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On Apr 2, 2014, we issued an updated research report on Telefonica (TEF - Analyst Report). While the company’s bottom line improved year over year, the top line  plunged from the year-ago quarter.

We expect Telefonica to deliver strong revenues and profits from increased commercial activity, faster adoption of smartphones, expansion of mobile broadband services and cost-cutting initiatives. In order to simplify process and consolidate operations, the company closed 6 datacenters, reduced physical servers by 12%, increased the mix of servers and turned down over 1,100 applications in 2013.

For 2014, the company is focusing on increasing network capacity to support data traffic growth and build network differentiation by developing high-speed infrastructure.

Latin America remains one of the best performing regions for Telefonica, especially Brazil. The company continues to lead the Brazilian market by expanding its LTE network and fixed broadband services. In addition, the company is focusing on adding high value customers, thus improving its ARPU prospect.

Telefonica is also increasing its foothold in other regions like Argentina, Peru, Chile, Venezuela and Columbia by prioritizing the adoption of both mobile and fixed broadband services on the back of cheaper devices, tiered pricing and enhanced network capacities. In Mexico, the company's increasing market share gain and improved mobile broadband growth are expected to turn around its business.

However, we believe that Spain is currently not working in favor of Telefonica. Though the Spanish market is recovering gradually, the lingering effects of the Eurozone crisis continue to affect the company’s performance.

Domestic competition remains a major concern too as the unbundled local loop (ULL) regulation is forcing Telefonica to open its network to alternative providers. ULL regulation, coupled with increased exposure to direct access competitors, continue to be the primary reason behind wireline telephony access erosion.

Telefonica also contends with increased competition in Brazil, the largest contributor to its Latin American revenues. In addition, the company is facing strong regulatory impediments to its acquisition of KPN's German E-Plus unit.

The European Union antitrust regulator has objected to the acquisition stating that it would reduce the number of mobile providers in Europe's biggest market from four to three. We find the recurring regulatory issues as detrimental to the company’s future growth plans.  

Telefonica currently has a Zacks Rank #4 (Sell).

Other Stocks

Better-ranked stocks in the telecom sector include SK Telecom Co. Ltd. (SKM - Analyst Report), Shenandoah Telecommunications Co. (SHEN - Snapshot Report) and AT&T, Inc. (T - Analyst Report). While SK Telecom and Shenandoah carry a Zacks Rank #1 (Strong Buy), AT&T holds a Zacks Rank #2 (Buy).

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