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Telefonica (TEF): Long-Term Prospects Bright, Risks Prevail

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On Mar 4, we issued an updated research report on Spanish telecom giant Telefonica S.A. (TEF - Free Report) .

Telefonica reported mixed financial results in the fourth quarter of 2015. Though the company's earnings in the reported quarter bettered expectations of a loss, the top line lagged the Zacks Consensus Estimate.

Meanwhile, the company is poised to benefit from the widespread adoption of broadband and data services, pricing revision, network enhancement and strategic collaborations. Moreover, Telefonica’s continued focus on organic growth and portfolio optimization should serve it well in the long term.

Telefonica had earlier closed the acquisition of Vivendi’s broadband assets – GVT. For Telefonica, synergies from the acquisition appear quite promising. The GVT deal is expected to place Telefonica in a better position within the broadband segment vis-a-vis a stronger rival like America Movil S.A.B. de C.V. (AMX - Free Report) .

Telefonica recently announced its plans to launch video services in seven new Latin American markets in 2016. If things go as planned, it will make Telefonica the largest pay-TV operator in the Spanish and Portuguese TV content space.

Also, Telefonica, which has a strong foothold in Latin America, has announced that its Mexican unit is open to enter into a wireless network sharing agreement with rival operators.  Mexico is the largest economy in the Latin-American region. Also, the wireless penetration rate is relatively low in this country. Telefonica already boasts a strong presence in the Mexican wireless industry commanding nearly 20% market share. Considering such positives, business agreements with formidable rivals like America Movil and AT&T, Inc. (T - Free Report) may bode well for Telefonica before the market reaches saturation.

Meanwhile, Telefonica is successfully capitalizing on the opportunities in the digital world through several growth strategies. Moreover, the company has significantly accelerated the deployment of ultrafast networks which resulted in 31 million premises passed with fiber in 2015 and LTE coverage of 49%. Notably, the company continues to witness increased traction in the smartphone arena and LTE penetration reached 12% at the end of 2015. Thus, continued rollout of fiber and LTE are set to drive considerable growth at the company.

However, the communications regulator in the U.K. -- Ofcom – has recently attempted to lobby the European Union Competition Commission (EC), expressing concerns regarding the proposed merger deal between Telefonica and Hutchison in the country and its possible consequences. Thus, over the short term, we remain on the sidelines considering the apprehensions regarding the Telefonica-Hutchison deal.

Moreover, despite the retrenchment plan, asset sales and debt cuts, Telefonica’s earnings prospects remain gloomy owing to its highly leveraged balance sheet. Intensifying competition has further added to the company’s woes.

Telefonica currently carries a Zacks Rank #3 (Hold). A better-ranked stock in the same sector is Chunghwa Telecom Co., Ltd. with a Zacks Rank #1 (Strong Buy).

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