UPDATE 2-Telefonica in talks to buy KPN's German business

Mon Jul 22, 2013 1:38pm EDT

* Telefonica, KPN boards meet Monday on deal - sources

* Telefonica would pay $6 bln and give KPN stake in new firm

* KPN confirms in talks to sell business

* Telefonica confirms negotiating a deal

* Deal likely to face EU antitrust review

By Andrés González and Leila Abboud

MADRID/LONDON, July 22 (Reuters) - Telefonica and KPN are in talks to combine their German mobile businesses in a deal worth over $6 billion that would help them compete with bigger competitors Deutsche Telekom and Vodafone.

Under the terms being discussed, Spain's Telefonica would pay the Dutch telecoms operator $6 billion in cash and KPN would get a stake of between 15 and 30 percent in the newly-created company, two people familiar with the matter said.

Telefonica would issue hybrid debt to help finance the deal, another person said. Two sources told Reuters the boards of KPN and Telefonica would meet on Monday and were expected to approve a tie-up.

KPN, which is controlled by Mexican tycoon Carlos Slim, confirmed in a statement that it was in talks to sell its German business, E-Plus, and Telefonica said it was involved in negotiations in Germany, but neither company mentioned the other.

"At this stage the outcome is not yet clear. Further announcements will be made, if and when appropriate," KPN said. Telefonica said no deal had been closed.

Shares in KPN jumped 13 percent.

E-Plus and Telefonica's O2 Deutschland vie for third place in Europe's biggest mobile market and both are facing tough competition from their larger rivals. E-Plus cut its prices in January in an attempt to gain market share.

For KPN and its backer Slim, the world's richest man, a merger would help keep it competitive in Germany. It has smaller mobile spectrum holdings and weaker coverage than its competitors.

For Telefonica, the deal would improve profitability in its third-biggest market in Europe after Spain and Britain. Combining the two businesses could bring synergies - cost savings and revenue gains - of 4 billion euros or more, according to analysts.

Both companies also need more firepower to invest in fourth generation wireless networks - KPN is in an especially weak position because it has none of the best spectrum in 4G.

Telefonica already listed part of O2 Deutschland last year in a drive to cut debt and raise cash as the group suffered from its exposure to Spain's recession-hit economy.

The talks with KPN were first reported by the Financial Times. Slim's company America Movil and E-Plus declined to comment.

FOUR WEEKS OF TALKS

America Movil competes head-to-head with Telefonica, which is present across Latin America.

KPN and Telefonica have discussed a tie-up and sharing of networks several times in the past decade, including just before Slim bought 28 percent of KPN last year. At that time, KPN sought a tie-up with Telefonica to avoid falling under Slim's control.

Those talks fell apart at the last minute because of valuation and Telefonica's high debt, which made borrowing during the euro zone crisis difficult.

This time the talks went much more quickly, two sources said. They began in earnest over the past four weeks, since KPN completed a 3-billion-euro rights issue.

Telefonica's shares closed up 1.32 percent on the day at 10 euros, while KPN's share price shot up 13 percent to 1.80 euros. The price of insuring KPN's debt fell by around 4 percent, while Telefonica's credit default swaps (CDS) also tightened slightly.

KPN launched a 3 billion euro rights issue in April to help reduce debt and invest more in its networks in the Netherlands and in Germany.

The firm, with outstanding debt of 14.4 billion euros, also cancelled its dividend for this year and next.

KPN will unveil its second-quarter results on Tuesday morning, with a Reuters consensus of 10 analysts expecting a 17 percent fall in core profit, mainly due to a pronounced decline in its international mobile unit, of which Germany is the largest part.

Although Telefonica is burdened with around 50 billion euros of debt, it would do well to expand in a healthy market like Germany to offset weakness in countries such as Spain.

Competition is heating up as consumers switch to smartphones from basic handsets and operators shake up tariffs to focus on data and raise spending on marketing.

A KPN-Telefonica tie-up is likely to attract scrutiny from both German authorities and Brussels regulators and the combined company may be forced to offer remedies such as access for virtual operators (MVNOs) or giving back spectrum.

"What I ask myself is what the regulator would do with this," said analyst Jos Versteeg at Theodoor Gilissen private bank. "In other countries, we've seen more operators entering. This would leave Germany without a real challenger."

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