Leila Abboud is a Bloomberg Gadfly columnist covering technology. She previously worked for Reuters and the Wall Street Journal.

In Spain, Telefonica is showing what the European telecom carrier of the future will look like. It's pushing all-inclusive packages of mobile and broadband, investing heavily in fiber networks, and betting big on exclusive content by buying the local pay-TV operator.

Unfortunately for Chairman Cesar Alierta, this investment-heavy strategy is being overshadowed by concerns about Telefonica's debt mountain and exposure to slowing growth in Brazil.

Debt Drag
Telefonica's debt remains stubbornly high -- despite asset sales in recent years
Source: Bloomberg

Free cashflow has dwindled and the company's net debt has crept up to 49.9 billion euros ($55 billion) -- 3.8 times Ebitda, the most among its peers, according to Bloomberg data. Cutting it will depend on European regulators approving the 10.25 billion-pound ($14.3 billion) sale of its British mobile unit to Hutchison's Three in coming months. If it can't, it will have to sell assets or reduce the cash part of its dividend. Economic weakness in Latin America, which accounted for 70 percent of operating profit last year, isn't helping either.

Telefonica Decoupling
The shares are lagging peers on debt, Latin America concerns
Source: Bloomberg

So investors have punished the shares, which are down 30 percent in the past year compared with an 11 percent decline in the European telecoms index. The company trades at 12.2 times estimated earnings, a lower multiple than any of its major peers, according to Bloomberg data.

Earnings Multiple
Telefonica shares trade at the lowest multiple of earnings of all major European carriers
Source: Bloomberg data

Before shareholders give credit to Telefonica for its vision in Spain, investors need to see more proof that fiber and television investments will pay off and that the debt can be reduced.

The early results since Telefonica bought pay-TV operator Digital Plus in May 2015 are encouraging -- but not conclusive.

Organic revenue rose 0.2 percent in the third quarter, the first quarterly increase since 2008 -- but slipped 2 percent in the fourth quarter as the company discounted products to win customers around Christmas. Customer churn is stable and average revenue per user on the all-included Fusion packages climbed 7 percent in the fourth quarter to 74.40 euros a month. 

Telefonica's push into pay-TV adds volatility to the costs in Spain -- but the TV business's higher profitability should help to widen domestic margins. It paid 60 percent more in the latest auction for rights to Spain's La Liga soccer matches. The additional 350 million euros the rights cost amounts to 6 percent of domestic operating profit.

The company will have to pass on those higher costs to consumers: it introduced price increases at the end of last year. But it remains to be seen how much higher Telefonica can push them before losing customers. The carrier is also reducing costs, introducing an early retirement plan for Spanish employees aimed at saving 370 million euros a year.

Telefonica is betting that pay TV will be powerful driver of its business because convergence is a reality in Spain like nowhere else in Europe. At the end of the third quarter, some 65 percent of customers were on all-inclusive bundles of fixed, mobile, broadband and TV plans. The country is also the European leader when it comes to connecting customers' homes with fiber.

On top of the debt, Telefonica needs to show that combining telephones with pay TV, mobile and broadband generates higher profit. The whole European industry is waiting for the answer. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Leila Abboud in Paris at

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Edward Evans at