KPN's thrift puts German operations in jeopardy

FRANKFURT/AMSTERDAM Mon Jun 7, 2010 8:17am EDT

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FRANKFURT/AMSTERDAM (Reuters) - Dutch operator KPN (KPN.AS) may lose its appeal as a potential partner or acquisition target after competitors snatched the most popular bands in Germany's mobile spectrum auction.

KPN doubled the amount of spectrum of its German wireless unit E-Plus in an auction that ended last month, but due to its tight budget strategy it is left without access to the popular 800 Mhz band in the crowded German market.

KPN has brushed off concerns its network would not be able to handle fast-growing mobile data usage, banking on partnerships to alleviate potential network deficiencies.

Both KPN and Telefonica (TEF.MC) have signaled they are open to partnerships and analysts in the past have generally agreed a tie-up between the two would make sense.

However, Telefonica is in the midst of an increasingly acrimonious battle with Portugal Telecom (PTC.LS), which it wants to force out of a joint venture in Brazil.

In addition, Telefonica acquired 800 Mhz spectrum at a lower than expected cost in Germany, reducing the immediate need to recoup investments by network sharing.

Telefonica may just bide its time and bet it can grab KPN's German business cheaper if it shows some patience, analysts said.

"If Telefonica was the big winner in this auction, then KPN was the big loser," Banesto Bolsa analysts said in a note to clients.

TO SELL OR NOT?

KPN's E-Plus will have problems competing with rivals who are better equipped to handle large amounts of data. It is the only operator in Germany which is not offering a data plan for Apple's new iPad, for example.

Due to its lack of adequate spectrum, KPN also cannot offer bundled packages of fixed and mobile services unlike its competitors in Germany.

The German operations are essential to KPN because E-Plus, the main driver of the profitability of KPN's international mobile unit, generated a quarter of KPN's first quarter 3.3 billion euros ($4.04 billion) revenue and a third of core profit.

If Telefonica is reluctant to partner with E-Plus after receiving valuable spectrum, KPN could consider a sale of the business which some analysts say the Dutch operator has already done.

"They (E-Plus) have positioned themselves to be sold," said Dario Talmesio, senior analyst at Informa Telecoms & Media.

At the same time financial sources said KPN was not at all considering a sale of E-Plus. "They internally value E-Plus at 7 to 8 euros per share," one source said. KPN shares traded at 10.64 per share by 1130 GMT.

Another financial source said after meeting with KPN top management this week he had the impression Chief Executive Ad Scheepbouwer, who will retire next year, had no plans to sell E-Plus. "But you never know what the next CEO will do," he added.

Informa's Talmesio said a sale "would be better now than later for KPN...later is risky because their business would deteriorate."

MERGER IS ON THE BACK BURNER

A combined entity between E-Plus and Telefonica's O2 in Germany would bring their joint market share to about 30 percent, below Vodafone's (VOD.L) 33.8 percent and Deutsche Telekom's (DTEGn.DE) T-Mobile's 36 percent.

But BPI analysts said KPN's defeat in the auction meant it really has lost some of its attraction for Telefonica as a possible acquisition target.

"Any possible merger with KPN is now on the back burner," BPI analyst Pedro Pinto said.

E-Plus could focus its strategy more or less exclusively on the major cities, where its license portfolio gives it a better chance to compete effectively, but even there it will face fierce competition from Telefonica, Vodafone and T-Mobile.

"This is a case for a serious strategic rethink for what KPN will do in Germany," research firm IHS Global Insight said.

"KPN is really missing important part of the spectrum, the most valuable one...there's not much that can be done with 2.6 spectrum," Talmesio said.

Smart phones and mobile devices are becoming increasingly mainstream and operators are under pressure to upgrade their networks and extract value from data traffic.

Customers expect an experience on their mobile devices which is as seemless as on their home PC and have little patience for dropped calls and slow connections.

"This means that E-Plus will not have a feasible means to expand its network to cover the whole country, as well as that the indoor reception in the areas where it does have coverage will remain patchy," research firm IHS Global Insight said. (Additional reporting by Robert Hetz in Madrid; Editing by David Cowell)

($1 = 0.8163 euro)

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