Telefónica Gets the Last Laugh

Controversial acquisitions have helped make the Spanish company Europe's top telco and—with 40% net income growth—its best-performing

by Joan Tarzian

You have to grant César Alierta Izuel a bit of gloating. The low-key chairman and president of Spanish telecommunications giant Telefónica suffered a lot of skepticism last fall when he shelled out an eye-popping $31.4 billion for British wireless company O2—the biggest telecom acquisition in 2005 and one of the top M&A deals of the year. Telefónica (TEF) shares dropped 14% in the days following the bid, to €12.16 ($15.44), and some analysts lowered their ratings on the company.

Fast-forward to July 27, and with O2 in his pocket, Alierta now presides over Europe's best-performing big telco. Thanks to the addition of Britain's No. 2 wireless operator and Prague-based Cesky Telecom, which Telefónica also bought last year, revenues for the first half of 2006 grew 46% from a year earlier, to €25.2 billion ($32 billion) and net income grew 40%, to €2.6 billion.

Even stripping out the contribution from the new properties, Telefónica turned in respectable 7.7% revenue growth vs. the first half of 2005. That compares with 2.6% organic first-half growth reported on July 25 by Telecom Italia (TI) and paltry 1.4% growth at France Telecom (FTE). Alierta didn't speak publicly about the results on July 27, but at the annual shareholders' meeting in May he crowed, "Telefónica is growing and will continue to grow more than other operators."

GROWTH TRAIN.

No question, Telefónica is on fire. With the addition of Cesky and O2, plus continued growth in the Latin American businesses it bought from BellSouth (BLS) in 2004, Telefónica has now become the third-largest telecom operator in the world, by number of clients, after China Mobile and China Telecom. All told, it has nearly 192 million "accesses" around the world—fixed line, broadband, and cellular subscribers.

What matters, of course, is the revenues Telefónica manages to squeeze from those customers, and the numbers are impressive there. It now counts 6.8 million broadband DSL subscribers, up nearly 50% from a year earlier. Revenue growth in its big Latin American operations, which account for 35% of Telefónica's top line, came in at a decent 4.4%, adjusted for a sharp rise in the value of the euro.

Telefónica is even managing to find gold in saturated and competitive European markets. O2's British business surged 15%, compared with flat results for France Telecom's Orange unit and a 1% uptick for Vodafone (VOD). "It's not a flash in the pan," says Peter Erskine, the former chief executive of O2, who now runs the Telefónica O2 Europe unit. "We are very much pulling the lever of growth."

Analysts are impressed. "Telefónica is a better managed operation [than rivals]," says Bosco Ojeda, an analyst with UBS in London. "It has positioned itself in high growth markets, both in terms of geography and products." Ojeda particularly likes that Telefónica is managing to maintain its market share in existing services, while going aggressively after new offerings such as DSL and Internet TV.

STRATEGIC SHIFT.

It wasn't always clear that the Madrid-based company would be such a star. The former state-owned Spanish phone monopoly, it was fully privatized by the then-ruling center-right government of José María Aznar in 1997. Ownership is now widely distributed: The two largest shareholders are Spanish bank BBVA (BBV), with 5.6%, and Spanish savings and loan La Caixa, with 5.4%, and 90% of the shares are in free float.