Investors in Telefonica are wary of any move by the Spanish telecoms group to counter a 4.5 billion euro ($6 billion) joint bid for effective control of its long-courted neighbor, Telecom Italia.
But few expect Telefonica, one of the most acquisitive telecoms companies in Europe, to stand meekly on the sidelines and watch arch-rival Carlos Slim's America Movil and AT&T of the United States become the largest shareholders in the Italian group.
"It couldn't pass up such a deal, especially if by not doing it, it puts its rival ahead," said one fund manager with a stake in Telefonica. "But the market would still penalize (Telefonica shares for) such a deal."
Top U.S. telecoms company AT&T and America Movil, which is controlled by Mexican billionaire Slim, enraged Rome and surprized the market on April 1 with a joint offer of 2.82 euros per share for a majority stake in Olimpia -- a holding company that controls Italy's flagship telecoms operator.
AT&T and America Movil plan to buy a third of Olimpia, Telecom Italia's top shareholder, with an 18% stake and are in exclusive talks to do so until April 30.
A successful purchase would end years of on-off talks with a peer which shares Telefonica's Mediterranean culture, whose European assets complement its own and, most importantly, whose Brazilian business would help secure its position in South America's biggest economy.
The deal values Telecom Italia at about seven times estimated 2007 core earnings (before interest, tax, depreciation and amortization), analysts say. And with the sector trading at about 6.3 times 2007 EBITDA, few doubt Telefonica would balk at raising the stakes to 3 euros per share, excluding dividends.
"Should they sit on the sidelines now? Absolutely not," said Robert Grindle, telecoms analyst at Dresdner Kleinwort. "They could have been at the top table. I think they will be livid, quite frankly, and looking at all options."
Recent European telecoms takeovers have focused on mobile operators that have commanded EBITDA multiples of between seven and nine times, although mobile businesses tend to command higher multiples because they face less regulation.
After a hefty spending spree culminated in the 17.7 billion pound ($35 billion) purchase of U.K.-based mobile phone group O2 in 2005, Telefonica has promised investors it will spend no more than 1.5 billion euros on acquisitions this calendar year.
But this figure excludes proceeds from sales and the company is likely to raise around 6 billion euros from the sale of its British emergency services communications network, O2 Airwave, and Dutch television production company Endemol alone.
This leaves Telefonica, which put on ice its last negotiations with Olimpia's owner Pirelli in April, with plenty of scope to splurge.
And some analysts say Italian Prime Minister Romano Prodi, who has been urging local banks to counter the bid by AT&T and America Movil in a quest to keep Telecom in Italia, might back Telefonica as part of an Italian bidding consortium.
Leading banks Intesa Sanpaolo and Mediobanca said on Tuesday in separate statements they were in talks with unnamed potential investors to buy a majority stake in Olimpia.
Telefonica has declined to comment.
"The government would definitely prefer Telefonica to America Movil," said Roberta Ciacca, analyst at Kepler-Landsbanki in Milan. "I think (Rome) would be really keen, especially after this deal for Enel to enter Spain."
Analysts suspect that backroom political shenanigans between Rome and Madrid are behind an Italo-Hispanic deal to buy Spain's biggest power firm Endesa -- which could also favor Telefonica's positioning in Italy in a tit-for-tat move.
"They don't like their rival pouncing on Italy, I'm sure," said another Spanish Telefonica investor. "But it's not Italy that bothers them ... it's Brazil."
In Brazil, Telefonica has seen its Vivo joint venture with Portugal Telecom (PT) struggle against the might of Slim's America Movil, while in Europe relations between Vivo's parents have hit new lows since Telefonica backed a hostile, but failed, takeover bid for PT.
As Telefonica has made no secret of its wish to buy the other half of Vivo, analysts believe PT will set a high price.
Telecom Italia may be a preferable option, politics allowing.
"I think they'll have a look (at Telecom Italia) ... they backed the wrong horse in negotiating with (sacked Telecom Italia chairman Guido Rossi) and walked away from Pirelli and Pirelli has now gone with their arch-rival in South America," said Grindle.
"They will be aware that they have a reputation for just going out with their cheque books ... But until someone else is owning it, I think Telefonica will be in the frame."