Tech

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

It can't have been easy for Telefonica Chairman Jose Maria Alvarez-Pallete to cut the dividend only seven months into his tenure, and less than two months after assuring investors it was safe. So, credit to him for trying to do the right thing on Thursday.

Unfortunately, the move doesn't go far enough to ensure that Telefonica regains control over its own destiny and avoids a credit-rating downgrade.  

Unfavorable Ratio
Telefonica's net debt to Ebitda has remained stubbornly high despite years-long efforts to cut debt via asset sales. European telecoms tend to have net debt to Ebitda ratios between 2-3 times.
Source: Moody's Investor Service

This year's dividend was trimmed from 0.75 cents in cash to 0.55 cents, with 0.35 cents to be paid in shares. The decision to cut the 2017 dividend to 40 cents per share payable in cash will save Telefonica about 1.8 billion euros ($2 billion), according to Moody's analyst Carlos Winzer.

That's still far short of the over 10 billion euros of cash that Winzer has said Telefonica needs to come up with to preserve its investment-grade credit rating. Keeping hold of that rating is crucial for the company, which held about 50 billion euros of net debt at the end of September, to keep its borrowing costs low and stay in the European Central Bank's bond-buying program. Moody's rates Telefonica at Baa2, two levels above junk, with a negative outlook. It's at the same level at S&P and Fitch, but with stable outlooks.

Out of Line
Telefonica isn't generating enough cash to cover dividends and network investments while paying down debt
Source: Bloomberg

For his part, Pallete emphasized on an investor call that Telefonica's free cash flow was improving, which would help it pay down debt gradually. Free cash flow in the first nine months nearly doubled from the same period a year earlier to 2.32 billion euros.

That is progress, but who knows if the trend will last, especially given that competition in Britain and Germany is likely to intensify as the move toward all-included discounted bundles picks up.

Killing the 2017 dividend outright would have been more prudent. Telefonica took that drastic step in 2012 during the financial crisis in Spain. The move would've been unpopular with investors who choose low-growth European telecoms for their dividends. But it would also have given Pallete a stronger hand to negotiate further asset disposals since it would have boosted cash enough to buy some time and dispel the sense that Telefonica is a forced seller that can be strong-armed into accepting lowball offers.

The perception that Telefonica was a forced seller was a factor in killing its attempt to list its infrastructure unit Telxius in September. Investors demanded a low valuation thinking Telefonica would cave, leading the seller to pull the IPO.

The psychology matters. Next up could be a planned listing of U.K. mobile carrier 02 sometime next year, or selling Telxius to a private equity or strategic buyer. Pallete has missed an opportunity to strengthen his position for these deals.

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