DEALWATCH: TalkTalk's Broadband Base May Tempt Rivals

TalkTalk Telecom Group PLC (TALK.LN), the largest of the U.K.'s four main residential broadband providers, is likely to become an attractive acquisition target over the medium term, industry experts and bankers say.

Telecom operators are looking to beef up their broadband services and with around 4.2 million U.K. broadband customers, TalkTalk, which in March demerged from parent retailer Carphone Warehouse Group PLC (CPW.LN), would provide immediate access to roughly 23% of the country's broadband market.

"We expect TalkTalk to be bought longer term," Liberum Capital analyst Mark James said.

James said the increasing trend for mobile operators to provide broadband services means TalkTalk will likely come into the crosshairs of larger companies like Vodafone Group PLC (VOD), Telefonica SA's (TEF) O2, or possibly the U.K. joint venture between Deutsche Telekom's (DTE.XE) T-Mobile and France Telecom SA's (FTE) Orange.

Although it has the most residential broadband customers, TalkTalk's relatively small size overall makes it an affordable bite: with a market capitalization of approximately GBP1.26 billion, adding in its current debt level of around GBP450 million and a reasonable premium, a takeover could take place at between GBP2 billion and GBP2.2 billion on an enterprise-value basis, or higher if a bidding war develops.

Meanwhile, for the other major broadband providers, BT Group PLC (BT.A.LN), British Sky Broadcasting Group PLC (BSY.LN) and Virgin Media Inc. (VMED), TalkTalk could also be a way to leapfrog into a market-leading position, though regulatory issues would likely stand in the way of a deal with BT.

Mobile operators are looking for ways to boost revenue from each customer, particularly as traditional voice and text revenue shrinks; bundles of three or four services boost revenue and also help to keep customers.

"There are several precedents of mobile operators buying broadband operations and a growing desire to cross sell related services to improve their value proposition," said Evolution Securities analyst Steve Malcolm. He said Virgin Media, created from the 2006 merger of Virgin Mobile with cable operator NTL, had successfully cross-sold mobile and fixed-line broadband together with cable television and now has 2.9 million customers on triple play.

Elsewhere, Spain's Telefonica earlier this year completed its EUR900 million acquisition of German broadband company Hansenet from Telecom Italia SpA (TI), significantly raising its fixed-line market share. Telefonica also paid EUR7.5 billion in July to buy out Portugal Telecom SGPS SA's (PT) stake in Brazilian mobile operator Vivo Participacoes SA (VIV), aiming to combine it with its Telesp fixed-line operations.

The three U.K. operators that provide TV, broadband and mobile--BSkyB, Virgin Media and BT--all reported greater growth in average revenue per user than TalkTalk on a year on year basis to March. Crucially, all of them offer content and are able to sell television, pay-TV and interactive services, a proposition TalkTalk can't match right now.

TalkTalk is, however, a co-partner in YouView, a service that will bring Internet content and new video-on-demand services to television next year after a one-off payment for a set-top box. That could help plug the content gap, although it remains to be seen whether YouView proves a major threat to established content providers.

"The combination of fixed-line and pay-TV makes sense, because the purchaser will tend to be making decisions for an entire household," said Ian Watt of media consultancy Enders Analysis. "With mobile, it's a much more personal decision," making the economic logic for a mobile operator to buy TalkTalk less clear.

But that hasn't stopped bankers from speculating. One London-based investment banker who regularly looks at telecom deals says he believes TalkTalk's majority shareholder, Carphone Warehouse founder Charles Dunstone, who retains roughly one third of the company's equity, will at some point face a dilemma: unable to invest enough capital to keep up with the expansion plans of rivals, he will eventually seek a bigger backer.

"If you think that the U.K. broadband market will eventually distil down to three; BSkyB, Virgin Media and BT, funding will at some point become an issue for TalkTalk," this person said. "At that point they will need a bigger backer in order to drive investment."

TalkTalk declined to comment on the issue.

-By Jessica Hodgson; Dow Jones Newswires; +44207 8429373; jessica.hodgson@dowjones.com

(Lilly Vitorovich and Paul Sharma in London contributed to this article.)

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