Spain’s Tax Hike Set to Accelerate Telefonica Sales Fall

Telefonica SA (TEF), already hampered by shrinking demand and higher borrowing costs in Spain, faces another hit to earnings from a tax increase that threatens to drive crisis-stricken consumers to discounters.

Spain’s biggest phone carrier will be hurt by the boost in the value-added tax in September, part of the government’s austerity efforts, because it will prompt consumers to seek savings and curb spending, said Alexandra Delgado, an analyst at BCP Investimento in Lisbon. Telefonica gets a quarter of its revenue from its home market, where the Madrid-based operator competes against TeliaSonera AB (TLSN)’s Yoigo and the local units of Vodafone Group Plc (VOD) and France Telecom SA. (FTE)

“More taxes are just the last straw for Telefonica in Spain,” Delgado said. “The increase in VAT will affect consumption in Spain, thus having an indirect negative impact on Telefonica’s top line down the road.”

Further customer losses in Telefonica’s home market would add to pressure on Chief Executive Officer Cesar Alierta, who is seeking to revive a stock weighed down by rising debt and falling profit. Alierta is reversing his decade-long expansion strategy and trying to sell assets including shares in German and Latin American units to cut 57 billion euros ($69 billion) of net borrowings.

Telefonica may say second-quarter earnings before interest, tax, depreciation and amortization fell 6 percent to 5.29 billion euros, according to the average of analysts’ estimates compiled by Bloomberg. The company is scheduled to report earnings tomorrow before the market opens in Madrid.

Austerity Measures

Shares of Telefonica have lost 36 percent this year through yesterday, the worst performance among the 23 companies in the Bloomberg Europe Telecommunication Services Index (BETELES), which fell 7.3 percent. They rose 1.7 percent to 8.78 euros at 9:24 a.m. Madrid time.

As Spain struggles to narrow its budget deficit and cut the highest unemployment rate in the European Union, the government is undertaking the deepest austerity measures in three decades. Prime Minister Mariano Rajoy will increase the most common rate of sales tax to 21 percent from 18 percent on Sept. 1.

Sofia Gonzalez, a designer in Madrid, said she plans to switch to a cheaper carrier such as Yoigo when her contract with Telefonica expires in October. Her family now spends about 130 euros a month for three mobile phones and a package of fixed- line, broadband and pay-TV services.

High Prices

“I’m tired of Telefonica’s high prices and poor customer- service,” said Gonzalez, 22. “Even as my dad pays for my phone bill and still wants to keep Telefonica because he thinks the others aren’t good enough, I will switch without thinking twice.”

Potential benefactors from Spain’s economic malaise include Telefonica’s rivals such as Jazztel Plc (JAZ) and other so-called mobile virtual-network operators, which are grabbing market share from the Spanish former monopoly, said Javier Mielgo, an analyst at Mirabaud Finanzas in Madrid.

“The crisis has forced Spanish consumers to try new things and that has dismantled the old myth of Telefonica being untouchable,” Mielgo said by phone.

A Telefonica official declined to comment.

Spanish Revenue

The company’s mounting challenges mirror those faced by Europe’s other major phone carriers.

Yesterday, Royal KPN NV (KPN), the Dutch phone company partly owned by billionaire Carlos Slim’s America Movil (AMXL) SAB, cut its dividend forecast by 61 percent after profit trailed analysts’ estimates as demand in its home market shrank. Last week, Vodafone reported first-quarter service revenue that missed estimates as customers in Spain and Italy cut spending and growth in India slowed.

Telefonica may be forced to reduce prices because the economic crisis and tax increase make customers more sensitive to new offers by rivals, BCP’s Delgado said. That will contribute to hurdles weighing on Telefonica’s revenue growth.

“All issues affecting Spanish consumption, along with higher competition, mean Telefonica loses several hundreds of millions euros a year in revenues,” Delgado said.

Telefonica’s revenue decline in Spain may accelerate to 9 percent this year from a drop of 7.6 percent in 2011, according to an estimate by Alexander Wisch, an analyst at S&P Capital IQ Equity Research in London.

The carrier’s second-quarter domestic revenue may have slid 12 percent from a year earlier, said Andres Bolumburu, an analyst at Banco de Sabadell in Madrid. Full-year sales at home will fall 9.8 percent, he estimates.

Preserving Margins

In May, Telefonica lost more than 204,000 mobile-phone lines in Spain, bringing its market share down to 38.04 percent from 38.24 percent in April, data from the CMT regulator showed.

After coming back from a three-week trip to London, Ane Escribano, a mechanical-engineering student in the northern Spanish city of Bilbao, found herself with a 170-euro mobile- phone bill from Telefonica. That triggered her to switch to Vodafone at the end of last year and get a cheaper offer and a smartphone.

Telefonica continued to charge her 7 euros for two more months, the 22-year-old said. “It was a very disappointing experience,” she said.

Even with the competitive threats, Telefonica has chosen to preserve its profit margins by, for example, cutting handset subsidies, said S&P’s Wisch. That has resulted in the market- share losses, making the strategy unsustainable in the long term, he said.

“Telefonica’s Spanish revenues are under significant pressure so what can it do?” Wisch said. “We could see the company fighting back later in the year.”

To contact the reporter on this story: Manuel Baigorri in Madrid at mbaigorri@bloomberg.net

To contact the editor responsible for this story: Kenneth Wong at kwong11@bloomberg.net

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