Orange and Bouygues have signed a confidentiality agreement in advance of starting negotiations about a takeover deal, according to a report from French newspaper Le Journal du Dimanche, which cites sources close to the matter.
France's former state-owned telecom monopoly is said to be considering a €10 billion (US$10.9 billion) acquisition of Bouygues Telecom that would see it pay €2 billion ($2.2 billion) in cash and €8 billion ($8.7 billion) in shares to Bouygues, leaving the French industrial conglomerate with a 15% stake in Orange (NYSE: FTE) following the transaction.
A merger would bring together the country's number-one and number-three players and leave France with just three network operators, helping to reduce pricing pressure in what has become one of Europe's most competitive markets.
The subject of consolidation is perennial talking point in France's telecom sector, but some recent attempts to merge networks have failed to bear fruit.
Indeed, Bouygues last year rejected a €10 billion ($10.9 billion) offer for its telecom business from cable group Altice , which had planned to merge the company with its Numericable-SFR business, France's second-biggest telecom operator. (See Bouygues Says 'Non' to Altice.)
At the time, Bouygues told investors it saw greater potential in remaining a standalone entity, although there were suspicions it had come under political pressure to turn down Altice. (See Altice Queries Bouygues' Motives in Rejecting €10B Bid.)
Politicians including Emmanuel Macron, France's economy minister, are concerned that further consolidation could be detrimental to competition and not in France's longer-term telecom interests.
Overcoming political and regulatory opposition to a merger is likely to be a major challenge for Orange and Bouygues, according to Bengt Nordström, the CEO of market research and consulting company Northstream.
"It would create a very dominant player which I think has very low probability to be approved by French and EU regulation and competition authorities," he tells Light Reading. "A merger between Free [the brand used by Iliad, France's number-four player] and Bouygues has a bigger probability of being approved but with current regulatory winds even that one would be unlikely, at least in 2016."
That Bouygues is now in discussions with Orange, however, suggests there has been a major change of heart among the company's directors.
Conditions have been tough in France's mobile phone market ever since the arrival of Iliad (Euronext: ILD) in early 2012: Formerly a disruptive presence in the country's broadband sector, Iliad has taken its price-cutting practices into mobile with devastating effect.
Even so, Orange, Numericable-SFR and Bouygues have recently sounded a more upbeat tone when discussing their outlook and Bouygues managed to increase its EBITDA margin by two percentage points, to 24.7%, in the third quarter of 2015, compared with the year-earlier period.
That performance ensures it is well on track to achieve a 2017 target for its EBITDA margin of 25% -- a level it has not seen since 2011.
Bouygues directors may simply feel that Orange's cash-and-shares offer holds far greater attractions than the bid from Altice, which has a reputation for engaging in ruthless cost-cutting activities at the organizations it has acquired.
Orange would expect a Bouygues takeover to have a big impact on its operational performance in France: Sales fell by 0.6% in the third quarter of 2015, compared with the year-earlier period, although this marked an improvement on declines of 0.8% in the second quarter and 1.8% in the first.
According to a report from Dow Jones, Orange is eager to bulk up in the face of growing competition from web rivals such as Google (Nasdaq: GOOG) and Facebook , whose communications offerings are adding to the pressure on traditional service providers in particular markets.
Shares in Orange had fallen by 2.6% in Paris during morning trading on Monday, while those in Bouygues were up 1.7%.
— Iain Morris, , News Editor, Light Reading