Reducing the huge debt pile
Through a number of acquisitions, Telefonica S.A. (ADR) (NYSE:TEF) has built up an unsustainable debt pile that peaked at above $80 billion in 2012. Now, the company is reducing debt by paying off capital with internal funds (it suspended the dividend last year) and through asset sales. As a matter of fact, net debt fell by $2.6 billion over the second quarter to $64 billion, or just below 2.6 times EBITDA. The company aims to keep on reducing debt. According to Telefonica, net debt at the end of the year should be below 2.5 times EBITDA.
Asset sales should keep on helping the company pay-off debt. Last year, Telefonica made some sales such as the aforementioned Atento call-center business. The company also also sold other operations such as 5% of ChinaUnicom, O2 UK broadband, 40% of Telefonica Central America, and 100% of Telefonica S.A. (ADR) (NYSE:TEF) O2 Ireland. I believe other operations might be coming.
The one I have been expecting the most is related to Telefonica S.A. (ADR) (NYSE:TEF)’s investment in Telecom Italia SpA (ADR) (NYSE:TI). The Spanish group needs to take a strategic decision regarding Telecom Italia SpA (ADR) (NYSE:TI): whether to buy out its partners or to sell its 10.4% stake in the company. Since Telefonica is taking debt-off its balance sheet, I do not imagine management thinking of buying out their Telecom Italia SpA (ADR) (NYSE:TI) partners even when many of them are willing to sell.
A combined sale to a third party would be more likely despite Telecom Italia SpA (ADR) (NYSE:TI)’s cheap market valuation (3.3 times EV/EBITDA). If the Spanish company could get 5 times EV/EBITDA, it could bring in more than $1.3 billion to its coffers.
Industry consolidation
Brussels wants to encourage a cross-border consolidation within the industry and Telefonica S.A. (ADR) (NYSE:TEF) is playing its part. Stiff competition and bad economic conditions have been driving up churn and lowering rates to a point that is making companies stop investing as much as needed to keep infrastructure up-to-date. Indeed, very recently, Telefónica, through its German subsidiary, proposed a $10.5 billion deal with the Dutch operator KPN for its German E-Plus unit to create Germany’s largest mobile phone operator.
The combination between Germany’s third and fourth mobile players is creating a company with a market share of 32% and revenue of $10.4 billion. The deal is expected to be closed very soon despite the abstention of KPN’s single biggest shareholder, the Mexican billionaire Carlos Slim, who controls two seats on KPN’s board of directors through America Movil.
Slim’s abstention had everything to do with pricing. He wanted a better deal despite knowing that KPN’s market position in Germany was truly weak given the company’s lack of sufficient 4G spectrum that it needed to compete. Now, KPN will get up to $6.5 billion in cash plus a 17.6% stake in the combination between E-Plus and Telefonica Deutschland.
Fair operational prospects
Thanks to a consolidating industry, European telecom companies should start performing much better in the medium term. Not only Telefonica will benefit from this trend. All other players, such as KPN, should also benefit through selling their weaker businesses (such as Germany, where KPN was not going to achieve its market share targets) to concentrate on their stronger markets (such as the Netherlands in KPN’s case, where the company is a strong player).
All the above being said, market pressures should continue until the end of next year when I expect the mobile phone market to have less players and the European economy to be in better condition. Since Telefonica and KPN should be reaching their debt targets by 2014, I also expect this companies to resume their dividend payments.
Foolish conclusion
After years of under-performance relative to their American peers, it looks like European telecom companies are ready to catch-up. The macroeconomic situation is not helping as much as I would wish, but consolidation will be a powerful force behind the stabilization of mobile and broadband rates in the Euro-zone. Telefonica S.A. (ADR) (NYSE:TEF) should be one of the main beneficiaries of this up-and-coming trend.
The article Expect Better Performance From This Telecom Company originally appeared on Fool.com and is written by Federico Zaldua.
Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Federico is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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