Foreign Telecoms Reach Out

Private equity groups are frantically dialing up telecom deals, attracted by the stable cash flows of phone companies and the opportunity to boost earnings with cost cuts. Buyout activity reached a new high in early July on several big deals involving foreign phone companies.

Canadian phone company BCE BCE agreed to be acquired for $32.6 billion by the Ontario Teachers' Pension Plan and two private equity firms, Providence Partners and Madison Dearborn.

U.S.-based Capital Group, meanwhile, upped its stake in KPN of the Netherlands to more than 23%. Blackstone Group owns 4.5% of Deutsche Telekom DT. Earlier this year, Blackstone eyed taking a stake in Telecom Italia TI.

Private equity groups acquired Danish phone company TDC in 2006 and Ireland's Eircom in '01.

Phone companies in developing countries with fast-growing economies also make attractive prey. Singapore-based Parallax Capital and First Pacific Holdings grabbed a stake in Philippine Long Distance Telephone PHI in January.

What makes emerging-market operators attractive targets? They often have "virtual monopolies" over telecom operations, despite regulatory steps to open up markets, says Tania Harvey, an analyst at TeleGeography.

1. Business

Governments in Europe and Asia began privatizing former state-owned phone companies in the late 1990s. But privatization lags in many developing countries, especially in central Asia, the Middle East and Africa.

India's big telecom market has also been slow to liberalize. Some countries, including China and Indonesia, still limit foreign investment.

When governments finally do open up markets, large foreign telecom firms rush to cash in.

Oil-rich Saudi Arabia opened up its fixed-line phone market to new competitors this year. Ten foreign companies bid for licenses, including U.S.-based Verizon Communications VZ, China Telecom CHA, India's MTNL, Hong Kong's PCCW, and phone companies in the Gulf region.

In Europe, governments still hold large equity stakes in former monopolies such as Deutsche Telekom, France Telecom FTE, Greece's OTE OTE (Hellenic Telecommunications Organization) and Sweden's TeliaSonera TLSNF.

The possibility that governments may sell off more shares often creates an overhang on stocks because such moves dilute the equity of existing shareholders. That's why France Telecom's shares dipped in June after the French finance ministry said it would sell up to $5 billion in shares to cut the public debt.

Despite investor enthusiasm, cutting costs isn't easy for some former monopolies. They often have labor woes because they're still heavily unionized. Deutsche Telekom reached a key pact with unions in June over its plans to cut wages and transfer workers to new business units.

And then there's the ongoing problem of shrinking wireline voice revenue, phone companies' traditional cash cow.

It will continue to drop as consumers and businesses shift to wireless calling and Internet-based phone service, analysts say.

Name Of The Game: Former monopolies are focused on high-speed Internet and wireless to grow revenue, says Harvey.

2. Market

Many fixed-line incumbents, whether in developed countries or emerging markets, have expanded into wireless.

Brazil's Tele Norte Leste Participacoes TNE, known as Telemar, now gets most of its revenue growth from its wireless business.

In India, fixed-line operator BSNL owns the country's third-biggest mobile firm, with 22% of the market. And only one in six people in India have wireless phones, leaving plenty of room for growth.

In Europe, though, most consumers already have mobile phones. So many of Europe's landline phone companies have focused on expanding wireless operations overseas, Harvey says.

Spain's Telefonica TEF has emerged as the second-biggest wireless firm in Latin America -- and the third-biggest worldwide -- through a series of acquisitions. Earlier this month, Telefonica made a bid to acquire Portugal Telecom's PT stake in Brazil's Vivo Participacoes.

Deutsche Telekom's biggest growth driver is T-Mobile USA, the fourth-largest mobile firm in the U.S., with 26 million subscribers.

Norway-based Telenor's wireless reach spans eastern Europe and southeast Asia. Telenor owns 30% of Russia's fast-growing Vimpelcom VIP as well as stakes in wireless firms in Pakistan, Thailand and Malaysia.

Globally, there's plenty of growth left in speedy Internet services. About 21% of 1.3 billion households worldwide have broadband service, according to a recent study by UBS. Only 15.7% of households in Asia have broadband service. While 88% of South Korea's households get speedy access, the percentage is just 14% in China and less than 1% in India.

In Europe, UBS says, more than 50% of households already have broadband, which makes for a fierce battle among the big telecoms.

Europe's regulators have forced national operators to share their high-speed networks with rivals. As a result, the broadband market share of Deutsche Telekom, Telecom Italia and others has been steadily falling.

France Telecom faces a different challenge. In France, well-funded startups have invested in speedy fiber-to-the-home Internet service. The startups, including Neuf Cegetel and Iliad, are grabbing customers quickly.

3. Climate

In many developing countries, fixed-line incumbents still enjoy virtual monopolies over wireline services. They get a leg up in wireless, too.

In the Philippines, for instance, PLDT's Smart cellular unit has an almost 60% share.

But slowly, markets are opening.

Saudi Telecom's monopoly over fixed-line services will end soon. But it has plenty of cash to expand overseas and is already making deals.

In June, Saudi Telecom struck a deal to acquire a 25% stake in one of Malaysia's wireless firms for $3 billion.

Restructuring is also common among telecom firms in emerging markets. Many are owned by holding companies.

In Russia, state-backed holding group Svyazinvest is consolidating its regional fixed-line assets in OAO Rostelecom Long Distance ROS. The Russian government also owns a stake.

Some Latin American companies are pushing to renationalize private industry. Shares in Telefonos de Mexico TMX, or Telmex, and America Movil AMX fell sharply this month after Mexico's government signaled that it might try to curb the dominance of the phone companies. Both are controlled by billionaire Carlos Slim, who recently leapfrogged Microsoft MSFT founder Bill Gates as the world's richest person.

4. Technology

As cable companies fight for Internet and phone subscribers, emerging technologies such as Internet Protocol TV are helping the telecoms fight back.

"Providing value-added services, like IPTV, over broadband lines is a big opportunity" for phone companies, said Jouni Forsman, an analyst at Gartner Group.

The research firm estimates that IPTV subscribers in Europe will reach 16.7 million in 2010, up from 3.2 million in 2006. France has the most IPTV users in Europe.

In Hong Kong, Merrill Lynch says PCCW's Internet-based TV service served 36% of homes, the highest market share among phone companies anywhere.

5. Outlook

With private equity firms on the prowl, analysts expect no letup in mergers and other equity deals.

Aside from BCE, another Canadian operator, Telus TU, looms as a buyout candidate, analysts say.

France Telecom says its mulling tie-ups with private equity groups to expand overseas.

Upside: While revenue growth has slowed from wireline voice services, they still generate cash.

Former monopolies use that money to expand internationally. Japan's NTT NTT, for instance, says it'll move into nontelecom areas such as real estate.

Risks: Many governments are opening up airwaves for new wireless broadband services, such as WiMax. In India and other emerging markets, WiMax-based services could emerge as serious rivals to landline-based Internet services by 2009, analysts say.