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Spanish telecom giant Telefonica S.A. (TEF - Analyst Report) intends to spend €1.5 billion ($1.86 billion) to acquire spectrum in the forthcoming UK auction, likely to be conducted by the year-end.

The auction plans were announced last month by the UK regulator Ofcom. The regulator will put two airwave bands —800 MHz and 2.6 GHz — on sale. The lower frequency band will be part of the digital world and suitable for widespread coverage while the higher frequency band will help in delivering higher speeds.

UK mobile operators getting the 800 MHz band will have to deploy broadband to at least 98% of the domestic population by 2017. Ofcom would try to balance the sale of airwaves between the largest and small operators in order to keep prices low and ensure better coverage.

The regulator said that the largest share would be received by the three major operators — Vodafone Plc (VOD - Analyst Report), Everything Everywhere (a joint venture between France Telecom’s Orange and T-Mobile) and Telefonica (O2 unit). The remaining portion will be reserved for the small operators or new entrants to increase competition.

The spectrum auction, considered the biggest so far in the UK, will have 80% more spectrum than the 3G auction conducted in 2000.

Telefonica generated 11% of its revenue from the U.K. market in the first half of 2012 despite intense competitive pressures. The acquisition of the UK licenses would be long-term growth drivers for Telefonica. The transaction will provide the company more capacity to enhance its LTE networks to new markets. Currently, Telefonica is deploying LTE services in Germany using the 800 MHz and 2.6 GHz frequency bands acquired in the German 2010 auction.

Further, the company plans to double its revenue from the Telefonica Digital division to €5 billion by 2015 from the current €2.4 billion.

We are maintaining our long-term Neutral rating on Telefonica. For the short term (1–3 months), the stock retains a Zacks #3 (Hold) Rank.

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