a pretty big bite for private equity at current prices so they'd have to team up in a consortium, something they aren't always willing to do."

An industry veteran who has worked on several telco bids for private equity funds predicted that KPN could sell off its German mobile operator E-Plus, now third place in the market, which could attract bids from rival operators and funds.

Such takeovers are not without risk. Carlyle's Benoit Colas said the fund would only consider buyouts in markets where competition has stabilized, lowering the risk of price wars or massive client defections. "We are conscious of the fact that telecom is a sector with little growth so we have to be vigilant not to overpay," he said.

The valuation paid by Apax for Orange Switzerland of roughly 6.5 times the unit's annual operating profit, which was seen as quite high by bankers and private equity rivals, is likely to serve as a benchmark for further deal-making.

Apax has a licensing deal with France Telecom to use the Orange brand for five years although it could rebrand the service earlier. Asked whether Apax's ultimate aim was to try again to merge with Sunrise, Cipparone said such a deal was not in the funds base case given the regulatory risks involved.

"We think Orange Switzerland could be a good candidate for an initial public offering in the local market once value has been created," he said.

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