Telefonica S.A. (TEF), the former Spanish public telecommunications monopoly, has undergone quite a bit of scrutiny in the equity markets lately. Today, the company is still the sixth-largest telecommunications provider worldwide, offering landline and mobile telephone service, Internet services, and digital television subscriptions to its millions of customers.
While Q1 2012 EPS dropped from the same quarter last year, growth in Latin America - especially in the Brazilian market - makes me very confident of future earnings increases and stability. Telefonica's management has acted very rationally in response to the recent European financial crisis and subsequent economic downturn; management has restructured operations to separate European and Latin American divisions, as well as created two separate business units: Telefonica Digital and Telefonica Global Resources. This improved business structure will allow the company to pursue growth by the most efficient means possible.
Metrics in both the strictly financial and business segments of TEF's operations point to sustained future growth prospects. For instance, total customer access reached 309.4 million at the end of the first quarter this year, which represents a 6.5% increase from last year. This was primarily driven by a 10.8% annual subscriber growth rate in Latin America, which is truly extraordinary given competition in the region. Mobile access rose 8.1% to 241.1 million customers - the key force in this growth was the 55% increase in mobile broadband customers to 41 million users. TV subscriptions rose 16% annually to 3.3 million customers, while Internet and data access grew 2.7% to nearly 20 million customers. TEF management also projected revenue growth of 1% into 2013 with a substantial decrease in leverage ratio (net debt-to-EBITDA) to 2.35x, down from this year's 2.55x (which was down from 2011's 2.63x). All of these figures demonstrate the continued vitality of Telefonica's business operations, and the integrity of management's philosophy to improve leverage ratios and bring the company back to a comfortable operating position.
Competitors France Telecom S.A. (FTE), Vodafone Group PLC (VOD), China Mobile Ltd. (CHL), America Movil SAB de CV (AMX), and others will certainly do their best to keep TEF out of the market. However, given recent customer growth, synergies from quality of services delivered and word-of-mouth are likely to be high. Analysts should look to Latin America alone - the firm's growth in Brazil alone could make it a highly successful venture and a major player in South and Central America. Even outside Latin America, news from Telefonica subsidiaries has been primarily good. This has yet to be reflected in the price of current equity shares, representing a compelling opportunity for value-seeking investors. Moreover, a high dividend and favorable USD-EUR exchange rate is simply added bonus for American investors willing to sit out the current instability and inefficiencies in European markets.
Recently, critics have claimed that TEF's dividend is unsustainable at current levels. However, such claims are fundamentally flawed: Telefonica's financial metrics and overall position in the global telecommunications market make it a prime candidate for strong growth into the future. Those looking to invest for the long-term would be wise to purchase TEF shares at current prices in the $12-$13 range. Discounted cash flow valuation with baseline assumptions (even lower than management projections) yields an implied price per share of at least $17, which would be a buy signal even at a price several dollars above the price at which shares are currently trading. TEF should strongly outperform the market in the medium-to-long term, based on its current earnings strength, relative valuation, and recent price movements (especially the very recent sell-off after its ex-dividend date, which was greatly exaggerated). The fundamental value of Telefonica S.A. is higher than its current market capitalization. Thus, brave investors would be wise to take advantage of this opportunity.
The market rewards those with patience and conviction, especially in the pursuit of a good idea. TEF, at its core, represents one of these situations. Unless some severe materially impacting information comes forth in the near future that invalidates some of the metrics analyzed, I will be doubling down on my position in TEF this week - and so should you.