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Telefonica Continues Divestments

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In a bid to lower the debt level, Spanish telecom giant Telefonica S. A. (TEF - Free Report) has planned to divest its call center business, Atento, to privately-held Bain Capital for €1 billion ($1.3 billion). The deal value includes a deferred payment of €110 million ($142.7 million) plus a vendor financing of €110 million.

The deal, awaiting regulatory approvals, is expected to complete by the end of this year. Telefonica will remain Atento’s service provider for nine years.

The divestiture is a part of the company’s efforts to increase its financial flexibility. As of June 2012, Telefonica had a high debt level of €58.31 billion, above €56.3 billion at the end of 2011 and €55.6 billion at the end of 2010. In addition, the company was compelled to plan such a move as it needed to retain its investment-grade credit rating from Moody’s, after the recent downgrade by Standard and Poor’s.

Additionally, Telefonica is struggling hard and underperforming in its home market as the lingering Euro-zone debt crisis is intensifying the headwinds. The company is exposed to increased churn rates (customer switch) and lower Spanish revenue due to the ongoing reduction in MTRs, which is the fee that operators charge each other to connect calls.

Further, 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) added to its concerns.

Apart from divesting its call center business, Telefonica is taking various efforts to reduce its debt. Earlier this month, the company had announced plans to sell its stake in its German unit, O2 Germany, through IPO. Additionally, the company is looking to sell some assets in Latin America through public offerings. Latin American operations include the two largest markets - Mexico and Brazil, which are healthy contributors to the company’s revenue and earnings.

Moreover, Telefonica is restructuring its Colombian business. The company sold 13.23% stake in Hispasat in March and 4.56% of its stake in China Unicom for €1.13 billion ($1.4 billion) in July.

We believe this asset-light model would strengthen the company’s balance sheet by trimming its debt. These would lead to a €1.5 billion debt reduction this year, which will be 2.35 times of OIBDA compared with 2.63 times at the end of 2011. Such actions will also help in winning back investor confidence and would uplift shareholder returns in the future.

We currently have our long-term Underperform recommendation on Telefonica. For the short term (1–3 months), the stock retains a Zacks #5 (Strong Sell).

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