Spain: Back Home, Telefonica Is Still A Titan

Burned in Brazil, the phone giant is grabbing share in Spain

For Telefonica Chairman Juan Villalonga, the timing could hardly have been worse. In late July, Villalonga led Spain's former phone monopoly into Brazil and blew away other bidders with a $7 billion cash offer for controlling stakes in the jewels of Brazil's national phone system, including Sao Paulo's network. Although critics charged that he had paid too much for them, Villalonga stuck by his strategy. "There is only one global operator in the telecommunications market in Latin America, which is Telefonica, and the rest are far behind," he announced.

Villalonga's message sank in--perhaps too well. When Russian fever spread to Latin America, investors treated Telefonica just like a local company and dumped its stock. In August alone, the company lost nearly one-quarter of its market capitalization, or $10 billion. Telefonica took the thumping even though it has only a $5.5 billion stake in the Brazilian partnerships. The Brazilian companies shed about $2 billion in value during the same period. Keeping in step with Brazil's gyrations through early September, Telefonica's stock danced a wobbly samba before rocketing up when the Brazilian market recovered.

"INCREDIBLY AGGRESSIVE." But investors may be drawing too straight a line between Brazil's economy and the Spanish phone company. Even with its Brazilian investments, the $15.7 billion Telefonica counts on Latin America for only 15% of earnings. And even without economic problems, Brazil wouldn't contribute any payback until Telefonica and its partners string up millions of new wires and build hundreds of cellular base stations--probably early next century. Meanwhile, hot growth in Spain, fueled by a booming cellular business, should boost earnings by 20% this year, to $1.6 billion. "The market has punished [the company] for Brazil," says mutual-fund manager Ramon Olleros at Madrid's A.B. Asesores, an investor in Telefonica. "But here in Spain, we're not feeling at all unsettled."

Nor should they. Back home, the giant is still throwing its weight around. When competition in the fixed-line market opened up earlier this year, Telefonica defended its 96% market share by advertising special bargain rates that had not yet been approved. At the same time, Telefonica won rate hikes in its local monopoly to compensate for competition in long distance. Meanwhile, the titan slugged it out in the cellular business with newcomer Airtel by slashing rates and creating special cell-phone deals for customers with fixed lines. The result: Telefonica nudged up cellular market share a full percentage point, to 66%, while quadrupling profits. "They're incredibly aggressive," says an executive at one competitor.

Now, Villalonga is focusing on phones in Latin America. Telefonica has already built up operations in Argentina, Chile, and Peru, which together provide earnings topping $230 million a year. The challenge is to turn the same trick with Brazil, building up the customer base quickly through a 10-year, $11 billion investment campaign. Over the next three years, according to Villalonga, the Telefonica-led companies should double the number of phone lines in their areas. Sao Paulo alone, with 11 million lines, should double Telefonica's operations in South America.

ROLLING IN CASH. What if Brazil suffers a deep recession? Chief Financial Officer Fernando Abril says he expects "a slight drop" in earnings there, but not enough to sway Telefonica from projected earnings growth. In fact, while financial turbulence rocks the earnings of banks and manufacturers, utilities are finding themselves in a better position. Telephone usage never drops too much, and even in a financial crisis, many of Brazil's 5 million potential customers waiting for lines will find the money to buy one. What's more, Telefonica's new companies there, all pieces of former phone monopoly Telebras, have $1 billion in cash. "We'll be able to make our investments without having to finance them locally, where interest rates may be 40%," says Abril.

The question remains, of course, whether Villalonga did spend too lavishly for his Brazilian treasures. His critics have charged the same thing about other Telefonica acquisitions--only to be proven wrong. But by the time the verdict on Brazil makes its way to Telefonica's bottom line, Villalonga is likely to be off spending billions elsewhere.

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