Telefonica Sells Telecom Italia Bonds as Telco Pact Unwinds

Telefonica SA sold 103 million euros ($140 million) of bonds that can be exchanged for Telecom Italia SpA shares the same week an investor agreement at Italy’s largest phone company began to unravel.

Telefonica disposed of the securities for 139.6 million euros, or a 36 percent gain since acquiring them seven months ago, according to Miguel Angel Garzon, a spokesman for the Madrid-based carrier. The bonds, which can be converted into Telecom Italia shares in 2016, are part of a 1.3 billion-euro sale last year to restore the carrier’s finances under Chief Executive Officer Marco Patuano.

Parting with the securities highlights a dilemma for Telefonica after three financial partners started to pull out of the group that owns 22.4 percent of Telecom Italia. Telefonica, the leading investor in Telco SpA, likely wouldn’t be able to increase its stake in Telecom Italia without drawing opposition from regulators in Brazil, where the two carriers compete. Exiting Telecom Italia would be admitting a strategic alliance struck seven years ago didn’t work.

“Telefonica’s move could be considered a first signal that they may sell Telecom Italia’s stake and eventually exit from the Italian business,” said Angelo Drusiani, who helps manage about 3 billion euros of securities at Banca Albertini Syz & C. in Milan. Another possible reason is that Telefonica may be concerned about a possible decline in the securities’ prices as bond yields increase in the coming months, he said.

Asset Sales

“The sale was purely a financial decision,” Telefonica’s Garzon said by phone.

The disposal was completed on June 16 with the help of JPMorgan Chase & Co., according to a person familiar with the matter, asking not to be named as the transaction isn’t public.

A spokesman for Milan-based Telecom Italia declined to comment on the sale, as did a JPMorgan representative in London.

Patuano, who took over from Franco Bernabe as CEO in October, has sold assets including a stake in Telecom Argentina SA as he seeks to revive Telecom Italia’s sales.

In Brazil, Telecom Italia and Telefonica remain locked in disagreement over the future of the Italian carrier’s local unit Tim Brasil. While Patuano is in favor of keeping Tim and expanding it through an eventual merger with Vivendi SA’s GVT unit, Telefonica and Oi SA -- the country’s No. 4 wireless carrier -- are exploring a plan to break up Tim as early as this year, people familiar with the matter said last month.

Junk Rating

Telecom Italia, privatized by the government in 1997, had its debt cut to junk by Standard & Poor’s and Moody’s Investors Service last year and needs funds for investments to reverse falling sales. Its net debt amounted to about $37 billion at the end of March.

Telecom Italia’s five-year credit-default swap contracts rose as much as 4.2 percent to 162 basis points today, signaling a deterioration in perceptions of creditworthiness.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a contract protecting 10 million euros of debt for five years is equivalent to 1,000 euros a year.

Telecom Italia shares slipped 2.5 percent to 92.8 euro cents at 4:16 p.m. in Milan. Telefonica dropped 0.3 percent to

12.77 euros on the Madrid exchange.

Pay-TV Buyout

In Spain, Telefonica is seeking to expand its pay-TV offerings by taking full control of Distribuidora de Television Digital SA, or DTS. This month, it agreed to buy its partner Promotora de Informaciones SA, also known as Prisa, out of the venture for 750 million euros.

Mediaset Espana Comunicacion SA, another DTS shareholder, has failed to reach an agreement to sell its 22 percent stake to Telefonica for as much as 355 million euros, a person familiar with the matter said today. The Italian company has two weeks to continue negotiations with Telefonica.

Mediaset has an option to make its own offer for the DTS stake held by Prisa. In a statement today, Telefonica said the deadline for exercising that option has been extended to July 4.

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