Fitch Affirms Telefonica's at 'BBB+' Outlook Negative

Mon Apr 8, 2013 10:33am EDT

(The following statement was released by the rating agency) LONDON, April 08 (Fitch) Fitch Ratings has affirmed Telefonica SA's (TEF) Long-term Issuer Default Rating (IDR) at 'BBB+' with Negative Outlook. At the same time, the agency has affirmed the senior unsecured rating of the bonds issued by Telefonica Europe BV, Telefonica Emisiones S.A.U at 'BBB+' and Telefonica Finance USA LLC's preference shares at 'BB+'. The agency has affirmed TEF's Short-term IDR at 'F2'. TEF executed its objective set at the start of 2012 to reduce unadjusted leverage to 2.35x (reported 2.36x). It achieved this primarily through debt reduction (reported net debt down to EUR51.2bn from EUR56.3bn). A target to get net debt down to EUR47bn is evidence of an ongoing commitment to manage the balance sheet and further reduce leverage. Fitch's rating case envisages ongoing top-line pressure and little prospect of margin expansion. The company continues to exhibit the best portfolio diversification among the large European incumbents. With roughly one-third of EBITDA (32% in 2012) generated in one of the most economically challenged domestic markets in Europe, sovereign pressure, in terms of both the economy and funding environment, are key factors driving the Outlook. KEY RATING DRIVERS Sovereign Pressure The Negative Outlook on TEF's rating is mainly driven by sovereign concerns, the prospect of further weakness in the economy, increased austerity and sovereign bond yields, how these factors might affect TEF's domestic business and ability to fund itself. Spain's sovereign rating is currently 'BBB'/Negative. Depending on the factors surrounding any potential sovereign downgrade, Spain could be downgraded to 'BB+' without, in itself, forcing a downgrade of TEF's ratings (a differential of three notches compared with previous guidance of two notches). Notching guidance takes into account the company's strong geographic diversification, funding achievements through 2012 eurozone conditions and actions to improve leverage and liquidity. Potential notching if the sovereign was downgraded to sub-investment grade would incorporate the impact on Spanish corporate funding costs. Deleveraging & Liquidity Despite eurozone conditions, TEF raised a total EUR15bn in debt markets in 2012, as well as achieving cash savings through changes to its distribution policies (the mainstay of which will be seen in 2013) and asset sales. Fitch considers that management reacted well to what looked like being a challenging year in terms of financial markets and the company's ability to deleverage. The 2012 dividend holiday both preserves cash and provided time to achieve disposals on management's own terms. Spanish Pressures Unrelenting While TEF has the best diversification among the western European incumbents, Spain still accounts for close to one-third of EBITDA. The severity of economic conditions remains a concern with the continued rise in unemployment and weak consumer confidence likely to further pressure domestic revenues. The Q412 launch of TEF's quad-play Fusion model has had good initial results in stemming subscriber losses. Fitch will monitor Fusion's medium term effects on customer churn and profitability as a result of this new model launch. Brazilian Paradox Accounting for 22% of 2012 EBITDA and one of the group's key growth drivers, the performance of Brazil in 2012 was mixed. The business is the market number one in a competitive mobile market, consistently generating strong organic growth and good margin expansion. However, its fixed line business is under significant pressure as both the company and wider market lose access lines to mobile substitution. Currency weakness has compounded this effect with 2012 EBITDA falling by 2.7% despite 4.8% organic growth. Further Disposals TEF's 2012 dividend holiday will preserve cash. Fitch estimates cash saving of EUR5.8bn in 2013 relative to a previous DPS commitment of EUR1.3. With a reported net debt target of EUR47bn and in Fitch's view, operating cash flow pressures to persist, this target will be challenging without further assets sales. A potential listing of its Latin American businesses has been ruled out. However, Fitch expects some disposals; whether of whole businesses or minority sell-downs. Although these transactions generate one-time cash inflows, Fitch also monitors the point at which ownership dilution might affect cash circulation, with the potential to deconsolidate these businesses. RATING SENSITIVITIES Positive: Future developments that could lead to positive rating actions include: A stabilisation of the Spanish sovereign is the single most necessary near-term event to prompt a revision of the Outlook to Stable. Outside of sovereign linkage TEF displays strong portfolio diversification, scale and strong underlying cash flow; but its organic growth profile and ability to deleverage has stalled. Fitch would need to believe that weakness across Europe, in particular Spain, will not inhibit further deleveraging and evidence of the company's ability to continue to finance itself despite eurozone pressures, would also be expected, before the Outlook was revised to Stable. Negative: Future developments that could lead to negative rating action include: FFO net leverage of 3.19x in 2012 remains high for the rating but heading in the right direction. Fitch's rating case forecasts a metric trending towards 3.0x by YE13, which is consistent with the current ratings. High single digit pre-dividend free cash flow to sales is also expected at the rating level. Metrics expected to remain consistently outside these levels are likely to lead to a downgrade, with TEF currently having very limited ratings headroom. A downgrade of the Spanish sovereign to below 'BB+' would be likely to result in an immediate downgrade. If the sovereign was downgraded to 'BB+' Fitch would consider the implications for funding costs and market access for Spanish corporates and the company's prevailing liquidity, while recognising TEF's good geographic diversification. Contact: Primary Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Bulent Akgul Director +90 212 284 7883 Committee Chairperson Mike Dunning Managing Director +44 20 3530 1178 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable criteria, 'Corporate Rating Methodology', dated 8 August 2012; 'Rating Telecom Companies', dated 9 August 2012, are available on www.fitchratings.com. Applicable Criteria and Related Research Corporate Rating Methodology here Rating Telecom Companies here 2013 Outlook: European Telecoms and Cable here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. 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