Telefonica Grooms Pallete as CEO After Alierta M&A Spree

Last summer, Cesar Alierta endured the toughest stretch of his 12-year tenure as Chief Executive Officer of Telefonica SA. Pressure from rating companies and investors spurred him to swear off dividends and big-ticket acquisitions. And, at age 67, it was time for Alierta to consider naming a successor.

In September, Alierta, the longest-serving head of a major European telecommunications company, promoted Jose Maria Alvarez-Pallete to chief operating officer at the Spanish former phone monopoly. Since then, Pallete -- who had overseen European operations -- has wielded more decision-making power than his two predecessors, indicating that he’s being groomed as CEO, people familiar with the matter said.

Pallete was a driving force behind strategic moves such as the dividend halt, the sale of a stake in Telefonica’s German unit, and aggressive tariff cuts in Spain to stem customer defections, said the people, asking not to be identified discussing internal deliberations. In the twice-monthly executive meetings he runs, the 49-year-old is winning support from directors, managers and major shareholders, they said.

“He would be a great successor when Alierta decides to step down,” said Nicolas Gouju, who helps manage 80 billion euros ($105 billion), including Telefonica bonds, at Groupama Asset Management SA. “The fact that Alvarez-Pallete is taking more responsibility is very positive for us.”

Brazilian Commute

Madrid-born Pallete studied economics at Complutense University and joined Telefonica in 1999 as finance manager in the international division under Alierta’s predecessor, Juan Villalonga. It took him only seven months to rise to the top of the finance department, and the following year he oversaw the listing of Telefonica’s wireless division. He remained finance chief until he was asked to oversee the company’s extensive Latin American operations in 2002.

Seen as down-to-earth, charming and shrewd, Pallete commuted from Sao Paulo to Madrid almost weekly to see his family during nearly 10 years in Latin America. The occasional marathon runner is a big fan of Twitter, posting several tweets daily, mostly about entrepreneurship and technology.

After Pallete tripled revenue in the region over a decade, Alierta moved him back to run Europe in September 2011. Strategy chief Santiago Fernandez Valbuena, another potential successor to Alierta, took over Latin America.

Southbound Stock

Europe needed fixing. With the debt crisis in Spain deepening and unemployment above 20 percent, customers were leaving for cheaper rivals. Telefonica’s stock, already languishing at a five-year low, headed further south, and in the worst monthly drop since at least 2002, the shares plunged 19 percent in May 2012, according to data compiled by Bloomberg.

That month, Standard & Poor’s cut Telefonica’s bond rating to BBB, two steps above non-investment grade. Moody’s Investors Service made a similar cut a month later as the Spanish company’s net debt topped 58 billion euros.

Following the downgrades, the cost of insuring the company’s bonds using credit-default swaps jumped to an 11-year high in June, data compiled by Bloomberg show. Since then, it’s dropped by about half, below Telecom Italia SpA but still higher than Deutsche Telekom AG, Royal KPN NV, and France Telecom SA.

Last July, Telefonica suspended dividends to save 10 billion euros and slashed compensation for top executives. In the same month, it divested a stake in China Unicom (Hong Kong) Ltd., then in October it sold almost a quarter of Telefonica Deutschland Holding AG in Europe’s biggest initial public offering of 2012. Pallete was among the most fervent supporters of measures to address Telefonica’s debt, according to people familiar with the board.

Private Meeting

In mid-September, against a backdrop of discord among board members over how to reduce debt, Alierta called Pallete to his home and asked him to take over as COO, succeeding Julio Linares, who had been at Telefonica for more than 40 years.

“People like to work for” Pallete, who is more outgoing than his boss, said former Telefonica board member Maximino Carpio. “If I could still vote, he would be my candidate to succeed Alierta, whenever that happens.”

Alierta and Pallete aren’t available to be interviewed for this story, according to a Telefonica spokesman, who declined to comment on any possible succession planning.

Outperforming Peers

Telefonica shares have outperformed those of Europe’s former phone monopolies since Pallete’s promotion. While France Telecom has fallen 30 percent since mid-September through yesterday and KPN was down 57 percent, Telefonica has lost 17 percent. Telefonica, scheduled to report earnings Feb. 28, may say fourth-quarter revenue fell 3 percent to 15.6 billion euros as sales in Spain shrank and growth in Latin America slowed, data compiled by Bloomberg show.

The shares rose 2.5 percent to close at 9.73 euros in Madrid, giving the company a market value of 44.3 billion euros.

In contrast to the tight rein Alierta maintained on Linares and his predecessor, Fernando Abril-Martorell, who now runs Spain’s biggest media company, Promotora de Informaciones SA, the CEO is increasingly handing daily operations to Pallete, people familiar with the matter said. Alierta, though, still signs off on major decisions, they added.

To win back customers lost to cable and smaller fixed-line rivals, Pallete has introduced packages with phone, Internet and TV for as little as 50 euros a month. In Valencia, where customer defections were among the fastest, Telefonica dished out free paella and chocolate.

Picadilly Circus

Pallete already speaks out as Telefonica’s leader. In January, he took a team of executives to London for meetings at the company’s office near Picadilly Circus, where giant balloons with the Brazilian, British and Spanish flags loom over informal gathering spots for engineers. He was flanked by U.K. chief Ronan Dunne, digital business head Matthew Key, and Eva Castillo, a former Goldman Sachs Group Inc. banker who succeeded Pallete at the European unit.

While the CEO hasn’t indicated any immediate plans to step down, Manuel Bermejo, a professor at IE Business School in Madrid, says it may be time for him to consider passing full control to Pallete or another successor -- even if Alierta has been a strong leader for Telefonica.

“The naming of Alvarez-Pallete sends a clear signal to the market,” Bermejo said. “Alierta has enough sense of responsibility to figure out when he needs to step down.”

Before it's here, it's on the Bloomberg Terminal.