No quick fixes for Telefonica in Spain

Thu Feb 7, 2013 8:38am EST

* Domestic revenues to fall in 2013, possibly beyond

* Telefonica bets on bundles to stem client losses

* Spain still generates nearly half of group cash flow

* Recession, unemployment to weigh on domestic market

By Clare Kane

MADRID, Feb 7 (Reuters) - Telefonica faces an uphill battle to repair its recession-hit Spanish business, even after introducing discounted all-inclusive packages to stem client losses.

Stopping the rot in its home market, where over two million mobile clients were lost last year and sales dropped 13 percent in the first nine months, is central to attracting investors back to Telefonica shares that fell 25 percent last year.

Despite the former monopoly's decade-long expansion into over a dozen Latin American countries, Madrid-based Telefonica still derives one third of operating income from Spain and according to ratings agency Moody's, half of its cash flow.

Furthermore, a plan being studied by Telefonica to list up to 15 percent of its Latin American business would leave shareholders in the remaining group even more exposed to the Spanish economy, making a successful commercial strategy vital.

Telefonica hopes its new bundles dubbed "Fusion," which include mobile and fixed calling, TV, and Internet will stem the exodus of customers that began when it stopped subsidising mobile phones for new contract customers last spring.

Such quadruple-play bundles are increasingly being used by big telecom firms, especially in France, to lock up their client bases under attack by low-cost challengers.

Analysts say moving existing customers to "Fusion" will drag down margins, while attracting new clients will take time in a depressed economy where unemployment is over 26 percent.

Macquarie investment bank expects Telefonica's sales in Spain to fall 9.6 percent in 2013 and does not expect revenue to stabilise until 2018.

Analysts expect the Spanish economy, in recession since the end of 2011, to contract well into 2013.

"The underlying issue for Telefonica remains the economy and unemployment in Spain," said John Delaney, director of mobile research for Europe at market research firm IDC.

"Fusion is not a solution to that problem for Telefonica but it is a way of mitigating...the loss of customers due to handset subsidies, the need to try to avoid being dragged too far into price slashing and the need to keep customers paying for all four services when times are tough for the economy."

RIVALS RETALIATE

The bundles Telefonica introduced in October have been matched by Orange and prompted Vodafone to offer similar packages without TV. Fixed-broadband specialist Jazztel has ratcheted up competition with a bundled offer with up to 200 euros to cover switching fees.

Telefonica has been losing market share faster than its rivals while virtual mobile operators, Orange and Teliasonera's Yoigo are picking up its defectors. Virtual operators like Jazztel do not have their own mobile networks but rent them from others. Their share of the market rose to 8.8 percent in November from 6.3 percent a year ago while Telefonica's share shrank to 36.6 percent from 40 percent during that time.

Telefonica says it has signed up one million customers to Fusion in under three months but has declined to say whether they were new or existing clients.

Fusion will only increase revenues for Telefonica if it helps the firm acquire new customers. Morgan Stanley predicts average customer savings of 23 percent from migrating clients to Fusion could dent the firm's domestic revenues by four percent.

Telefonica declined to make any comment on Fusion before full-year results on Feb. 28.

"I'm still a bit more cautious on the outlook on the domestic economy. If (Telefonica) can keep that profit line stable they'd be doing well," said Andrea Williams, European Equity fund manager at Royal London Asset Management, who has a small holding in Telefonica.

In France, all-inclusive bundles promoted by Orange, Vivendi's SFR and Bouygues Telecom are a drain on profitability but have helped stop customers leaving for low-cost rivals like Iliad.

Analysts said although Fusion may chip at revenues in the near-term, it is more important for Telefonica to hang on to clients in such a difficult economic environment.

As Telefonica seeks to stabilise Spain, it is also weighing up a listing of its faster growing Latin American assets to raise about six billion euros as part of its drive to cut debts of 56 billion euros ($75.76 billion) as of September 2012.

Raymond James Euro Equities' Stephane Beyazian warned that the move, following a similar listing last year of 20 percent of Telefonica's German business, could put further pressure on Telefonica shares because investors will be able to invest directly in the most attractive parts of the business.

($1 = 0.7392 euros) (Editing by Leila Abboud and Elaine Hardcastle)