BT prepared to pay £12.5bn for EE

BT has moved a giant step closer to re-entering the UK mobile market, not with Cellnet - the business it sold off and which was renamed O2 by its new owners - but with EE in a deal worth £12.5 billion. That's much more than the £10 billion the City had pencilled in, yet BT reckons there are massive savings to be found and this is certainly a sensible move given the phone company's ambition to dominate the so-called quad-play market.

Three weeks since BT admitted it was talking with O2 and another UK mobile network operator, the company is in exclusive negotiations with equal owners Deutsche Telekom and Orange about buying EE. The period of exclusivity will last several weeks during which time BT will carry out due diligence and agree the fine detail.

It has already fixed a price, which will be payable £6.5 billion in cash and £6 billion in shares. If the deal goes ahead, Deutsche Telekom will own 12% of BT and Orange 4%. It's unclear how BT will raise the cash element, although it has said it is "mindful of the importance of maintaining a conservative financial profile."

In the year to June, EE made £1.59 billion, valuing the acquisition at 7.9 times enterprise value-to-cash profit. But BT is banking on savings from network and IT rationalisation, back-office consolidation and savings on procurement, marketing and sales costs. Broker UBS estimates savings reaching £300-£500 million per annum based on deals done elsewhere in the sector. If accurate, it will lower the acquisition multiple nearer to 6 times.

Clearly, there's a lot of sense in picking EE over O2. After all, it has the largest subscriber base - 24.5 million direct mobile customers - the largest spectrum holding and the most developed 4G subscriber base. It will also improve prospects for BT's quad-play - mobile phone, broadband, pay TV and fixed-line - which was already going to use EE as the mobile virtual network operator (MVNO) host. Buying EE will certainly make it easier for BT fixed-line customers to switch to other services and for BT to steal market share from Vodafone and O2.

With no objections, the deal could gain regulatory clearance within 2-3 months. If there are, it could be another six months before it's is in the bag.

BT's share price has tripled in four years and has rarely been this high since 2001, the year before it spun off O2 (then Cellnet). On about 13 times forward earnings, they're hardly expensive either, but breaking above 420p will require a significant catalyst. This deal is certainly significant, although regulatory concerns and the threat of a big fundraising soon could cap upside, temporarily.

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