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Hello? Debt-laden Telefonica still a show-me story

A visitor walks in front of Spanish communications company Telefonica's stand at the 3GSM World Congress in Barcelona on Feb. 15, 2007.


Telefonica is making some progress, but it is still somewhat behind the curve. It has long been hard to see how the telecom operator will make meaningful inroads into its €57.1-billion ($72.9-billion) debt pile. The recent downgrade from a rating agency to BBB was a clear warning sign. Now the Spanish telecom company has delivered, a bit. It will pay part of its dividend in shares, and list minority stakes in Germany, and possibly Latin America. Yet while the move may assuage the rating agency nerves, shareholders may still be asking questions.

Telefonica might need to cut debt by around €6-billion to €7-billion in order to bring down its multiple of net debt to OIBDA (operating income before depreciation and amortization) down to its target of 2.35 times by the end of this year. To help get there, while maintaining a small share buyback program, it will pay part of its dividend in scrip. But shareholders have the choice. Assuming 60 per cent of investors take up the scrip option, the move might save €2.5-billion, according to Morgan Stanley estimates.

Telefonica might have slashed the dividend further. The market, which accords the company a dizzyingly high yield, seems already braced for what may be inevitable. In the circumstances, spending over €4-billion on cash dividends and buybacks looks increasingly hard to justify.

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Instead, Telefonica has pledged to maintain the dividend this year – albeit helped by the scrip – and fill the funding gap by listing its German and Latin American units, as well as other sales. A German sale would tick some boxes: The local market is less depressed than Spain and the proceeds might be decent. An IPO of Germany might raise €2-billion, according to JPMorgan estimates.

But even if market conditions are better abroad than in Madrid, they are far from ideal. Telefonica would likely have to cash in at a discount, while forgoing cash flows from higher-growth, core markets. Selling other non-core assets, such as China's Unicom, might be a better priority. Besides, asset sales will increase Telefonica's exposure to its hard pressed domestic market.

With the stock offering a 13.8 per cent yield and trading on a 2012 a share price of 6.8 times 2012 earnings – a discount to peers – investors are still unconvinced.

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