Buy Telefonica: 11% Dividend Stock Turned Into A Growth Story

| About: Telefonica S.A. (TEF)

Telefonica (NYSE:TEF) was one of the global telecom carriers to recently slash its dividends, largely due to the economic downturn in Europe and due to higher levels of debt. The company recently announced that it will no longer be paying out dividends due to the harsh economic climate and weaker spending by consumers. Another reason is that it is focusing on paying its debt, which currently stands at around 58 billion Euros. Despite growth in revenues, the company's earnings took a hit largely due to European weakness, but growth in Latin America was able to partially offset the decline.

Despite the dividend cut and cancellation of the share repurchase program announced by the company, the market has taken the aforementioned steps positively, as they will help the company save cash as well as reduce its high debt. According to estimates, the decision to suspend dividends for the financial year 2012 would save the company in excess of 6 billion Euros. Since our last report on TEF, the stock is up over 13%, and we believe it has further upside potential based on its exposure to high growth in Latin American markets, and given the recent steps taken by the company's management.

The most recent step taken by the company's management came a few months after it announced (back in May) that it plans to sell shares in its German subsidiary, O2. The company, in an attempt to reduce its debt burden, has planned to list almost 20% of its German O2 units between 5.25 Euros and 6.5 Euros per share, which is expected to bring over 1.5 billion Euros in funds to the company. The public offering, which is to be closed by the end of the month, is capped at 23% float, and the shares will start trading on October 30. Moreover, the IPO will certainly prove to be financially beneficial for the company, apart from the obvious 1.5 billion Euros that the company expects to receive. It is expected that TEF would not have to pay taxes for the next three years because of tax credits received due to losses related to its mobile phone licenses. That makes it particularly attractive for investors, as the company can use the cash saved for making strategic investments for further growth of the company.

Another recent step taken by the company is its decision to sell its Atento call center business to a U.S. private equity firm that is basically looking for exposure in the high growth Latin American markets. Bain, a private equity firm co-founded by U.S. presidential candidate Mitt Romney, will pay over $1 billion for the call center operations. The deal also includes that the call center company will continue to provide services to Telefonica for another nine years.

Overall, both deals can be taken positively, as the company is trying to battle with a weak economy in the region and high debt levels. The sales will help the company in coping with its debt payments as well as avoiding a possible credit downgrade. The German division IPO should be an attractive option for investors, as the company would have insignificant debt and higher growth potential without the shrinking fixed line business. Moreover, its quarterly results have been impressive with growth in revenues and earnings, and currently it is the third largest wireless company in Germany, serving almost 19 million customers, half of which belong to the rapidly growing prepaid market segment. Moreover, Telefonica Deutschland plans to pay its shareholders approximately 500 million Euros in the financial year ended 2012, which is expected to increase going forward.

The company's management has publicly announced that it will resume dividend payment from next year. Before the dividend suspension, TEF was offering a dividend yield of 11%. Historically, it has produced cash flows in excess of dividend payments, as well as the capital expenditures. In the financial year ended 2011, TEF paid cash dividends of approximately 7 billion Euros, while generating operating cash flows of 17 billion Euros, which indicates that the company was capable of financing the high dividend payouts.

However, the recent move to cut dividends, and the sale of its call center business indicates that the company is aiming to focus on its core competences, and at the same time reduce its high debt levels, which has reflected positively in its share price. Share price gained almost 5% since the disposal announcement of its call center operations.

High operating cash flows, strategic decisions involving recent sales and exposure to high growth market in Latin America as well as reduced debt burden in next year are reasons enough to believe that the company may resume its dividends in the next year. On the resumption of dividends, which is expected in the second half of 2013, the company will make payments of 0.75 Euros per share, which translates to a very attractive dividend yield of around 7%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Telecom Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.

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