* Top picks — We upgraded KPN to Buy on the basis that improving sector dynamics, relatively low valuation, our expectation that its sale of E-Plus is approved and downside protection from a possible renewed bid from AMX will outweigh the now relatively well-understood risk of the new entrant in Dutch mobile. We retain Buys on Vodafone, BT, Belgacom and Tele2. We see United Internet with its 1.9m strong MVNO as one of the main external beneficiaries of the TEF De/E-Plus deal.
* Least favoured — We retain Sell ratings on Telefónica and Telecom Italia, where our estimates are 5% and 10% below consensus for 2014E EBITDA due to Latam currencies and, in TI's case, also Italian fixed line. We retain our Sell on Orange, which we think is not as relatively cheap as its EV/EBITDA multiple appears once the high French corporate tax rate and limited life of the Iliad wholesale revenue are taken into account.
* High activity levels to continue in 1H — In 2014 we expect continued elevated bid activity, better mobile trends and increased capex on fast broadband and 4G as positive drivers for the sector. The first half of the year we see dominated by Vodafone's £51bn distribution (in parts on 24 February and 6 March) pushing liquidity into the sector, and, in our view, likely approvals of consolidation deals in Germany (May) and, with less certainty, Ireland (April), though we expect quite tough remedies from the EC. We see an in-market breakup of TIM Brasil and a combination of Sprint and T-Mobile USA as less likely to achieve approval.
* Premium valuation provides a challenge — The sector has performed well and average sector valuations have moved up into demanding territory, though they do not yet look worryingly excessive by historical standards. Trailing sector EV/EBITDA is approaching one standard deviation above the 10-year average while the 12 month forward sector PE is at an unusually robust premium to the market on forward PE of 7.5% vs a 10-year average of a 2% discount. We see downside risk to consensus EBITDA for 2014 and do not see earnings alone as enough to even justify the rally, never mind extend it.
* Softbank maybe focusing on US, not Vodafone — Softbank's apparent interest in T-Mobile USA would, if confirmed, seem to us to rule it out from contesting any bid for Vodafone. That T-Mobile could itself see contested bids, with mentions of Dish's possible interest in the press, we view as a positive for DT. However, we expect German mobile to see tougher competition in 2014 and, with United Internet establishing a second MVNO contract with E-Plus in anticipation, we doubt the likely TEF De/E-Plus deal remedies will leave much benefit for the incumbents.