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    Telefónica O2 Czech Republic and its unique voluntary division

    Telefónica O2 CR
    (2012-2015)

    In 2012, PPF Group decided to enter the Czech telecommunications market. Following a failed attempt at winning LTE frequencies in an auction to set up a new mobile operator, PPF bought Telefónica O2 CR from its Spanish owner. This case study outlines the takeover process, company restructuring, and also the process of a unique voluntary division into two companies: one a purely infrastructural wholesale part, and the other a retail mobile operator.

    2012/2013: PPF enters the Czech telecommunications market

    In 2012, PPF Group decided to enter the Czech telecommunications market. At that time, the Czech Telecommunications Office (CTO) called an auction of unused frequencies for broadband mobile connection (LTE), stipulating that a part of the frequency band was to be reserved for the entry of a new (fourth) operator into the market. PPF Group joined the auction next to the three then existing mobile operators (Telefónica O2, T-Mobile, and Vodafone). Unfortunately, in March 2013 the auction was cancelled by the regulator, the CTO, on the grounds the auction’s conditions had been incorrectly set.

    PPF still wanted to build a fourth operator on the market. Compared with the first auction, the new auction did not suffer from the same shortcomings, but new mistakes appeared: the CTO included a rule prohibiting any “connection” between the new operator and any other auction participant for seven years in the conditions of the tendering procedure. The telecommunications market is dramatically changing due to the revolutionary technological changes and this prohibition, unprecedented in Europe, was therefore irrational in terms of its substance and in economic terms; for all practical purposes, it prevented anyone from attempting to build a fourth operator in the Czech Republic.

    In the meantime, the incumbent operators, who were concerned about a strong new player entering the market, made their retail offerings more attractive; they had enough time to do so thanks to the failed first auction of the frequencies. They launched a price revolution, i.e. they introduced packages (tariffs), making their services less expensive. Notwithstanding these actions, their move only accelerated the trend towards declining profitability across the entire mobile service sector. PPF Group regarded this situation – whereby, on the one hand, the former oligopoly players found themselves under market pressure while, on the other hand, their operations, in particular those of Telefónica O2 CR, continued to be highly inefficient – as a business opportunity.

    In September 2013, the Spanish Telefónica decided to sell its Czech operator, also due to the worsening situation on the Czech market. Following one month of intensive talks, in early November the two parties disclosed their agreement on the sale of a 65.9% equity stake in the company to PPF Group. Thus, for a total purchase price of CZK 63.3 billion (a total of CZK 305.6 per share, but with a deferred due date for a part of the purchase price) PPF acquired two-thirds of the largest integrated operator in the Czech Republic, including its wholly-owned subsidiary Telefónica Slovakia, one of the three Slovak mobile operators. Subsequently, PPF bought stakes from minority shareholders in several steps and, in July 2015, PPF achieved an equity stake of 84.91%.

    2014: PPF Group takes over O2 (Telefónica CR) and begins to restructure it

    In mid-January 2014, the European Commission approved the PPF-Telefónica transaction, and it was closed on 28 January. Part of the agreement was the Czech operator’s option to retain the O2 brand for the following four years (subsequently, this licence was extended to 2019 with an option to continue to 2022). In line with taking control of the company, the process of improving operational efficiency and achieving cost savings was immediately started. In March 2014, O2’s General Meeting symbolically decided to reduce the number of seats on the Board of Directors, on the Supervisory Board, and in the Audit Committee.

    The new O2 management was successful in streamlining the company as early as 2014. It was therefore able to report a 5.6% lower operating expenditure, and a decrease in payroll costs by as much as 10% for the first three quarters of 2014. As regards management costs, this expenditure dropped by a significant 44% in 2014. Over the course of the first year under PPF’s management control, the company’s headcount decreased by 715 individuals, i.e. more than 12% of the staff.

    However, the tendency towards declining profitability was still not arrested in 2014; net profit dropped by 30% year-on-year. Radical changes had to be continued and a new strategic plan also had to be put in place.

