By Julien Toyer
MADRID (Reuters) - Britain's BT Group and Spain's Telefonica have stepped up talks over a cash and share deal which would allow BT to buy back the 02 mobile network it once owned, a source with knowledge of the matter said on Tuesday.
The source, speaking on condition of anonymity, however said that a reported valuation of around 14 billion euros (11.11 billion pounds) for O2 was too high. Spanish news website El Confidencial had cited that price based on Telefonica getting a 20 percent stake in BT and a cash payment of 6 billion euros.
Telefonica and BT confirmed on Monday they were in early stage talks over the British mobile operator. The two groups declined to make further comments on Tuesday.
"It's heating up but it is not sure the deal will be done in the end," the source said, adding that the valuation of 14 billion euros was "surreal".
BT has kept its options open by also discussing a potential deal for O2's bigger rival EE, which is owned by France's Orange and Deutsche Telekom.
A return to the mobile sector would complement BT's strong position in the consumer market in Britain where it has broadband, landline and pay-TV businesses.
COMING FULL CIRCLE
European telecoms firms are currently valued by analysts at between 6 and 7 times their annual earnings before taxes, interest, depreciation and amortisation (EBITDA).
Based on EBITDA of 1.29 billion-euros in the first nine months of 2014, Telefonica's O2 unit would be valued at between 10.3 billion and 12 billion euros.
The source agreed with this valuation and said that assuming Telefonica would take a 20 percent stake in BT, worth around 8 billion euros, the cash element would have to be reduced.
A deal would return O2 to the BT group, having been spun off in 2001 and then bought by Telefonica in 2006 for 18 billion pounds ($28 billion).
Telefonica has said that O2 remains core to its business but it has not ruled out asset sales to meet a target to reduce debt to less than 43 billion euros by the end of the year. The group needs to raise 2 billion euros to meet the target.
Analysts and investors have welcomed the news of talks being held, pointing at the potential benefits.
"Synergies on a possible merger between O2 with BT would be substantial," Deutsche Bank analysts said in a note, adding that these could cut any deal multiple to five times core earnings (EBITDA).
"Any possible discussions are complicated by BT's ambitions to target multinationals in Latin America as well as pension valuations, (and) football content bidding," they added.
Shares in BT closed up 0.43 percent while Telefonica shares rose 0.83 percent on Tuesday.
(Additional reporting by Sonya Dowsett and Robert Hetz in Madrid, Paul Sandle in London; Editing by Mark Potter and Keith Weir)