Telefonica Buoyed by Europe, LATAM - Analyst Blog

Spanish telecom giant Telefonica (TEF) reported first quarter 2010 results with a net income increasing 2% year over year to €1.66 billion (US$2.3 billion), supported by higher sales as a result of healthy contributions from Latin America and the UK which offset weaknesses in the carrier’s domestic operation.

Consolidated revenues grew 1.7% year over year to €13.93 billion (US$22.1 billion). Latin America contributed 40% of the group’s revenues followed by Spain at 33% and Europe at 25%.

Result by Segments

Telefonica Espana

The operator’s Spanish revenues declined 5.7% year over year to €4.6 billion (US$6.4 billion), impacted by a reduction in mobile termination rates (inter-operator fees) and a soft economy. Wireline business revenues dipped 7.7% year over year to €2.8 billion (US$3.9 billion) due to lower access and voice service revenues. Revenues from wireless operation fell 3.6% to €2.1 billion (US$2.9 billion) on account of lower service revenues.

Telefonica Europe

Revenues from Europe climbed 7.4% year over year to €3.5 billion (US$4.8 billion), driven by higher revenues from Telefonica’s British unit O2 UK, the highest contributor to the carrier’s European sales. Revenues from O2 UK rose 4.6% to €1.6 billion (US$2.2 billion) as expanded smartphone adoption and associated data services boosted subscriber accretion. Revenues from Germany soared 21.2% while in the Czech Republic they declined 3.1%.

O2 UK has struggled with underperformance in the past quarters as the entity is operating in an increasingly competitive environment. Competition has intensified in the British mobile market following the merger of the respective UK operations of Deutsche Telekom (DT) and France Telecom (FTE).

The integrated company has dethroned O2 UK as the largest wireless carrier in the UK. Moreover, O2 UK has lost marketing exclusivity on Apple’s (AAPL) iPhone with Vodafone (VOD) and France Telecom’s Orange UK selling the iconic device in the UK. However, the healthy operating results indicate that O2 UK has weathered the loss of its iPhone exclusivity.

Telefonica Latin America

Latin America remains the principal growth engine for Telefonica, posting healthy results in the quarter. Revenue from this region grew 4.2% year over year to €5.6 billion (US$7.8 billion), boosted by solid subscriber accretion. Revenue in Brazil (the largest market) surged 21.4% year over year to €2.3 billion (US$3.2 billion), favored by the rapid economic recovery in the country.

Vivo (Brazilian wireless operation), a 50-50 joint venture between Telefonica and Portugal Telecom (PT), gained 2.2 million customers in the quarter, bringing its total subscriber base to 53.9 million (up 18% year-over-year). Net additions represent a more than threefold annualized growth.

Vivo maintained its leadership in terms of share of net additions and exited the quarter with a 30.1% market share. Telefonica’s Brazilian wireline subsidiary, Telesp posted revenue growth across broadband and Pay TV businesses, offset by lower sales from its legacy voice telephony operation.

While Telefonica continues to lead the Brazilian wireless market, the carrier is faced with an increasingly competitive market. France-based media company Vivendi SA, which has acquired a controlling stake in the Brazilian telecom operator GVT Holding, represents an emerging threat. Moreover, the carrier’s biggest rival in Latin America, America Movil (AMX) is integrating its Brazilian wireless and wireline assets.

To counter intense competition, Telefonica is currently exploring acquisitions. As part of this strategy, the carrier recently offered €5.7 billion (US$7.3 billion) to acquire Portugal Telecom’s stake in Vivo. However, the Portuguese carrier spurned the offer stating that strong results from Vivo are helping it to offset the weakness in its home markets.

Subscriber Statistics

At the end of the quarter, total customer access points reached approximately 273 million, up 4.6% year over year. Churn improved year over year to 2.2%. Broadband and Pay TV businesses remain on the positive growth tracks which continue to offset decline in the fixed-line voice customer base.

Total retail broadband access grew 25.2% year over year to 16 million, boosted by the rapid adoption of bundled services (dual/triple-play service packages). Total wireless access reached 206.7 million, with roughly 4.4 million net additions, driven by contributions from Brazil, Germany and Mexico. Pay TV access reached 2.6 million, up 11.3% year over year.

With a net addition of just 247,000 customers, Spain exited the quarter with 47 million access lines (down 0.3% year over year). Spanish wireless subscriber base reached 23.7 million (up 0.5%). Europe registered 53.9 million accesses (up 15.5%), with the mobile customer base growing 6.6% to 44.6 million driven by healthy contract customer growth and steady subscriber accretion in the UK (up 4.6%) and Germany (up 9.4%).

Total customer access in Latin America reached 172.3 million (up 8.1%) with roughly 3.7 million net additions (a three-fold year-over-year growth) in the quarter. Wireless subscriber base grew 11% to 138.4 million with a net addition of 3.7 million, boosted by growth at Vivo.

Outlook

Telefonica has reiterated its financial guidance for 2010. The operator continues to expect a basic EPS of €2.10 and dividend per share of €1.40 for the year. Consolidated revenues are projected to grow 1%-4% year over year with annual OIBDA growth forecasted in the range of 1%-3%. Telefonica plans to boost dividend to at least €1.75 a share in 2012.

Capital expenditure for 2010 is projected between €7.45 billion (US$10.4 billion) and €7.65 billion (US$10.7 billion). A major portion of the budgeted capital spending has been directed at expanding its broadband network infrastructure in Brazil.

Telefonica’s dominant position in the Spanish telecom market, attractive growth prospects in Latin America and healthy dividend payouts remain positive factors for investment considerations. However, we remain cautious with regard to the carrier’s declining wireline business, aggressive acquisition strategy and highly leveraged balance sheet.