Deutsche Telekom looks to private equity to expand

Deutsche Telekom (DT) announced it had entered an agreement with the private equity group Marfin Investment Group (MIG) to purchase a 20% stake in Greek incumbent Hellenic Telecom (known and OTE) for €2.5 billion. The expectation is this is a first step towards a full take-over of OTE by DT.

Comment: on the face of it this looks like an odd deal. Why would DT look to take over the Greek incumbent‾ The answer is not to look to Greece, but OTE's mobile investments in Bulgaria, Macedonia, Romania and Albania. Mobile growth is difficult to find in most countries, but in the Balkan states and some eastern European markets the potential is there. DT is buying is the top-line growth these countries can bring to T-Mobile over the next few years, plus the added opportunity to leverage scale economies across its European mobile footprint. This footprint already covers 11 countries (Austria, Bosnia, Croatia, the Czech Republic, Hungary, Macedonia, Montenegro Netherlands, Poland and the UK,) in addition to its domestic market. This looks like a win-win (on revenues and costs) deal.

Regular readers will recall that last year we published a report on the role of private equity in telecoms and its potential to be a catalyst for change in the sector. Private equity's impact on the telecoms sector is predicated on predictable finance. Events over the weekend with Bear Stearns illustrate the financial crisis is clearly far from over. MIG pulling out of OTE could be an indicator that private equity is starting to pull back from the telecoms sector. Time will tell if this proves to be the case.

The need for consolidation is something we have talked about a great deal in the past. We had anticipated that private equity could have driven this as the industry itself seemed reluctant to do so. The collapse of the KPN/Belgacom and Telenor/Telia merger talks of five years ago, and the struggles encountered by TeliaSonera illustrated the problems with incumbent marriages.

Now the Telefonica/Telecom Italia tie-up and now DT/OTE link seems to indicate that the larger incumbents (with the free cash flows) look to be the most likely agents of change. Two years ago few would have thought this likely and while two points do not make a trend this approach has a logic that failed it in the past. Today the market is becoming more complex and the bigger the enterprise the more likely it is to control its destiny. Expect more consolidation, not less.

Pursuing mobile for growth is, of course, part of the DT strategy to' Focus, fix, and grow' as we have seen. Arguably buying into mobile is just what Telenor and others have been doing for years. But credit where it is due: buying into OTE characterises the modern DT, where action speaks louder than words. Until recently few would have thought that DT would be the large European incumbent demonstrating this.

Mike Cansfield, Telecoms Strategy Practice Leader

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