Press speculation last month suggested BT Group (LSE: BT-A) (NYSE: BT.US) was eyeing up an acquisition of a UK mobile network operator: either O2 (demerged from BT in 2001 and now owned by Telefonica) or EE (jointly owned by Deutsche Telekom and Orange).
BT confirmed the rumours, and has this week announced its entered exclusive negotiations to acquire EE for 12.5bn in a cash and shares deal.
Renowned fund manager Neil Woodford was initially sceptical about the merits of such a deal. While BT already had plans for providing enhanced mobile services of its own, the prospect of a mega-acquisition was a whole different ball game, challenging Woodfords previous investment thesis for backing the company.
According to one of Woodfords team:
The investment case has increasingly represented a cash return story over the last couple of years. As capex on the 3bn commitment to rolling out fibre starts to decline and revenues from customer subscriptions ramp up, we had envisaged improving cash flows and substantial growth in dividend payments.
Naturally, Woodford was initially nonplussed by the idea of cash flows being directed towards acquisitions rather than back to shareholders.
From scepticism to enthusiasm
On further consideration, though, Woodfords team have embraced BTs strategic move, and are excited by the companys opportunity to become dominant in taking the quad-play fight (broadband, fixed line telephony, pay TV and mobile) to the competition.
They see a number of long-term benefits for the business, and thus for long-term shareholder value:
Free cash flow prospects should ultimately be far more robust from the enlarged entity, less reliant on price increases and cost rationalisation, with the focus moving to meaningful growth from a cross-selling strategy. This should result in more management control and less susceptibility to price-based competition in the fixed-line market.
The price is right
Not all analysts reckon BT has got a good deal. According to Deutsche Bank, BTs offer is more expensive than expected; this after some serious speed dating.
Woodfords team has a different view:
BT has taken full advantage of its unusual position in these negotiations as a sole buyer with two keen sellers. It looks like a good price, particularly when considering the substantial cost synergies in areas such as IT, back office and procurement, which make the financial logic behind the deal even more compelling.
If Woodford and his team are right on the pricing of the EE deal, and on the enhanced prospects for the enlarged group, BT, which is the CF Woodford Equity Income funds fifth-largest holding at 6% of the portfolio, could be a big long-term winner.
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