An Iberian falling out

Citation

Curwen, P. (2011), "An Iberian falling out", info, Vol. 13 No. 1. https://doi.org/10.1108/info.2011.27213aab.001

An Iberian falling out

Article Type: Rearview From: info, Volume 13, Issue 1

A regular column on the information industries

They were allies when Wellington fought the French across the Iberian Peninsula in 1809-1813, and in more modern times they have mostly maintained a good relationship. But Spain and Portugal have currently undergone a major falling out and the reason has to do with mobile telecommunications.

Historically, South America was the natural place to turn for both Telefónica and Portugal Telecom (PT) when seeking to expand overseas, with PT particularly keen on Brazil for linguistic reasons. Originally, the Brazilian market developed as a collection of regional networks, in five of which both operators built up varying stakes, but in March 2006 these five networks were merged together into what became known as Vivo. Each operator took a 50 percent stake in Brasilcel, a holding company which ended up with what amounted, in total, to just over 60 percent of Vivo and thereby conferred joint control upon the Iberian operators.

Initially, Vivo was unprofitable and its share price plummeted from the value placed on it when first listed in 2006. This had a severe impact upon both operators, but the impact upon Telefónica was indirect as well as direct since by the end of 2004 it had built up a stake of 9 percent in Portugal Telecom. Furthermore, Telefónica began to come under increasing pressure in its home market as a result of the launch of 3G licensee Yoigo, owned by TeliaSonera, and several MVNOs including Carrefour and Ono. Meanwhile, PT had troubles of its own as a smaller Portuguese telco, Sonae.com, had launched a takeover bid.

Both PT – assuming the bid failed – and Sonae.com – assuming the bid succeeded – indicated a willingness to sell the PT stake in Brasilcel to Telefónica. The stake was valued at €2.7 billion in early 2007 at which point Vivo had 29 million subscribers. As a precaution, Telefónica also began to look into the possibility of buying TIM Brazil from Telecom Italia. The initial step proved to be by way of Telefónica buying a stake in Telecom Italia itself, partly in order to secure a binding commitment that TIM Brazil would not be sold to arch-rival América Móvil although, in practice, the Brazilian regulators were highly unlikely to sanction any further consolidation.

With Sonae.com safely seen off, PT proved disinclined to consider the transfer of its stake in Vivo – an unsurprising outcome given that Brazil provided PT with more than half of its revenue-generating subscribers and that Telefónica, in its capacity as a large PT shareholder, had supported Sonae.com’s takeover bid. Telefónica’s response was to offer to buy the stake for roughly €3 billion ($4 billion) in July 2007. This was rejected and an uneasy peace descended which lasted until the beginning of 2010, at which point Vivo provided each operator with 15.4 million revenue-generating subscribers representing 56 percent of the total for PT but a mere 8 percent of the total for Telefónica.

This might be interpreted to mean that Vivo was far more important for PT than for Telefónica, but the Spanish market was depressed and growth in the Brazilian market had fallen below 10 percent. With Latin America increasingly dominated by rival América Móvil, Telefónica felt the need to achieve increased scale. It accordingly considered two main options, firstly to buy out PT from Vivo – in which Brasilcel now held a 59 percent stake – at an anticipated cost of roughly €4.5 billion and secondly to buy PT itself at an anticipated cost of €7 billion.

In May 2010, Telefónica tabled an offer of €5.7 billion for the PT stake in Vivo. This was promptly rejected by the PT board which asserted that Vivo was a core part of PT’s strategy – becoming highly reliant upon the home market in the midst of a European banking and euro-connected crisis was understandably not an attractive prospect. Nevertheless, on the face of it, the offer was very generous since it represented a huge premium to the then value of the stake, but Telefónica for its own part was becoming increasingly anxious to take advantage of the synergies potentially available were it to be able to merge together its loss-making fixed-wire business in Brazil (Telesp) with Vivo.

On 31 May, Telefónica sought to break the deadlock by raising its offer to €6.5 billion and a PT shareholder meeting was convened on 30 June to consider the offer. Meanwhile, keen to show that it was not exercising undue influence on other shareholders by voting its 10 percent stake in PT, Telefónica announced that it had sold an eight per cent stake during June. However, the Portuguese financial regulator ruled that this transaction was such that Telefónica still controlled the voting rights attached to the stake, which raised a question mark over how these rights would be exercised at the meeting.

In a final attempt to turn the tide in its favor, Telefónica raised its bid yet again on 29 June, this time to €7.15 billion, and shareholders responded enthusiastically. Within a matter of hours the Portuguese government had asked state-owned bank shareholders to vote against the offer, but fearful that this would be insufficient to win the day – in practice 74 percent of shareholders voted in favor – the Prime Minister also exercised the state’s “golden share” to veto the offer on the grounds that he was protecting the interests of the country.

Ironically, the European Court of Justice was anyway about to rule on the legality of the golden share – the case had been launched in January 2008 and the decision was due to be handed down on 8 July – and it came as no surprise when the ruling was unfavorable to the Portuguese state. However, enforcement would be another matter, probably taking a further two years which would hardly help Telefónica’s immediate ambitions. Telefónica accordingly set a deadline of 16 July for the PT board to accept the offer irrevocably and, when they failed to respond, Telefónica walked away – at least officially. However, it was reported that the offer had subsequently been raised again to €7.5 billion (but in reality slightly less after adjustment for payments by installments etc.), which seemed somewhat curious given that the PT shareholders had already accepted the lower offer – unless, of course, the government had agreed not to object.

A number of conclusions can be drawn from the above. Most obviously, despite numerous cases involving the legality of golden shares, all ending with a ruling that they are unlawful, certain Southern European countries continue to flout European law in this respect when it suits them to do so. This continues to demonstrate not only that these countries adopt a “pick and choose” approach to EU law but also that their governments are fully prepared to trample over the legitimate interests of shareholders in a free market.

In this case, Telefónica could simply have got PT shareholders to accept a renewed offer for its Brasilcel stake and challenged the government to exercise its veto a second time. Alternatively, Telefónica could have made an offer for the whole of PT – the modest €2 billion additional cost could be financed easily enough – but this strategy would have greatly increased the odds of a second government veto. Finally, it could, as a last resort, have prevented any further payment of dividends by Vivo which, combined with PT’s debts, would have put PT under severe financial pressure given the poor state of the Portuguese economy, so it is just as well for inter-Iberian relations that agreement was eventually reached.

The €7.3 billion in cash could have been used to wipe out PT’s debts and protect its future as another small European operator in the style of TDC or Belgacom, which could be seen as a reasonably attractive prospect but would not have explained away the withdrawal of the government’s veto. In practice, PT opted to reinvest €3.7 billion in Brazil via a 22.4 percent stake in fourth-ranked operator Oi which, unlike Vivo, also had fixed-wire operations. It was rumored that Oi would then acquire Telefónica’s stake in PT but this remains uncertain.

On the one hand, Telefónica has achieved a successful end to negotiations, while on the other it has suffered a setback in being obliged to over-pay by a wide margin for the Brasilcel stake, and América Móvil is likely to take advantage of Telefónica’s straightened circumstances. The bottom line issue is whether Vivo can possibly be worth roughly €25 billion even with, say, a prospective 70 million subscribers, and if it is what does this imply for the market value of networks in other emerging economies?

Peter CurwenVisiting Professor of Telecommunications at the Department of Management Science, Strathclyde University, Glasgow, UK.