MADRID Fresh from snapping up German mobile operator E-Plus, Spain's Telefonica (TEF.MC) will deliver a sharp reminder of challenges closer to home when it publishes first-half results on Thursday.
Just 48 hours after reaching a deal to buy E-Plus, the German arm of KPN (KPN.AS), for 8.1 billion euros ($10.7 billion), the group is expected to post a 9 percent drop in revenues and a 6.4 percent fall in net profit.
The numbers will reflect the size of the challenges facing Europe's biggest telecoms operator by revenue. Top of the list: hitting its debt cutting target to protect investment grade ratings; resuming dividend payments in November as planned; and weathering the storm in recession-hit Spain and the larger market of Brazil.
To achieve this, analysts say, Telefonica will have to stick closely to its divestment plans and review assets across all regions, execute the KPN deal efficiently and pray for Spain's sovereign debt woes to remain in check.
Given the pressure it faces in Spain, the increasing maturity of its Latin American business and the need for steady investment, the emphasis on debt reduction needs to continue, said Morningstar analyst Michael Hodel in a note to clients released on Wednesday.
Telefonica is one of the most indebted European telecom operators, with net leverage at about 2.6 times earnings before interest, taxes, depreciation and amortization at end-March.
It has already reduced its debt load to about 51.8 billion euros from 58 billion euros one year ago and analysts expect the group to announce a fall below 50 billion euros at the end of the second quarter. It said on Tuesday it was sticking to its objective of cutting debt below 47 billion euros by year-end.
The deal will increase net debt by between 0.8 billion and 1.6 billion euros but it will have no impact on the 2013 objective as the operation will not be completed until mid-2014.
Credit ratings agencies Fitch and Standard and Poor's affirmed their ratings for Telefonica on Tuesday.
WHAT'S NEXT ?
The firm holds several big investments - including a 10.5 percent stake in Telecom Italia (TLIT.MI) and 5 percent of China Unicom (0762.HK) that help mitigate the debt factor and could be sold.
While the Telecom Italia investment is rapidly depreciating, it enables Telefonica to get a grip on one of its competitors in Brazil, Tim Participacoes (TIMP3.SA), which is a unit of the Italian company.
Movements on that front could, however, come as soon as September when the likely dissolution of holding company Telco, which controls 22.4 percent of Telecom Italia, could leave Telefonica as the biggest shareholder in the Italian firm.
It would then have more say in Tim Participacoes. But Italian media speculated on Wednesday the shakeup could lead to a sale of Tim to America Movil's (AMXL.MX) Carlos Slim, who owns a 30 percent stake in KPN and is Telefonica's main opponent in Brazil.
Like the rest of the Latin American region, which makes Telefonica vulnerable to unfavorable exchange rates, the Brazilian market is proving particularly challenging.
Telefonica Brasil (VIVT4.SA) posted a 16 percent fall in second-quarter net income on Wednesday, while earnings before interest, taxes, depreciation and amortization fell 17 percent from a year ago.
Back in Europe, the short-term outlook is tough. First of all, Telefonica will have to repair its all-important Spanish business, which lost over 3 million mobile customers last year. It is trying to win back business by bundling Internet, television, mobile and fixed line services.
In Britain, where it got rid of its broadband business, it struggles with falling revenues and negative cashflow, although the country offers a relatively benign trading environment amid the euro zone debt crisis.
Telefonica could put its Czech business on the market, although a source with knowledge of the matter said it was in no rush. Czech Telefonica is not performing as well as in the past, with revenues down 6.2 percent year-on-year and operating cash flow also down 16.3 percent. But it is still faring better than the rest of Telefonica's subsidiaries in Europe.
In Germany, while the vast majority of analysts are positive on the E-Plus deal, a few say it may just increase pressure on Telefonica.
"On our calculations the terms of the deal only start to create value for Telefonica shareholders if the market is prepared to value the 'newco' at a sector average multiple and if Telefonica is able to extract and retain over 45 percent of targeted synergies," said Paul Marsch, analyst at Berenberg.
Others, however, suggest that the Spanish group is one of the best placed in the continent to benefit from the consolidation process its German bet may soon trigger.
(Additional reporting by Clare Kane and Robert Hetz in Madrid, Jan Lopatka in Prague and Danilo Masoni in Milan; Editing by Mark Trevelyan)