LONDON/FRANKFURT British mobile firm Vodafone (VOD.L) is pursuing Kabel Deutschland (KD8Gn.DE) after having an initial 7.2 billion euro (6.1 billion pounds) bid proposal knocked back by Germany's biggest cable operator, sources close to the matter said on Wednesday.
The world's second-biggest mobile operator has long been linked with a move for Kabel Deutschland, which operates in its most important European market and would help it to meet growing demand from customers for television, broadband, mobile and fixed-line services - so-called "quad play" - from one provider.
Vodafone sent a letter by email to Kabel Deutschland last week announcing its interest and indicating a price of 81 euros per share, three people familiar with the matter told Reuters.
That proposal, which was a 10 percent premium to last week's price, was deemed to be too low by Kabel Deutschland, four sources said, speaking on condition of anonymity,
Those sources said the talks were amicable - with the firms issuing identical statements to confirm the approach, without giving any details - suggesting further contacts were likely.
One Kabel Deutschland shareholder, who also declined to be named, said Vodafone's offer "must begin with a 9" euros per share, which would take it to about 8 billion euros.
Any deal, which would be Vodafone's largest since 2007, could help it better compete against mobile operators, which are cutting prices, and against the pan-European cable group Liberty Global (LBTYA.O), which has been on an acquisition spree.
Analysts said U.S. tycoon John Malone's Liberty Global could make a counterbid for Kabel Deutschland, though they added it would likely face greater regulatory scrutiny than Vodafone because it already owns Unitymedia in Germany.
Shares in Vodafone, which went ex-dividend on Wednesday, fell 5.7 percent, as some analysts worried about the cost of a deal and that it could signal similar moves in other countries.
Vodafone Chief Executive Vittorio Colao said earlier this year he could afford to do deals in Europe without having to sell his prized asset, a stake in U.S. group Verizon Wireless, which its joint partner Verizon Communication (VZ.N) has said it would like to buy in one of the world's biggest deals.
Kabel Deutschland shares jumped over 9 percent at one point to a new high of 83 euros. They had been trading at 63 euros before Vodafone's initial interest was reported in February.
Germany is Vodafone's largest market excluding its U.S. venture and it has recently negotiated a deal with Deutsche Telekom (DT) (DTEGn.DE) that would allow it to rent lines from the fixed-line group to offer TV and broadband services.
"What might perturb investors is that this approach comes so soon after Vodafone signed a wholesale DSL deal with DT that was seen and touted as a solution to their convergent needs," Deutsche Bank analysts said.
"To then approach KDG suggests that this is merely an infill and that infrastructure ownership is ultimately necessary to provide a fully competitive convergent offer. Unsurprisingly this is likely to read across into other markets."
One person familiar with Vodafone's thinking said the Deutsche Telekom deal would strengthen its hand if and when it came to negotiate with Kabel Deutschland.
"Vodafone has the option not to buy fixed assets in Germany now that it has the wholesale deal with Deutsche Telekom that allows it to sell converged offers," the person said.
A banker advising telecom companies who is not involved in this deal said Kabel Deutschland was expensive and that the two groups could struggle to agree terms.
According to ThomsonReuters Starmine, Kabel Deutschland shares trade at an enterprise value (equity plus debt) to core earnings ratio of 10.1 times, compared with peers on 7.2. These include Liberty Global on 7.8.
STEALING A MARCH
Quad-play services have caught on rapidly in markets like France and Spain where they have been pioneered by major local companies France Telecom FTE.PA and Telefonica (TEF.MC).
Germany is some way behind and buying Kabel Deutschland could allow Vodafone to steal a march on Deutsche Telekom.
Vodafone owns some fixed lines in Europe, including in Germany, but only offers quad-play services in Portugal.
Analysts at Espirito Santo said there would be significant synergies for Vodafone from migrating some of its fixed-line customer base on to Kabel Deutschland's cable infrastructure, possibly worth as much as 16 euros per Kabel Deutschland share.
They said the deal would also help defend its market share in Germany, including against the possibility of Kabel Deutschland ramping up its own mobile offering in partnership with Telefonica.
Citi analyst Simon Weeden said Vodafone could finance a deal through its own balance sheet. Vodafone has indicated it would be willing to move to a lower credit rating of BBB+ for an interim period to accommodate a deal.
Vodafone had 32 million customers in Germany at the end of March, making it the biggest mobile operator in the country.
Kabel Deutschland is Germany's largest cable operator with about 15 million of the 28 million homes passed by cable.
Vodafone usually works with Goldman Sachs and UBS on acquisition deals. A source close to the matter said earlier this year that Morgan Stanley was advising Kabel Deutschland.
($1 = 0.7533 euros)