Telefonica takes Latin lessons from Santander

Thu Nov 15, 2012 7:04am EST

* Santander ahead in cash-raising strategy

* Both follow same path for slightly different reasons

* Telefonica could list LatAm business in 2013

* Santander to list Argentina after Mexico IPO

* Santander faring better, risks for both

By Clare Kane

MADRID, Nov 15 (Reuters) - Spanish group Telefonica is following in the footsteps of compatriot Banco Santander by looking to squeeze cash out of its Latin American business to help battle a grim recession at home.

Both Spanish corporate giants took advantage of cultural and language links with Latin America by expanding aggressively into the region in the 1990s, years before a real estate crash in Spain triggered the country's worst recession in half a century.

Latin America accounts for more of Telefonica's revenues than Europe, while half of Santander's profit comes from the fast-growing region.

Now both companies are shedding assets outside their core market and trimming balance sheets to show investors they can keep their heads above water if the situation deteriorates in Spain and Madrid has to request international aid.

"They're following similar paths but the starting point is slightly different," said Fiona MacRae, who manages Alliance Trust's European Equity Fund. She holds Santander shares but has not had Telefonica stock for around two years.

"They're reaching their targets ... but you could argue that they're selling part of their future growth."

Santander is ahead with the strategy of asset sales, stock market listings, dividend cuts, a buying freeze and a buy-back of subordinated debt, but Telefonica, with more than 50 billion euros ($64 billion) of debt, is quickly following suit.

Santander is under regulatory pressure to raise core capital because of Spain's banking crisis, while Telefonica must pare debt to avoid losing its prized investment grade rating and the spiralling financing costs that would accompany a downgrade.

Telefonica, which had 56 billion euros of debt at end-Sept., has said it will meet its year-end target leverage ratio of 2.35 times operating income before depreciation and amortisation.

PENALISED BY SPAIN

Both companies are rated two notches above junk by ratings agencies Moody's and Standard and Poor's. If Spain, hovering one notch above, is downgraded, they will fall too.

"Both Telefonica and Santander are being penalised in the markets because of negative perception of Spain's sovereign risk," said Jose Carlos Diez, economist at Intermoney Valores.

Santander's shares have risen 3 percent this year to date, underperforming European peers which were up by 15 percent in the same period, while Telefonica's 26 percent share price fall year-to-date is steeper than the average for European telecommunication companies.

Similarities in strategy are not surprising given close ties between the corporate and banking worlds in Spain. Telefonica chief Cesar Alierta joined the company in 2000, after a career in finance that included a stint on the board of the Madrid stock exchange.

Telefonica has followed the bank's lead on buying back preference shares - something Santander first offered to do in Dec. 2011 - and on dividend payments. While Santander has offered shareholders the option to take dividends paid in shares rather than cash, Telefonica scrapped its payout completely.

Santander sold a stake in its Chile business in Nov. 2011, swiftly followed by a sale of its Colombian unit. Telefonica has sold a number of assets this year, including its call centre business Atento and part of its China Unicom stake.

Telefonica said it could seek a stock market listing for its Latin American businesses in 2013, following a successful flotation of 23 percent stake of its German business in October.

Overseas initial public offerings (IPOs) provide funds for companies to feed into their core businesses and give them alternative locations to raise money on the capital markets.

Santander raised $4 billion in September when it listed its Mexican unit, the biggest ever initial public offering in the country. Santander Mexico's Chief Executive Marcos Martinez said none of the proceeds from the listing would go to Santander Mexico.

The bank, which raised $8 billion from its Brazilian IPO in 2009, also plans to list businesses in Argentina and Britain.

Telefonica Latin America Chief Executive Santiago Fernandez Valbuena, however, ruled out listing individual countries' businesses, as Santander has done.

"The Latin American IPO approach is likely the simplest and quickest thing to do next and will bring in significant proceeds," a banking source told Reuters.

Telefonica's Brazilian business has a higher credit rating than Telefonica S.A. and its share price has increased around 3 percent over the last year.

Growth prospects may be rosier in Latin America than in Spain - the region is expected to register 3.2 percent growth this year, compared to a consensus 1.5 percent contraction in Spain - but it is not immune to global economic jitters.

Brazilian authorities have cut interest rates to record lows, offsetting concerns about a slowdown there, but investors also worry about political instability in countries like Argentina and Venezuela.

RISKS AHEAD

So far, Santander looks to be in a better position. But risks lie ahead for both companies, not least the possibility their core businesses could end up as holding companies for subsidiaries around the world.

"The concerns you hear are that they are potentially selling off the family silver," said Kevin Lilley, Old Mutual European Equity Fund manager, who holds Santander stock but no Telefonica.

The telecoms firm also faces more fundamental business challenges, with big customer losses in Spain and shifting technologies globally. Santander, on the other hand, is attracting more customers in Spain as worried Spaniards put their money with the bigger healthier banks.

"Technology is absolutely fundamental for Telefonica's business, and will require a lot of investment from the company. Banking is still the same, it is just that it has been hit by the collapsed real estate market," said Alberto Zumarraga, managing director at Bilbao-based brokerage Mercagentes.

Alliance Trust's MacRae pointed out that Telefonica looked backed into a corner compared to Santander.

"Santander has had to sell some assets, but at the same time they've always had this strategy of having listed subsidiaries," she said.

"In Telefonica's case, they're shrinking and in Santander's case, they're no longer expanding." ($1 = 0.7867 euro) (Additional reporting by Jesus Aguado in Madrid and Leila Abboud in Paris; Editing by Sonya Dowsett and Jon Hemming)