Here's What's Going On With Telefonica Right Now, And No, It's Not All Bad

Jun.14.12 | About: Telefonica S.A. (TEF)

These last few weeks I've seen quite a few Telefonica S.A. (NYSE:TEF) investors here on Seeking Alpha trying to understand what the deal is with one of the world's largest telecommunications companies, operating globally under the Telefonica, Movistar, O2, and Vivo brands. Trying to do my bit in answering some of these questions and concerns from SA-readers, I decided this morning that it's perhaps easiest to just give my overview of recent company developments and go from there. So here we go.

Telefonica spent $85 billion on acquisitions during the last decade, of which $9.75 billion spend in 2010 to acquire the remaining stake in Brasilcel, the investment vehicle that owned Vivo, from Portugal Telecom (NYSE:PT). Two years on Telefonica is finding itself under pressure from the market and rating agencies to reduce some of this $57 billion Euro ($71.25 billion USD) in net debt, especially after S&P cut Telefonica's rating recently, and we've subsequently seen the board responding in several ways.

First off, very important for investors primarily invested because of Telefonica's dividend, the company finally making the sensible decision to slowly switch from an all-cash dividend policy to an SCRIP configuration, taking full effect in May 2013 when the final dividend for FY 2012 (€0,90 Euro gross) will be distributed. I considered the recent May 2012 SCRIP to elect shares for part of the €0,83 Euro dividend quite favorable already as it saved on paying 21% Spanish withholding tax on that portion of the 2011 final dividend (ex-date was 18 May 2012). I generally prefer SCRIP policies along the lines of Shell (NYSE:RDS.A) (NYSE:RDS.B) or Unilever (NYSE:UL) (NYSE:UN), whereby you can elect new shares for the entire gross dividend amount.

Telefonica determined its new remuneration policy for 2011(Nov-2011, May-2012), 2012 (Nov-2012, May-2013), and 2013 (Nov-2013, May-2014) at the end of last year:

The dividend for the year 2011 has been paid, as usual, in two tranches: a first payment of 0.77 euros per share last November, and the remaining amount has been paid in two tranches: the first one of 0.53 euros per share in cash(May 18th, 2012) and the second part through a scrip dividend, having shareholders the option of receiving the dividend in cash (or selling their free allotment rights in the Spanish market or selling back to Telefónica at a fixed price of 0.285 euros) or in shares (one for every 38 rights).

For the year 2012, shareholder remuneration will amount to 1.50 euros per share, including the payment of a dividend of 1.30 euros per share and a share buyback for the remaining amount (0.20 euros per share), to be completed before May 2013. Treasury shares acquired will be cancelled subsequently. In regards to the dividend of 1.30 euros per share, a first payment of 0.40 euros per share will be made in November 2012, and the remaining amount (0.90 euros per share) will be distributed on May 2013 as a scrip dividend.

The purpose of the 2013 remuneration means minimum total shareholder remuneration per share similar to the one for the year 2012 (1.50 euros per share). The remuneration mix for the year 2013 (dividend, share buyback or the combination of both) will be decided considering market conditions and investor preferences at that time.

On Monday, Telefonica announced its decision to sell half of its stake in China Unicom (NYSE:CHU) for $1.4 billion, paring the holding to 5% from 10%. The board is clearly trying to show its willingness to accelerate debt reduction wherever possible and showing investors it's taken the concerns seriously. Telefonica's CEO Alierta will remain a China Unicom director and China Unicom's CEO Xiaobing will stay on the board of Telefonica.

From a business point of view, It didn't make much sense anymore to have a 10% stake without being able to increase it further. It again highlights the difficulties for overseas carriers to expand in China's telecom market beyond minority stakes. Vodafone (NASDAQ:VOD) did something similar in 2010 when it sold its 3.2% stake in China Mobile Ltd. (NYSE:CHL) for $6.5 billion.

On the debt front, Alierta and Telefonica have set a target to cut the company's debt level by a range of €6 to 8 billion Euro ($8 - $10 billion) during 2012. The company is also considering an IPO of 20% stake in its German O2 unit, which is expected to raise about €2 billion Euro. Telefonica is also seeking about €1 billion Euros from the disposal of its Atento call-center division.

