What Does Telefonica Have that AT&T (Might) Want?

One of the more interesting M&A rumors is the story that AT&T had made a bid for Spanish telecom giant Telefonica, a move that was blocked (says the rumor) by the Spanish government.  Telefonica has since denied any overtures were made, and it seems likely that one or the other of these negatives would be enough to make a deal doubtful.  Still, one must ask “Why?”  Is such a deal logical under any circumstances?

In fundamental terms, Telefonica doesn’t seem to be exactly the poster child for outside M&A interest.  Spain is in the midst of a truly bad economic slump, and while telecommunications isn’t typically hit as hard during these slumps as other industries, there’s no question that the telecom giant is burdened by debt (as is Spain at large).

It’s also true that the EU telecom landscape has been replete with examples of Eurotelecom giants running to emerging markets to invest because margins and ROI are too low in their home territory.  That’s been much less a problem for US telecom companies, so it’s hard to see what AT&T would see in a Telefonica buy.  They’d likely do better in ROI terms by investing at home.

OK, then, what’s the benefit that might be driving AT&T’s interest?  I think it’s Telefonica Digital.  Somebody asked me recently who was, in my judgment, the most innovative of the carriers in facing the future and my response was “Telefonica”.  It’s not likely that AT&T would want Telefonica’s business, but they might want the innovation.  And they might yet get it, in one way or another.

Telefonica Digital has done a couple of fairly impressive things.  First, just by being there it’s an example of the first critical step a telco has to take to be a player in a modern notion of services.  You can’t make Bell-heads into Net-heads, so you have to keep the two partitioned organizationally so you can create a culture for the latter and offer a career path that would make sense.  Second, Telefonica Digital has come closer to framing a credible service-layer strategy than anyone else, even an equipment vendor.  Third, Telefonica Digital has been a leader in targeted OTT-modeled services, in critical areas like health care, digital payments,   They’ve made strides in digital content, and they’re big in Brazil and Latin America in general, a space that some US operators covet.

US operators are trying to become players in next-gen services, but the culture barriers to success have been formidable.  Arguably, the history of being a public utility has been the greatest political barrier and the barrier posed by integration of new services with OSS/BSS has been the most difficult technical barrier.  Telefonica has alleviated the first with its spin-out of Digital, and the story is that they’re working on the second as well.  If that’s the case, then they could be a highly valuable commodity.

AT&T is perhaps under the most pressure of the US operators.  They have a lower economic density than rival Verizon.  They also have a smaller percentage of enterprise headquarters sites than Verizon, and it’s the HQ that makes business network buying decisions.  Their business sites, overall, are less likely to be cloud compute candidates, which hurts that side of AT&T’s business service plans.  In short, they could use some insight into OTT service creation and the cloud, and that’s something that Telefonica could bring.

Or something that Telefonica Digital could bring.  If AT&T can’t buy Telefonica, could it do a deal for Telefonica Digital?  Could, in fact, that be the deal that AT&T’s been interested in all along?  Nobody would likely think that Spain would approve the sale of its national carrier.  But would Spain go along with a deal to sell an OTT subsidiary of that national carrier when the sale might well keep Telefonica solvent?  I think they might.  They would obviously have no problem with a deal that would license Telefonica Digital work to AT&T on a non-exclusive basis or create some other digital-layer partnership.

We may be seeing the first step in what will become a land rush as operators attempt to use M&A to gain more than just a tech nibble here and there.  The clock is running down on network profitability.  We have little time to frame a new business model, particularly considering that capex through 2016 will likely be up as operators try to use their last gasp of financial latitude to prep for the future.  M&A is a darn good way to get in the game again.

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