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By Bloomberg

When Telefonica SA lost a bid to sell its U.K. wireless business, it also missed out on proceeds to help pare its 45 billion euros ($56 billion) in net debt, among the industry’s highest in Europe.

BT Group Plc yesterday agreed to enter exclusive talks to buy EE for almost $20 billion, favoring the wireless provider over Telefonica’s O2 unit. A similar multiple would have valued O2 at about $17 billion. A deal with either carrier would allow Britain’s former telecommunications monopoly to sell bundles of mobile, landline and TV services.

Telefonica’s net debt more than doubled in the decade through September 2014 as Chief Executive Officer Cesar Alierta went on an acquisition spree in Europe and Latin America. This year, Alierta completed the $11 billion takeover of German wireless rival E-Plus and agreed to acquire Brazilian broadband provider GVT for $9 billion. Telefonica’s net debt ratio has to decline to 2.35 times by the end of this year to meet the company’s target, according to Carlos Winzer, an analyst at Moody’s Investors Service. The 12-month trailing ratio is 2.52, according to the latest quarterly report.

“They have a strained balance sheet,” said Paul Marsch, an analyst at Berenberg Bank. “Telefonica has backed itself into a strategic corner in the U.K. with a pure-play mobile operator just at the time when the U.K. market is going to go down a converged route.”

Moody’s ranks Telefonica’s debt at Baa2, the second-lowest investment grade with a negative outlook. Standard & Poor’s has an equivalent BBB rating.

A Telefonica press officer declined to comment and referred to the company’s quarterly earnings conference call. On the Nov. 12 call, Chief Financial Officer Angel Vila said the company was mindful of the “need of executing further measures” and expected to make progress toward its 43-billion-euro net debt target. The company has several options and was analyzing “strategic alternatives in several markets” to reduce debt, he said.

Limited Options

Telefonica’s options are limited now, according to Morgan Stanley analysts led by Luis Prota. The Spanish carrier -- which paid 17.7 billion pounds for 02 in 2006 -- doesn’t view the U.K. as a convergent market and is unlikely to make another push for a sale, they wrote in a note today.

Among options Telefonica may consider is a sale of its remaining stake in China Unicom (Hong Kong) Ltd., according to people familiar with the matter, who asked not to be identified because the deliberations are confidential. Telefonica sold half of its 5 percent stake in China Unicom for about $860 million last month.

“We see opportunities to do more things in innovation and digital services with China Unicom. So, we would not envisage selling in the market additional shares, at least in the short term,” Vila said Nov. 12.

While the U.K. is Telefonica’s largest mobile market -- accounting for about 10 percent of the group’s operating income before depreciation and amortization in the first nine months of this year -- the company lacks a fixed-line network in the country. A union between EE and BT will be able to market bundled packages of fixed-line, wireless, broadband and mobile to U.K. customers.

Had the sale of 02 to BT gone ahead, Telefonica planned to focus on Spain and Germany in the European market, while reducing its debt to brace for further consolidation in markets such as Brazil, a person familiar with the plans said.

“For now, they are fine because there aren’t any converged players in the U.K., but when you are left with only the mobile option you will be a bit lost, and will have to look at other options,” said Andres Bolumburu, an analyst at Banco Sabadell.