From an operational point of view, first up the guidance provided at the beginning of the year:

Financial Guidance:
Net financial debt/OIBDA < 2.35x (equivalent to previous (Net Debt+Commitments) / OIBDA < 2.5x).
Shareholder remuneration of 1.50 euros per share, including the payment of a cash dividend of 1.30 euros per share and a share buyback for the remaining amount.

Operating Guidance (considering constant perimeter):
Revenue growth >1% at current exchange rates.
Lower OIBDA margin decline than in 2011.
Similar CapEx/sales as in 2011

Telefonica closed out 2011 with 72% of consolidated revenue and 67% of Group OIBDA being generated outside Telefonica's fixed and mobile businesses in Spain. Total customers grew 7% YOY, to 306.6 million accesses at the end of December, mainly driven by growth in Latin America. Net profit was €5.4 billion Euro with record high FCF (+9,5%).

Despite investor concerns, it seems growth momentum has continued into 2012, as visible in the March 2012 results. The company surpassed 309 million accesses at the end of Q1 2012, a 7% YOY growth. Total accesses continued accelerating their growth for the fourth consecutive quarter, underpinned by strong expansion in mobile accesses with +8% growth YOY.

The continuing adoption of smartphones resulted in a significant increase of mobile broadband accesses (+55% year-on-year) and also of those in the contract segment, which represent 1/3 of the Group's total mobile accesses. Telefonica Latin America closed the quarter leading the growth of the mobile market in the region.

Telefonica is seeing an improvement of consolidated revenue growth with +0.5% YOY versus -1.8% in the fourth quarter of 2011, despite negative impact from adverse regulation in Europe and a lower contribution from Spain. Revenues stood at €15.5 billion Euro in the Q1 2012, a 1.6% YOY growth excluding the impact of mobile termination rates cuts. Telefonica Latin America continues driving growth for the Group accounting for 48% of consolidated revenues and accelerating its revenue growth up to 8.3% YOY.

OIBDA reached €5 billion (€5.081 million) Euros in Q1 2012, with an OIBDA margin of 32.8%, an net income totaled 748 million Euro (€1.28 billion in underlying terms). The Company refinanced total 2012 maturities and prefinanced over 40% of 2013 maturities. Above mentioned results were in line with Telefonica's estimates of the Company, and the company reiterated its financial and operating guidance for 2012.

One final note on the European market. As Telefonica investors are already aware, the company has many assets throughout Europe, not merely Spain. The most important of course being the 'O2' brand, which has a major presence in the UK and Germany, but also Czech Republic, Slovakia and Ireland.

Telefonica is actively looking at ways to cut done costs while maintaining network quality, which is paramount. A prime example of this effort is an agreement announced last week to set up a 50-50 venture in the UK with Vodafone. Vodafone Group is the world's leading mobile telecom, operating in Europe, the Middle East, Africa, Asia Pacific, and the United States where it owns 45% of Verizon Wireless, with Verizon Communications (NYSE:VZ) owning the remaining 55% of VZW. Telefonica and Vodafone agreed to operate and manage a single network grid in the UK that will run two competing nationwide mobile internet and voice networks.

Funny enough, Telefonica and Dutch-based Royal KPN (OTCPK:KKPNY) are considering ways to merge their German units, a move that would create Germany's top mobile-phone operator by customers. The companies are evaluating a variety of options, including a combination of Telefonica's O2 Germany unit and KPN's E-Plus unit.

I say funny, because Telefonica's biggest competitor throughout Latin America, Carlos Slim's America Movil (NYSE:AMX) (NASDAQ:AMOV), just happens to be in the process of increasing its 4.8% holding in KPN to 28%, with Movil allocating €2.6 billion Euro ($3.4 billion). As many US investors may be aware AT&T (NYSE:T) currently owns a 9% stake in America Movil and has members on Movil's board. It's amazing to see to which extend these global telecom juggernauts are becoming intertwined in this day and age, with worldwide consolidation expected to continue in years to come.

Disclosure: I am long TEF, VOD, CHL, RDS.A, AMX.