Telefonica's 'Digital Revolution': What Does It Mean For Shareholders?

| About: Telefonica S.A. (TEF)


In 2011, Telefonica launched a transformation plan to better position the company in a more technological environment.

The company has made a lot of progress in its plan but still has a sizable amount to do.

Investors must decide if the inherent risk this plan creates is worth the potential reward.

Back in 2011, Telefonica S.A.'s (NYSE:TEF) management announced its plans for a "Digital Revolution" which would reshape the company and its operations to allow for continued profitability in the increasingly technological telecommunications industry. The transformation first started with the creation of Telefonica Digital and Telefonica Global Resources. These divisions were first created to lead the charge into the new opportunities that TEF foresaw occurring once the move to digital was completed as well as maintaining the growth experienced in each region the company operates around the world.

After successful launch of the transformation's first stage, the company currently finds itself at the latter end of stage two: accelerating efficiency gains. In order to maximize the profitability of this entire venture, TEF implemented four key focal points for stage two to be successful:

1. Increase Revenues

  • The primary effort of this simple-sounding goal is to concentrate on monetizing data traffic, digital services, and new commercial channels

2. Become a more high-tech company

  • Telefonica plans to do this by accelerating the modernization of its network by deploying more fiber and LTE

3. Increase efficiency and execution

  • Maximizing synergies between the new divisions of the company will be crucial to success in this stage

4. Position the company as a sector leader

  • The company feels that once it completes the transformation to digital, adept implementation of its technology and different departments can allow it to establish itself as the primary player in the space. TEF believes it can "reinvent the telco" and set the standard for a new version of the industry.

The image below is a slide from Telefonica's investor presentation at the end of February:

The company is now directing its effort towards finishing stage two and transitioning into the third phase. While this may seem like the simplest phase of TEF's plan, it will be likely be the most difficult and absolutely the most important as it will be when everything comes together for TEF. Telefonica now faces the challenge of not only implementing its past improvements and collaborations but also to maintain those developments into the future as the company grows its presence in Latin America as well as its other regions.

How should shareholders view this?

Owners of TEF stock should be excited by this 5-year plan as it is comprehensive and very profitable (if executed properly). However, there is a definite risk associated with this initiative. This transformation is multi-faceted and depends not only on the success of the individual components but of the integration between them. There are multiple scenarios one can envision in which Telefonica's digital move isn't as profitable as planned which results in a relatively high level of risk that comes in conjunction with investment. If the transformation does go smoothly, though, Telefonica will be excellently positioned in the various markets it operates. Management forecasted on its most recent Quarterly Conference Call that it will save $1.5B in OpEx and CapEx expenses annually on top of the benefit that will come from the increase in revenues, technological advances, and boosted efficiency.

Investment in Telefonica is very attractive right now especially given the over 6% yield, but it is almost entirely dependent on the digital transformation's success. Generally, signs are positive regarding the plan's progress but this isn't a situation where TEF's future is going to be affected by a new business initiative... Telefonica's future is this new business initiative. Between the restructuring, new technology and massive effort put forth, the foreseeable future for Telefonica is 100% reliant upon how its new plan works and if the company can integrate all these changes into its current operations. I like TEF's chances given how much progress the company has already made as far as the transformation is concerned but the risk can't be ignored. Overall, Telefonica seems primed to complete the digital enhancement and provide shareholders with a healthy return over the next few years.

Disclosure: I am long TEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.