Strategically, BT (LSE: BT-A) (NYSE: BT.US) is in a great position to negotiate a hard bargain. If it pays over the odds for 02 or EE, however, I believe its equity valuation could easily plummet to 300p by mid-2016 — a level where the shares traded 18 months ago.
The more BT stock rises, the higher the risk it will dive if a deal is not executed in early 2015.
This Week’s Events
BT confirmed on Monday that it could become more aggressive in M&A, targeting Telefonica‘s O2 mobile operations in the UK.
EE, the UK’s largest mobile phone network, could also be a valid alternative for BT, although buying back O2 ought to be BT’s preferred option, in my view. EE’s owners, Deutsche Telekom and Orange, announced on Wednesday that they “are in exploratory discussions” with BT.
Eager Sellers
The opportunity to snap up assets from distressed sellers such as Spain’s Telefonica is almost too good to be true right now.
Telefonica needs growth in Latin America, which is a core market for the Spanish behemoth. From Brazil to Mexico, plenty of capital must be deployed there. DT and Orange have been considering a market listing of EE for some time, but EE isn’t easy to value on its own. And for EE’s owners, the UK isn’t a core market, either.
BT should value O2 and EE at £5bn and £7bn, respectively, including net debt — a much lower valuation than that suggested by analysts, who believe BT will likely splash out up to £10bn for either target. Two separate low-ball bids would make lots of sense.
Financial Discipline
BT must stick with financial discipline: 02 and EE need heavy investment in the UK to be competitive. Their owners will unlikely want to devote precious time and resources to a market that is less strategic than others.
If the purchase price is right, BT shares could easily surge to 500p by early 2016. Managing expectations plays a pivotal role, yet revenue and cost synergies could be meaningful. Overpaying is not an option, though. While its true that BT is hoarding cash, and free cash flow is getting better and better by the day, its pension deficit could still be problematic.
A Fully Fledged Quad-Play
Deeper penetration in the UK mobile world would cement BT’s position in the broader consumer market, where it needs to grow. Customers want tailored packages from one provider: internet, digital TV and smartphone connections — all in one place, all from one supplier.
By acquiring O2, or EE, BT would become a fully fledged quad-play services provider. BT already plans to offer mobile services in 2015 via a mobile virtual network (MVNO) agreement with EE. If it acquires mobile assets, it will be able to sell its services to O2/EE’s existing customers, growing at a faster clip. That would boost the value of its shares, which have been looking for direction for a year now.
Still, M&A at any price is not the answer. Otherwise, a price target of 300p would be conceivable.