    2015: PPF carries out a project for a unique voluntary division

    In August 2014, O2 announced that it was analysing the option of splitting off the telecommunications infrastructure from O2 into a newly-established independent entity named CETIN (Česká telekomunikační infrastruktura a.s. [Czech Telecommunications Infrastructure]), which would provide wholesale services not only to O2 but also to other telecommunications companies on the market.

    The logic was similar to that of the unbundling of electricity networks from electricity generators and suppliers, or the railway infrastructure from České dráhy [Czech Railways], i.e., creating a purely wholesale company providing services to all operators in the telecommunications market (on the basis of a non-discriminatory approach under the same conditions). The most important aspect was the following: through this separation, the operator O2 would be released from the CTO’s stringent regulation, which predominantly focuses on the infrastructure of the fixed line network, thereby opening an opportunity for O2 to grow on the market of new services.

    Another reason for the division was to streamline both O2 and CETIN, including the managements’ greater specialisation in two quite different business models: for retail customers, a product-centred O2 emphasising customer service, the brand, and the flexibility to respond to the customers’ rapidly-changing requirements; and a technology-centred CETIN that makes investments in telecommunications infrastructure with a long-term investment horizon and is capable of financing such investments.

    The O2 Board of Directors and Supervisory Board approved the very first European project for the voluntary division of an operator (without being forced to do so by a regulator) on 27 February 2015; the division was approved in the form of a split-off, with the establishment of a new company called Česká telekomunikační infrastruktura a.s. (CETIN).

    The division proposal was drawn up in a document containing 6,358 pages, including appendices with complete lists of contracts, bank accounts, real estate properties, asset units and cost units, etc.; Wholesale and infrastructure, i.e. primarily the public fixed transmission network, including exchanges and data centres, and the physical infrastructure of the mobile network, were passed to CETIN. O2 has remained the key player in the market for end-user services for private individuals and for organisations; it is a retail provider for local loops, including the rapidly-growing O2 TV service that has also started to broadcast its own content; and it is a mobile operator that has retained frequency allocations for distributing mobile signals.

    Selected details from the division proposal:

    • For the division, an even exchange ratio was set, i.e. shareholders would acquire identical stakes in the two companies, corresponding to their then-existing stakes in the original company.
    • For the purpose of the division proposal, an expert valued the part of the assets and liabilities which was to be split off and slated for the new company, CETIN, at CZK 46.9 billion.
    • For regulatory reasons, the two companies had to be completely separated in management terms. Thus, only CETIN has remained under PPF Group’s direct control, while O2 is only a long-term financial investment for PPF, where the Group has no direct management control.
    • Of the total number of approximately 4,900 employees, approximately 1,200 have moved to CETIN.
    • O2 shares continue to be traded on the Prague Stock Exchange (BCPP), while CETIN shares are not publicly traded.
    • CETIN is separate in legal, financial and personnel terms, and also physically, and its registered office is in Prague 3 - Žižkov. O2’s registered office continues to be in Prague 4 - Pankrác.

     

    The division became legally effective as of 1 June 2015. CETIN concurrently presented a mandatory tender offer, since its shares had not been accepted for trading on the BCPP. PPF accompanied this offer with a higher voluntary public offer to buy out both CETIN and O2 shares. In aggregate, it offered to buy out both stocks for a price more than CZK 76 higher (i.e. 43%) than the price per O2 share at the BCPP before the effect of the division, i.e. as of 27 May 2015.

    PPF simultaneously announced that it would not seek to delist O2 Czech Republic a.s. shares and that, on the contrary, it intended to promote their public tradability in all respects. PPF stated that O2 was its financial investment and that it would not participate in the commercial management of the company. For CETIN, O2 has become a customer and is still a key wholesale account, but at the same time it is only one of many other wholesale customers, none of which can be given any preferential treatment on the market. On the other hand, PPF Group has included CETIN among its strategic assets that it wants to develop as their owner on a long-term basis.

    2016: Results of the division project

    As part of the voluntary buyout proposal, PPF Group increased its stake in O2 only moderately, to just under 85%. As regards CETIN, PPF achieved the limit of a 90% stake, which is required for exercising the right to the forced transfer of the title to CETIN shares (i.e., a squeeze-out). It subsequently carried out this process in accordance with the relevant regulations. Thus, in January 2016, PPF Group became the 100% shareholder of CETIN.

