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Telefonica Lags EPS, Rev Grows

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Spanish telecom giant Telefonica S.A. (TEF - Free Report) reported adjusted earnings of 38 cents per ADS (€0.29 per share) in the first quarter of 2012 that missed the Zacks Consensus Estimate of 43 cents. Earnings per share dropped 25.7% from the year-ago quarter.

Adjusted net income decreased 26.6% year over year to €1.28 billion ($1.68 billion).

Consolidated revenue inched up 0.5% year over year to €15.51 billion ($20.33 billion) in the reported quarter beating the Zacks Consensus Estimate of $20.21 billion. The improved performance was credited to solid growth in Latin America, which partially offset weaker operations in Europe.

Adjusted operating income before depreciation and amortization (OIBDA) slid 7.4% to €5.08 billion ($6.66 billion), resulting in OIBDA margin of 32.8%, down from 35.5% in the year-ago quarter.

Effective this year, Telefonica has restructured its operations into two regions –– Europe and Latin America –– and two global business units –– Telefónica Digital and Telefónica Global Resources. Operations in Spain will be included in Europe.

Segment Results

Telefonica Latin America: Latin Americacontinued to grow at a faster pace and remained one of the best performing regions. Revenues increased 8.3% year over year to €7.52 million ($9.86 million), driven largely by Brazil (accounting for 48% of the revenues in Latin America and representing a growth of 4.2%), followed by Venezuela (23.5%), Argentina (18.6%), Central America (17.1%), Ecuador (16.5%), Columbia (7.0%), Peru (5.8%), Chile (5.7%) and Uruguay (5.3%). However, revenue from the key Mexico market registered a considerable decline of 3.4% due to reduced MTRs.

Revenues in Brazil (the largest market) increased 4.2% year over year to €3.6 billion ($4.7 million) backed by strong mobile business. Telefonica’s Brazilian wireless business revenue increased 10.2% year over year to €2.21 billion ($2.89 billion) while Wireline revenues fell 4.1% year over year to €1.39 billion ($1.83 billion).

Telefonica Europe: Revenues from Europe slid 6.6% year over year to €7.55 billion ($9.9 billion) mainly due to lower MTRs and economic headwinds. The largest decline came from the operator’s Spanish revenues - Espana - that slipped 10.7% year over year to €3.90 billion ($5.11 billion).

In Espana, wireless revenue fell 13.7% to €1.7 billion ($2.23 billion) resulting from a reduction in mobile termination rates (MTRs). This was partially offset by strong mobile data revenues and improved handset sales. Wireline revenues also dropped 6.9% year over year to €2.49 billion ($3.27 billion) due to lower voice and access, and Internet broadband revenues partially offset by higher data and IT revenues.

Revenues from the UK, Ireland, and Czech Republic and Slovakia declined 6%, 17.0% and 3.5% year over year to €1.72 billion ($2.25 billion), €155 million ($203 million) and €496 million ($650 million), respectively in the reported quarter. On the other hand, revenues from Germany showed a 2.5% increase to reach €1.26 billion ($1.65 billion).

Other companies (ATENTO): ATENTO revenue increased 8.3% to €484 million ($634 million) from the year-ago quarter.

Subscriber Statistics

At the end of the first quarter, total customer access reached approximately 309.4 million, up 6.5% year over year, driven by a 10.8% year-over-year growth in Latin America.

On an annualized basis, mobile access rose 8.1% to 241.1 million customers driven by an outstanding 55% increase in mobile broadband access to 41 million. Total Internet and data access grew 2.7% to 19.28 million. Pay TV access reached 3.32 million, up 16% year over year. Fixed telephony access dropped 1.6% to 40.28 million subscribers in the reported quarter.

Liquidity and Capital Expenditure (CapEx)

Telefonica exited the first quarter with net debt of €57.13 billion, up from €56.3 billion at the end of 2011. The leverage ratio (net debt-to-EBITDA) improved to 2.55 times compared with 2.63 times as of December 2011.

CapEx grew 10.3% year over year to €1.71 billion in the reported quarter. Operating cash flow (OIBDA-CapEx) deteriorated to €3.37 billion from €4.02 billion in the year-ago quarter.

Looking Ahead

For 2012, Telefonica expects revenue to grow at least 1% year over year with lower EBITDA margin decline. Additionally, the company expects leverage ratio (net debt-to-EBITDA) to be equivalent to 2.35 times.

Our Take

We are impressed with the company’s efforts to improve efficiency, expand its broadband and data services through Global Resources and capture savings from restructuring plans across various countries. These increased efforts would lead to strong commercial activity, the main goal of the company, and would translate into strong revenue and profitability, thereby increasing shareholder returns.

However, these initiatives will increase commercial expenses, which will weigh on the short-term margins. Further, Telefonicaremains challenged by a weak domestic economy, the slowdown in Brazil, the ongoing reduction in mobile termination rates, a highly leveraged balance sheet and growing competition from France Telecom S.A. , Vodafone Group Plc (VOD - Free Report) , China Mobile Ltd. (CHL - Free Report) and America Movil S.A.B. de C.V. (AMX - Free Report) .

We are maintaining our long-term Neutral recommendation on Telefonica. For the short term (1–3 months), the stock also retains a Zacks # 4 (Sell) Rank.

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