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Ending all speculations, Vodafone Group Plc. (VOD - Analyst Report) has finally confirmed its preliminary approach to Germany’s largest cable network company, Kabel Deutschland Holding AG. We believe the multi-billion dollar acquisition would fortify Vodafone’s presence in the European telecommunication market.

In addition, it will also strengthen its position against players with equal potential such as Liberty Global Inc. (LBTYA - Analyst Report) and Deutsche Telekom AG in Europe’s largest telecommunication market.

According to Reuters, Vodafone has a made an initial offering of €7.2 billion (approximately $9.6 billion) to Kabel Deutschland. This represents Vodafone’s biggest acquisition proposal since 2007 and the second largest takeover in Europe, following Liberty Global’s acquisition of UK-based cable company Virgin Media.

Kabel Deutschland, with a net worth of €8 billion, covers over 8 million German households. It offers wireline services like HD and analog TV, Pay TV and broadband Internet with speed of up to 100 Mbps and fixed-line voice services through cable as well as wireless services through industry collaborations.

A possible takeover of this company would provide Vodafone access to the existing setup of Kabel Deutschland and solidify its wireline business in the key European market. Kabel Deutschland reported revenues of €1,700 million and adjusted EBITDA of €795 million in its fiscal year ending Mar 31, 2012. This points towards the financial synergies that Vodafone can draw from the deal.

Clash of  Titans

Similar to the other international markets, the German television broadcast market is governed by highly competitive market forces. Currently, there are two major companies — Kabel Deutschland and Liberty Global Inc. — that are dominating the current market for cable TVs.

These mega companies have been battling each other to foray deeper into the domestic market through mergers and acquisitions. Liberty Global Inc. remains ahead in this race with its purchase Unitymedia (the second largest cable operator of Germany) and Kabel Baden-Wuerttemberg GmbH & Co KG (the third largest) — in 2010 and 2011, respectively.

Given these two mega acquisitions, Liberty Global has become a formidable player in the German cable TV market. The enlarged Liberty Global manages around 7 million subscribers; close second to Kabel Deutschland GmbH.

In 2012, Kabel Deutschland proposed to buy regional service provider, Tele Columbus. The buyout was however rejected by German regulators citing competitive issues.

We believe the German cable TV market is already duopolistic and the takeover of Kabel Deutschland by Vodafone will lead to a true duopoly. Vodafone’s competitive position will likely be benefited by the mammoth European scale of operations that this acquisition offers. Added businesses from Kabel Deutschland would undisputedly increase Vodafone’s economies of scale, placing the company up and above Liberty Global.

What’s in Store for Vodafone?

When the whole world is in a wireless frenzy and the providers are desperately seeking LTE expansion plans, it might look like an out of the league strategy for a wireless company to seek expansion in the fixed line business involving significant investments.  However, given the lucrative opportunities in the European cable business, the strategy does not surprise.

These markets, West Europe in particular, are experiencing growing demand for pay-TV services together with triple-play bundled services that combine basic cable TV, and Internet. Telephone carriers like Vodafone are increasingly looking for markets, where they can increase share with bundled video, broadband, and telephone that warrants higher margin and lower churn rates.

It is evident that the prospective acquisition would oust major players in the German wireline industry. Vodafone would then be an undisputed leader in wireline business with the biggest loaf of cable TV and broadband business in Deutscheland.

But, beyond this, Vodafone foresees significant cost synergies (approximately 300–500 million Euros) by not having to pay rentals for copper lines to Deutsche Telekom. Vodafone currently requires these copper lines to provide its 3.3 million customers in Germany with DSL services.  

Further, Vodafone’s efforts to bring its customers within one network infrastructure (DSL to LTE) through the deal would result in additional savings for the company by curtailing spending on network build outs.

However, we believe that the implementation of network conversion remains a long-term process and involves structural changes. Hence, in the near future, we expect the likely Kabel Deutschland deal, which comes with an existing set of network backhauls, to provide a good platform for offloading data traffic and resolving spectrum issues for Vodafone.

Will it or Will it Not?

The million-dollar question here is whether the Vodafone-Kabel Deutschland deal will eventually materialize.

We believe the biggest challenge for the company will be to win antitrust approval.  Historically, this very issue has impeded the successful completion of many deals such as the AT&T Inc. (T - Analyst Report) and T-mobile acquisition. Given the size of Vodafone’s prospective deal and its impact on the competitive position of other players like Liberty Global, there lies a fair chance of regulatory interventions.

Vodafone, which operates in the European market with the likes of France Telecom , currently carriers a Zacks Rank #3 (Hold).

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