    The financial results and the development of the value of an independent O2’s shares show that the market, customers and shareholders have vindicated PPF’s strategic decision to carry out this unprecedented voluntary separation. Thanks to enormous effort, the vastly extensive project itself was successfully carried out in several months after the completion of the feasibility study, through its formal approval by the governing bodies, to its bringing into life in June 2015. The division took place without any impact on the services provided to customers, although it entailed a very complicated splitting of highly complex networks and, mainly, IT systems.

    The separation of CETIN, with its regulated infrastructure, made it possible for O2 to offset the downturn on the market through its range of attractive new services such as O2 TV, even at a time when income from conventional telecommunication services was declining. Since it was launched, O2 TV won approximately a quarter of a million customers, thereby becoming one of the biggest pay-TV players in the Czech Republic. In connection with the continued cost cutting, the operator’s overall results reported for 2015 and during 2016 have significantly improved.

    O2 has also clearly formulated its dividend policy, under which it has paid out dividends of CZK 16 per share. Over and above the dividend policy, in October 2016 the Board of Directors decided to propose another CZK 4/year from the share premium for distribution to shareholders.

    A short time after its separation, CETIN was successfully refinanced when it received a CZK 32 billion syndicated loan; in July 2016 it was granted an investment-grade rating by Moody’s, and in October 2016 by Fitch.
     

    • Financial results:
    Net profit, in CZK bn 2012 2013 2014 2015
    O2 CR 6.776 5.695 3.515 5.077
    CETIN - - - 1.835

    Source: BCPP (CETIN share price as at time of mandatory buyout offer)
     

    • Shareholder value:
       

     

    The different investment cycle has also resulted in a new method of financing. This fact, combined with PPF Group’s strong capital position, made it possible in the autumn of 2015 to take a decision on the capital expenditure plan, amounting to CZK 22 billion, for the following seven years. The objective is to build next-generation networks, including fibre-optic networks, and higher-speed access networks based on xDSL technologies across the Czech Republic. 

    In addition to O2, CETIN gradually entered into wholesale contracts with other major players on the telecommunications market (T-Mobile, Vodafone, Český bezdrát, ha-vel internet, etc.), thereby starting to pursue the objective of the successful provision of wholesale services to other operators.

    For the accounting period from 1 January 2016 to 31 August 2016, CETIN’s revenue totalled CZK 14.5 billion while its operating result amounted to CZK 2.5 billion, with the predominant part of this profit coming from the national network services segment. Profit after tax amounted to CZK 2.1 billion.

    Summary:

    • Since it bought into Telefónica O2 CR, PPF Group has successfully restructured and increased the value of this company in two years.
    • Employing a unique method, it has voluntarily divided the company into a purely wholesale entity and a retail operator. 
    • In as little as a year since the division, the results have vindicated the selected strategy, both in terms of growth in profitability and in terms of the significant increase in the shareholder value through the growing market price of O2 shares.
    • CETIN is broadening its portfolio of wholesale customers. It is completely independent of O2, offers its services to all market players, and invests heavily in next-generation networks. 
    • On the other hand, O2 as an operator has freed itself from regulation by the CTO, which gives the operator an opportunity for rapid development in many respects, such as O2 TV and other services with attractive content. 
    • The aggregate value of O2 and CETIN has grown thanks to the rising prices of O2 shares at the stock exchange. At the time of paying compensation to CETIN’s minority shareholders in January 2016, the aggregate value of CETIN shares and O2 shares (BCPP) was 40% higher than the value of the shares when the acquisition from the Spanish Telefónica was announced (November 2013), and 138% higher than just before the division of the company (May 2015). 
    • PPF has stated that O2 is its financial investment. PPF does not participate in its commercial management. On the other hand, PPF Group has included CETIN among its strategic assets that it wants to develop as its owner on a long-term basis. 

     

    Note: The division itself, and the method whereby the division was carried out, reflected the situation in the Czech telecommunications market. It does not necessarily constitute a universally appropriate approach for other foreign markets. 

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