Jeremy Warner's Outlook: Erskine's triumph may be Telefonica's loss as Spanish pay top dollar for once struggling O2

Let's hope that Telefonica's judgement in bidding an heroic £17.7bn cash for O2 is better than its ability to organise a conference call with journalists. Somewhat farcically, the Spanish telecoms giant was incapable of arranging any more than one line for UK journalists to tune into its Madrid press conference, and even then a technical hitch meant they were unable to ask any questions; it was listening only.

Still, it is in Spain, not the UK, that the awkward questions need to be asked. For O2 shareholders, this is a brilliant sale at a brilliant price which few would have thought remotely possible when the emaciated form of Cellnet, as the company used to be known in the UK, was spun off from British Telecom four years ago.

Back then, the company languished as a poor number three in the market after years of apparently deliberate under-investment by BT. Nobody rated Peter Erskine's chances of making a go of it. The O2 chief executive's life, finally free of the dead weight of the BT mothership, was instead roundly predicted to be nasty, brutal and short.

In fact, it has proved the reverse. Mr Erskine has succeeded in revitalising both the brand and the share price. Even the company's German business, which O₂ retained and invested in to the consternation of the City, is now a respectable operator in its chosen market.

Yet none of this easily explains the whacking great premium Telefonica is paying to gain access to some of the most competitive mobile phone markets in the world. Telefonica doesn't operate in either the UK, Germany or Ireland, so the synergies are unremarkable, even assuming the claimed £199m per annum can be achieved. Spanish companies are allowed to offset the amortisation of goodwill against tax, which yields a bit more. All the same, the net present day value of these savings doesn't come anywhere near justifying the price paid.

This can only be done if you buy into the Telefonica vision that there is an important strategic advantage in having a genuinely pan-European footprint alongside Vodafone, Orange and T-Mobile - that the winners in these markets will be those with the scale to combine capital and operational efficiency with cutting-edge innovation.

Believe it if you will, but one advantage that Telefonica does have over potential rivals is that there is no obvious regulatory reason for blocking it. For any existing operator in the UK and Germany, the synergies would be vastly greater, easily justifying an even greater premium. Yet it's impossible to believe competition regulators would ever allow them. Even T-Mobile would have approaching 40 per cent of UK subscribers if it merged with O2.

None the less, rival bids shouldn't altogether be discounted. With O2 shares trading last night at a 5.75p premium to the value of the Telefonica bid, the stock market is already betting on one. Hutchison's 3, or even British Telecom, could presumably bid without regulatory obstruction, but for the first it would be a huge stretch, and as for the second, it would be hard to keep a straight face. BT demerged O2 at less than half the price just four years ago.

Instead we need to look to the incumbents, who may optimistically take the view that with virtual operators swelling the number of players in the UK market to nine, the competition argument could be won. At the very least, any such intervention may unsettle or delay the Telefonica deal, rather in the manner Tesco managed to upset Wm Morrison's plans for merging with Safeway, and gain market share in the meantime, by making a bid which not in a month of Sundays was ever going to be allowed by the Competition Commission.

Mr Erskine has crossed the finishing line in some style, yet for Telefonica, the race has only just begun.

Takeover fever grips the City again

With live bids for BPB and O₂ and possible bids for Pilkington, P&O and Mowlem, the City is gripped by bid fever again. The economic outlook is uncertain, so why all the excitement? One reason is still buoyant corporate profitability. Another is that the UK market remains undervalued compared with many of its overseas counterparts. And a third is that the UK is one of the few markets in the world where it is possible to buy anything of any size.

Is it not a shame to see these once proud UK assets being sold up with such abandon to foreigners? Not at all. Takeovers are one of the mechanisms by which capital is recycled from the old into the new, and when it is someone else's money that's oiling the cogs, so much the better. By keeping our capital markets free and open, Britain underpins her continued competitiveness.

The shame is rather in failing to create a better environment for small business and entrepreneurialism. Big companies only reduce employment, and often wealth too. The French, Spanish, Japanese and Emirates can have the lot, provided they are prepared to pay the price. It is the smaller, new and growing companies we must worry about, for they are the ones that provide the jobs and riches of the future.

Tax advantages of AIM under scrutiny

Oh what a tangled web we weave... Not deceit in this case, but the distortions of the tax system, which have always been horrendous but seem to get worse by the year as ever more layers of complexity are added.

The Alternative Investment Market (AIM) is being forced to consider putting a £100m ceiling on new issues to counter Treasury concern at the growing number of larger cap companies queuing up to take advantage of the market's tax privileges.

AIM stocks carry a capital gains tax rate of just 10 per cent if held for two years, against 40 per cent for the main market. That's not the only tax advantage of floating on AIM. It is also free of inheritance tax too. What appears to have brought matters to a head is the IPO of John Duffield's New Star Asset Management, which is coming to market with a capitalisation in excess of £600m.

New Star's advisers reasonably point out that the company is a relatively recent business start-up, which was what the advantageous capital gains rate is there to encourage, and that the company could not have been floated on the main market anyway, as it doesn't have the necessary track record.

Yet if companies are floating on AIM purely for reasons of tax it creates a distortion in the capital markets. Worse, by prompting a crackdown by the taxman, it could eventually undermine the whole purpose of AIM as a market for fledgling companies.

A similar sort of distortion occurs in private equity, which also attracts the lower rate of capital gains tax by virtue of removing the company from the listed sector for two or more years. The main market is struggling to compete with private equity as a repository for business assets as it is; the tax break enjoyed by private equity creates a further disadvantage. Whatever the purpose of taxation policy, it should at least be neutrally applied. The effect of the present dual rate of capital gains tax is artificially to tip the playing field in favour of AIM and private equity away from traditionally listed stocks. This cannot be right.

But lest the Chancellor thinks I'm suggesting AIM and private equity should lose their tax concessions, I'm not. Rather, I'm arguing that the lower rate should be applied, or even abolished altogether, to all business assets, whether listed, AIM-quoted or private. The effect would be to produce a very considerable increase in business investment. Might the Chancellor be persuaded by such an obviously beneficial piece of tax simplification? Fat chance. Even imposing limits on the size of AIM flotations might not be enough to forestall an assault on the market's tax privileges.

j.warner@independent.co.uk

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