Analysis: Telefonica back in shape to clear debt hurdles

Spanish telecoms company Telefonica is off life support after a year of asset disposals and cash-saving moves and now must focus on repairing its domestic business, boosting its revenues and rebuilding profits.

Eight months ago it was weighed down with 58 billion euros ($78 billion) of debt threatening its investment grade credit rating, having built up larger debts than its peers by taking advantage of the credit boom in Spain a decade ago to fund a huge expansion into Latin America, where it operates in over a dozen countries.

But since last summer it has sold down its stake in China Unicom <0762.HK> for 1.1 billion euros and exchanged 800 million euros of preference share debt for equity. It also scrapped its dividend of 150 euro cents a share intended for 2012 and a share buyback program to save 6.8 billion euros. It also raised 1.45 billion from floating its German O2-branded unit .

As a result Telefonica is expected to say in 2012 results on February 28 that it has now got its ratio of net debt to earnings before interest, tax, depreciation and amortization (EBITDA) down to 2.35, from 2.65 at the end of June, credit analysts said.

That would protect its credit rating and could mean Telefonica will not have to spin off its Latin American arm with an $8 billion share offer as once expected, or follow rivals with other cash-raising measures.

Dutch group KPN earlier this month launched a 3 billion-euro share offer and 1 billion-euro hybrid capital issue while Telecom Italia is also planning on issuing hybrid debt to help fund infrastructure spending.

The main challenge for Telefonica now is to repair its all-important Spanish business, which lost over 3 million mobile customers last year, with the company now trying to win back business by bundling internet, television, mobile and fixed line services under its Movistar Fusion brand.

But credit analysts say even without immediate growth in EBITDA it could protect its debt/EBITDA ratio by continuing to hold back on its once hefty dividend payments.

EBITDA for 2012 is on average expected to come in at around 21.1 billion euros, the lowest level since 2007 and down from 23.7 billion in 2011 and top-rated analysts expect it to then fall to 20.4 billion euros in 2013, 20.5 billion euros in 2014 and 20.8 billion in 2015, according to Thomson Reuters StarMine.

Meanwhile they are forecasting the company will pay a cash dividend for 2013 of just 60 euro cents, followed by 74 cents for 2014 and 79 cents for 2015, well down on the 130 cents paid out for 2011 and 150 cents that had been expected for 2012.

"The temporary suspension of the dividend has had a greater impact on free cash flow than other telcos due to the size of the payment. As a result Telefonica should be able to de-lever to its target levels even with declining EBITDA," said Nancy Utterback, credit strategist at asset manager Aviva Investors.

NO MORE ASSET SALES?

"What (Telefonica) needs to do and what I expect them to do is to preserve the current debt figure and gradually improve EBITDA," said Carlos Winzer, an analyst at Moody's, adding that he believed another big asset sale such as the flotation of its Latin American arm was no longer necessary.

Telefonica's better profile in debt markets is already reflected in the cost of credit default swaps to insure Telefonica's debt over a five-year period, which have fallen from more than 550 basis points (5.5 percentage points) in July to just 250 basis points, meaning it costs 25,000 euros to insure 1 million euros of debt.

In comparison Telecom Italia's CDS trades at around 330 basis points, down 41 percent from its 560 basis-point high. Since this time last year, Deutsche Telekom's five-year CDS has fallen around 26 percent to 90 basis points while France Telecom's has edged just 8 percent lower to 128 basis points.

Meanwhile Telefonica last month raised 1.5 billion euros in a 10-year deal that priced at 230 basis points over mid-swaps, equating to a coupon of 3.987 percent. A year earlier a six-year bond priced at a much more expensive mid-swaps plus 300 bps.

"Spreads are still impacted by correlation to the sovereign, but yields have come down significantly," Utterback said.

SHARE PRICE

There are also some signs that group's capital work-out has attracted investors back to the stock, even though Telefonica must still prove it can fix Spain, which accounts for a third of operating profits, and address issues elsewhere in its empire.

A third of 39 analysts surveyed now have 'buy' ratings on the stock, with the other 26 evenly divided between 'holds' and 'sells', according to Thomson Reuters Eikon.

The company's share price has also increased 24 percent from its July low to close at 9.795 euros on Tuesday.

"The key thing that we're watching is cash flow sustainability on the core Spanish operation," said Laurent Millet, who manages the Artemis European Opportunities Fund.

"We wouldn't like them to float more assets," he added.

EUROPEAN COMPARISONS TELECOMS COMPANY EV/EBITDA RETURN ON CAPITAL DEBT/EQUITY NET DEBT (2012Est, euros) Deutsche Telekom 3.73 0.71 1.63 38.5 bln France Telecom 3.90 5.67 1.43 30.8 bln KPN 3.81 4.16 5.77 11.1 bln Telecom Italia 6.25 -6.58 1.75 28.6 bln Telefonica 5.02 6.86 3.32 51.5 bln

(Source: Thomson Reuters Eikon data) ($1=0.7487 euros)

(Reporting by Clare Kane in Madrid and Josie Cox at IFR Markets in London; Editing by Greg Mahlich)