Spain Hurting Telefonica

Spanish telecom giant Telefonica (TEF - Analyst Report) is suffering a continuous decline in its domestic market share due to a sluggish economy. The customers are switching to cheaper offers from smaller rivals, leading to lower revenues and earnings for the company.

Spanish operations were weak again in April following lackluster performances in the first quarter of 2011. In the first quarter, net income was hit by an uninspiring domestic market, both in the wireline and wireless businesses.

It is worth noting that Telefonica leads the Spanish mobile market, which includes both mobile phones and datacards. The company is persistently losing share in the mobile market, with 41.34% in April as compared with 41.46% in February and 41.58% in January.

In April, Telefonica lost out to its rival, Yoigo, a unit of Sweden’s Teliasonera AB, which added 40,080 customers in the month. Telefonica’s mobile subscriber base fell by 41,510 from the last month. In a season of losses, Vodafone Plc (VOD - Analyst Report) shed 131,120 customers and France Telecom SA (FTE - Analyst Report) also lost some customers during the month.

We believe Spain is not working in favor of Telefonica. The lingering economic downturn in that country, much longer than apprehended, is likely to drag the company’s profits and liquidity. In addition, the company’s Spanish revenue continues to be affected by the ongoing reduction in mobile termination rates, which is the fee that operators charge each other to connect calls.

Telefonica expects its operating margin to decline slightly over the three-year period, 2010–2013, from 38% earned in 2010, but to remain above the mid point of the 30–40% range. Further, the company’s highly leveraged balance sheet, increasing competition (especially in Brazil and UK) and regulatory involvement might limit the upside potential of the stock.

However, we believe Telefonica’s strong performance in Latin America, particularly Brazil, increased adoption of mobile broadband and continued investments in the expansion of broadband services (both fixed and wireless) are expected to stem some of the rot in the domestic operations. Telefonica is particularly well positioned in Brazil and Mexico, and is actively gaining market share from its dominant competitor, America Movil (AMX - Analyst Report).

Additionally, the integration of  Vivo Participacoes (VIV - Analyst Report) enables Telefonica to offer full competitive bundled services and strengthens its competitive position relative to its peers.

We recently downgraded our long-term recommendation on Telefonica to Neutral from Outperform owing to the depressed domestic market. For the short term (1–3 months), the stock retains a Sell rating with a Zacks #4 Rank.

Read the full analyst report on TEF

Read the full analyst report on FTE

Read the full analyst report on AMX

Read the full analyst report on VIV

Read the full analyst report on VOD