Telefonica Risks Getting Hit by Debt Costs on Spain Ties
Telefonica SA (TEF) faces the prospect of rising funding costs because of ties to crisis-ravaged Spain, putting more pressure on a phone company grappling with a 57 billion-euro ($71 billion) debt burden and falling profit.
Europe’s debt crisis, increasing unemployment and slowing economy have brought Spain’s credit rating within a hair of junk status. A further downgrade could trigger another cut for Madrid-based Telefonica too, said Carlos Winzer, senior vice president at Moody’s Investors Service.
Telefonica’s annual interest cost may rise by more than 500 million euros in that case, Winzer said, wiping out a larger chunk of profit at a company that’s already forecast to continue reporting shrinking earnings and stagnating sales. Further pressure on profit, in turn, would hurt Chief Executive Officer Cesar Alierta’s efforts to reduce the company’s debt.
“Capital markets still perceive Telefonica as a Spanish company holding the sovereign risk,” said Winzer, who is based in Madrid. “The exposure to Spain remains substantial in terms of cash flow, while its tight relationship with local banks through loans and customers bills doesn’t help either.”
Telefonica’s financing costs would increase by about 20 to 50 basis points for every level the carrier’s rating is downgraded, Winzer said. That means the interest rate the carrier pays could jump from about 5 percent to more than 6 percent, he said. Its annual net financing costs would rise to about 3.4 billion euros by the end of next year, up from 2.9 billion euros in 2011, said Winzer, who has been the lead Telefonica analyst at Moody’s for 20 years.
As Spain struggles to reduce its budget deficit through austerity measures, Moody’s this month cut its rating three levels to Baa3, one step above junk. This week, the ratings company downgraded 28 Spanish banks because of the country’s sovereign debt and souring real estate loans.
Today, euro-area leaders agreed to ease repayment rules for emergency loans to Spanish banks. They dropped the requirement that governments get preferred creditor status on crisis loans to the country’s banks and opened the door to recapitalizing banks directly with bailout funds once Europe sets up a single banking supervisor.
On June 20, Moody’s lowered Telefonica’s long-term debt rating one level to Baa2, the second-lowest investment grade, and said it may be reduced further as Spanish consumers scale back spending and the government’s credit profile worsens. Standard & Poor’s cut Telefonica’s rating last month to BBB, the equivalent of the Moody’s grade.
“Spain will be downgraded by the end of the year unless there is a big European intervention and so corporate bonds will suffer, especially Telefonica’s,” Nicolas Gouju, who helps manage 80 billion euros at Groupama Asset Management SA in Paris, which reduced its holding of Telefonica bonds in April because of the company’s exposure to Spain.
A downgrade could make it too costly for Telefonica to continue issuing bonds, “which could put the mid-term financial stability of the company at serious risk,” Gouju said.
A Telefonica official declined to comment.
The cost of insuring Telefonica bonds against default using credit derivatives has soared more than 80 percent to 567 basis points in the quarter. While that’s similar to Telecom Italia SpA (TIT)’s 557 basis points, it’s more than double the 161 basis points it costs to cover France Telecom SA (FTE) debt and the 108 basis points on Deutsche Telekom AG. (DTE)
“Telefonica’s credit position is more worrisome and vulnerable than that of peers such as Deutsche Telekom or France Telecom,” Winzer said.
Telefonica’s 2 billion euros of 5.431 percent notes maturing 2014 yield 574 basis points more than similar maturity government debt, up from 289 basis points on March 30. Spreads on its 1 billion euros of 3.661 percent debt due 2017 are 671 basis points, compared with 339 basis points at the end of the first quarter.
Spreads on Deutsche Telekom’s 2 billion euros of 6 percent bonds due 2017 were 144 basis points -- 84 basis points above the benchmark swap rate -- and have averaged 151 basis points this quarter. The bonds were issued at 265 basis points more than the swap rate, data compiled by Bloomberg shows.
Amid declining profitability and growing debt, Telefonica is struggling to soothe bondholders and equity investors. The former Spanish monopoly has cut its dividend while it tries to dispose of assets to help cut debt.
Telefonica’s debt pile ballooned because of ambitious expansion. Alierta spent $85 billion on acquisitions since taking over in 2000, transforming Telefonica into a global telecommunications company with presence in 25 countries.
As Alierta now seeks to unwind some of his acquisitions, Telefonica has an internal target to cut its debt by a range of 6 billion euros to 8 billion euros this year, a person familiar with the matter said this month.
The company is considering an initial public offering of a 20 percent stake in the O2 Germany unit, aiming to raise as much as 2 billion euros, people familiar with the matter have said. This month, Telefonica said it would sell half of its stake in China Unicom (Hong Kong) Ltd., paring its seven-year venture into one of the fastest-growing wireless markets.
Even with its international assets, Telefonica relies on cash flow from Spain to help pay for its debt costs, Winzer said. It needs to spend much of the cash it generates in each market on expenses such as network improvements and advertising.
“Telefonica’s geographic diversification is very significant both in terms of revenues and operating income before depreciation and amortization, but it’s not so much in terms of cash flows,” Winzer said. “The company operates in a highly capital-intensive industry, which makes it hard to repatriate any cash flow.”
To contact the reporter on this story: Manuel Baigorri in Madrid at firstname.lastname@example.org