Tech

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

Telefonica has taken a kicking from British voters -- but has gotten a stay of execution from Mario Draghi. It needs to use that time to reduce its 50 billion euro ($55.2 billion) debt pile to deliver on its pledge to keep its precious investment-grade credit rating.

The Spanish telecom is scrambling to keep its head above water after European competition regulators in May scuppered its big plan to cut debt with a 10.25 billion-pound ($13.3 billion) sale of O2, its British mobile arm. Britain's shock vote to leave the European Union derailed a backup plan to sell shares in the company or find a different buyer.

The European Central Bank's move this year to include company debt in its bond-purchase program is helping keep a lid on borrowing costs for Telefonica and other European companies. But pressure to delever persists. 

Hanging On in Credit Land
Telefonica hasn't been dealt an outsized blow by credit investors from the year's turmoil
Source: Bloomberg
Normalized performance of credit-default swaps

Moody's has already cut the outlook on its Baa2 credit rating to negative, and said that it wants to see "clear evidence of progress" towards deleveraging this year. Carlos Winzer, analyst at the rating agency, reckons Telefonica must cut 14 billion euros of debt for management to achieve its goal of a ratio of net debt to Ebitda of 2.35 times.

A sale of O2 is the only move available that will really take a significant chunk of out the debt. But the stars are not aligned for this to happen soon. Telefonica needs to pursue a patchwork of other options in the meantime, while it waits for market conditions to turn in its favor.

Management may have gotten this memo -- the company said Monday that it will raise 322 million euros by selling a 1.5 percent stake in China Unicom. That's a drop in the ocean, and it needs to do much more.

No Fun
Telefonica isn't generating enough cash to cover dividends and network investments while paying down debt
Source: Bloomberg

Telefonica should keep its eye on its plan to sell up to 49 percent of its Telxius infrastructure unit. That initial share sale was set to go forward in July but was also put on hold after the Brexit vote. It could raise up to 2 billion euros, and provided it can get a decent valuation, Telefonica should try going ahead with it.

It shouldn't wait around on that, either. One step it should take straight away is to either suspend its dividend outright or pay it completely in shares, which would save about 2.8 billion euros based on 2015 pay-out figures. Shareholders won't like either plan, but Telefonica's debt problem is more important. 

There are also other minority holdings it could unload to raise up to 700 million euros, according to Mirabaud Securities, such as the rest of its China Unicom stake, a 0.7 percent stake in BBVA or even its Argentinian television business.

It could be smart for Telefonica to issue hybrid bonds, deeply subordinated securities that have features such as permitting suspended coupon payments. Moody's counts them as half equity when calculating the size of a company's net debt load.

They're not a clean bet since rating agencies can also change their mind about how they're counted; last year S&P decided that 29 hybrid bonds, including one of Telefonica's, no longer qualified as 50 percent equity. But in a negative-rate world, the higher coupons on the securities could be attractive.

So it's worth a shot. Telefonica already has about 5.5 billion euros of these instruments on its balance sheet, and Moody's Winzer says it has room to add another 5.5 billion euros.

Teflon Telefonica
China meltdown and Brexit weren't enough to stop the upward march of Telefonica's hybrid bond price
Source: Bloomberg

The mix of steps the company must now take amount to a sad impasse for José María Álvarez-Pallete, who took over as chief executive in April. Just four years have passed since the company suspended its dividend for the first time in its history, during the height of the European debt crisis.

It looks once again like the company has been caught amid bigger historical shifts. All Pallete can do is show that he's determined to do everything he can to solve Telefonica's debt problems once and for all.

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

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net