UPDATE 1-Telefonica, KPN deal could be cleared with conditions

Wed Jul 24, 2013 1:07pm EDT

* European Commission likely to closely scrutinise deal

* Divestment of some mobile spectrum seen likely

* Would reduce number of German operators to 3 from 4

* Telefonica-KPN tie-up seen a watershed for European sector

By Foo Yun Chee and Leila Abboud

BRUSSELS/PARIS, July 24 (Reuters) - Telefonica is likely to persuade regulators to clear its 8.1 billion euro ($10.7 billion) bid for KPN's German mobile telecoms business by giving up some spectrum and easing the entry of new competitors, antitrust experts said.

The Spanish company's acquisition of KPN's E-Plus would broadly put it on an equal footing with leaders Deutsche Telekom and Vodafone in Europe's biggest mobile market and reduce the number of operators to three from four.

That scenario typically rings alarm bells with regulators concerned that less competition will drive up prices for consumers.

Miranda Cole, a lawyer at Covington & Burling, said the deal would run into some opposition, but that concessions on spectrum and network capacity should ease regulatory concerns.

"The deal is certainly going to get close scrutiny because Germany is the biggest mobile market in Europe," she said. It has around 110 million subscribers.

"It's likely to be about spectrum - how much would they be required to give up - and making sure that mobile virtual network operators (MVNOs) can continue to operate and making entry through spectrum auction feasible."

MVNOs do not own networks and often sell cheap mobile plans without long contracts, targeted at certain customers such as young people or ethnic groups. Regulators could seek pledges from Telefonica to rent access to MVNOs on favourable terms.

However, regulators may also be influenced by the fact that Germany is already one of the most expensive mobile markets in Europe and has lower-than-average smartphone penetration.

A monthly plan with 2 gigabytes of mobile data costs 39 euros, compared with 20 euros in France and 15 euros in Britain, according to consultancy Rewheel.

Vodafone and Deutsche Telekom enjoy profit margins in German mobile of 35 percent and 40 percent respectively, compared with the low-20s for carriers in Britain and low-30s in France.

SPECTRUM

Telefonica's strategy will be to offer enough concessions to secure approval without cutting too deeply into the benefits of buying KPN's E-Plus. The company expects the deal to boost profits by cutting between 5 to 5.5 billion euros of costs.

A person familiar with Telefonica's thinking said the company would argue the deal, announced on Tuesday, would create a strong third operator with the firepower to invest heavily in faster mobile networks to compete with the market leaders.

It would have 43 million customers, more than Deutsche Telekom's 37 million and Vodafone's 36 million. It would hold 31 percent of mobile revenue, said Citigroup, less than Deutsche's 34 percent and Vodafone's 35 percent.

"You have to assume that there will be spectrum divestments in the 1.8 and 2.1 gigahertz bands," the person said, referring to the mobile spectrum that the new group will hold most of.

"But beyond that there is no credible argument that big concessions are needed," the person said.

E-Plus Chief Executive Thorsten Dirks said on Tuesday the groups may have to give up frequencies to get the deal approved, since they would have more spectrum than rivals.

If Telefonica does give up spectrum, it runs the risk that the regulator could then sell it to a new company. Since Germany is holding another mobile licence auction in 2014 or 2015, a newcomer or cable group Liberty Global may buy enough spectrum to launch a competing mobile service.

In Austria, regulators told Hong Kong-based Hutchison to give back spectrum to get its purchase of Orange's local business approved, and will seek to resell it next year.

RAISED HOPES

Telecom bosses have lobbied heavily this year for Brussels to take a softer line on mergers, arguing that Europe has too many operators labouring under heavy regulation that saps their ability to invest in networks.

Neelie Kroes, EU commissioner for the digital agenda who wants a single market for telecom services across the 28-nation European Union, is receptive to their argument.

But the EU's top antitrust regulator Joaquin Almunia is more skeptical that telecom groups will actually pump money into better networks and services if they are allowed to get bigger.

Neal Milsom, the finance chief of EE, Britain's largest telecom operator, said he hoped the regulator's stance on the Telefonica deal would be a watershed.

"There is a really compelling case that you can get the best of both worlds: a great offer and service for customers but also a sustainable and profitable industry as well," he said.

A similar four-to-three deal with Hutchison buying Telefonica's Ireland unit is also now up for EU review, as is Vodafone's acquisition of Germany's Kabel Deutschland .

Despite Brussels' eagerness to foster a single telecom market in Europe, the idea is not likely to affect antitrust reviews, said professor Christopher Kummer at the Institute of Mergers, Acquisitions and Alliances.

"Even in a single telecoms market, you would like to avoid having only very few players around," Kummer said.

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