Via Financial Times

One of Europe’s most influential telecoms chief executives has hailed a new dawn for the sector — in terms of greater consolidation and higher valuations — after a landmark court judgment and two large deals struck at the height of the pandemic.

Speaking to the Financial Times, José María Álvarez-Pallete, chairman and chief executive of Telefónica, predicted that restrictions on telecoms mergers would be loosened after a ruling by the EU’s second-highest court. 

He added that recent deals — notably Telefónica’s £31.4bn agreement to merge its UK unit O2 with Liberty Global’s Virgin Media and the proposed private equity takeover of its Spanish rival MasMovil — were evidence of the “hidden value” in European telecoms.

“Something is changing in Europe . . . Something is changing in the telecoms landscape,” he said in an interview. “The stars are aligning for telecoms consolidation,” he added, making clear that Madrid-headquartered Telefónica expected to play a big part in the process.

European antitrust regulators under EU competition chief Margrethe Vestager have blocked several deals in recent years to promote competition at a time when analysts say more investment is needed.

Telefónica, which is highly indebted and exposed to currency fluctuations, has been one of the worst-affected groups, with its market value shrinking to €23bn from about €70bn five years ago. The combined market capitalisation of the wider European telecoms sector has collapsed 75 per cent since 2000 to an aggregate value of €300bn, according to Morgan Stanley research.


€300bn


Combined market cap of European telecoms sector, down 75% since 2000

But Mr Álvarez-Pallete believes that the door for consolidation is now open following last month’s ruling by the Luxembourg-based General Court, which annulled Ms Vestager’s 2016 European Commission decision to block a £10.25bn takeover of the O2 network by Hong Kong’s CK Hutchison.

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“I do think that competition rules are going to be read in a different way,” he said. He maintained that the ruling went against the “core” Commission argument that a merger reducing the number of players in a national sector would enfeeble competition. 

“At the end of the day I am not just competing with traditional players . . . I’m also competing with WhatsApp, I’m also competing with Facebook, I’m also competing with FaceTime,” he said. “Times have changed. It doesn’t make sense that there are hundreds of telecom operators in Europe,” he added, pointing to the large US and Chinese markets, which now both have only three large players. 

The Telefónica chief said that EU competition rules had slashed European companies’ returns, making it harder for them to invest and take on US tech giants. 

Line chart of Market cap (€bn) showing Falling prices for telecom services weighs on Telefónica

Morgan Stanley described European telecoms as among the most deflationary markets in the world, with the average price of a gigabit of data falling 33 per cent a year because of price regulation and a lack of consolidation. “Deflation is completely cancelling out very robust data volume/traffic leading to negative turnover growth,” said analyst Emmet Kelly.

But the Commission’s block on Telefónica’s sale of O2 to CK Hutchison’s Three ultimately benefited the group — as Mr Álvarez-Pallete acknowledged. He said Telefónica had got a better deal in the end since this year’s Virgin Media merger was done at a “significantly higher valuation” than the 2015 agreement to sell to Three.

He argued that both the Virgin-O2 merger and the Masmovil buyout were “the first moves of a trend” towards unlocking higher valuations in European telecoms.

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That is also the view of lawyers and bankers who are anticipating a bonanza of telecoms deals in markets including Spain and Scandinavia.

Maurice Patrick, an analyst with Barclays, argued in a note that a shift within the Commission to develop a long-term industrial policy under former France Telecom chief executive Thierry Breton is also a potential driver for deals. That could see regulation move away from a “one dimensional” focus on price competition when reviewing consolidation moves, he said.

Mr Álvarez-Pallete is confident that the O2-Virgin merger will be approved by regulators, partly because the two companies plan to invest £10bn in the joint venture in the next five years, putting pressure on rivals such as BT to do the same.

Telefónica is also hiving off its sprawling Latin American empire outside Brazil, while considering acquiring assets from bankrupt Brazilian operator Oi in conjunction with Telecom Italia.

Asked how Telefónica would fund an Oi deal, Mr Álvarez-Pallete said the company needed to be “careful in terms of managing the pieces” but would seek to strengthen core markets, including Brazil. 

Mr Álvarez-Pallete, an economist by training, has played a key role in reshaping the group’s future before. In 1999, aged 35, he was appointed the company’s chief financial officer but soon faced a huge task as the tech bubble burst, Latin American economies collapsed and Telefónica’s push into new areas such as media, with the acquisition of Big Brother maker Endemol, soured.

He then transferred to Latin America where he spent nearly a decade turning round a fragmented empire of companies before returning to Europe and, eventually, the top job.

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Despite Telefónica’s frenetic activity during the lockdown, including the €1.5bn transfer of its German mobile towers to Telxius, the mast company in which it owns a majority stake, Mr Álvarez-Pallete said the group’s infrastructure was still “totally undervalued”.

He said it would seek to continue deleveraging and spinning off units, as with Telxius, in which KKR and Spain’s Pontegadea now own the remaining stakes. He added that Telefónica “was analysing launching infrastructure funds with third parties” to boost investment in fibre.

Mr Álvarez-Pallete argued that the pandemic had proved a spur to dealmaking and vastly sped up the adoption of new technologies.

Before Spain’s lockdown began in March he said, he had “never been at home even one working day”. Afterwards, 95 per cent of the company’s 120,000 staff worked from home.

However, the crisis has also accelerated the pressure on Europe’s largest telecoms players to cut debt, reverse plunging share prices and improve returns. “In the middle of the pandemic we have been so active because I think it is execution time,” Mr Álvarez-Pallete said. “We need to prove that we walk the talk.”