Bloomberg News

Telefonica ‘Magic Touch’ Lost in Decade’s First Dividend Cut

December 20, 2011

(Updates with analyst quotes starting in fifth paragraph.)

Dec. 15 (Bloomberg) -- Telefonica SA’s first dividend cut in a decade highlighted the extent to which Europe’s sovereign debt crisis has hit Spain’s largest telecommunications company and may signal further disappointment for investors.

Spain’s former telephone monopoly reduced its 2012 dividend forecast yesterday by 14 percent, abandoning a policy set up two years ago, citing “significantly” changed market conditions. The Madrid-based company may next give up its profit forecasts as a slide in sales in Spain continues and growth in Latin America slows, analysts say.

As rising unemployment and a weakening economy in Spain spur customers to cancel phone subscriptions or switch to cheaper offers, Telefonica missed earnings estimates in eight of the past nine quarters and is struggling to reduce its own debt. With net borrowings at more than 55 billion euros ($71 billion), the operator is still “highly leveraged,” said Giovanni Montalti, an analyst at Credit Agricole Cheuvreux.

The dividend cut “is a step in the right direction, but it won’t be enough,” said London-based Montalti, who advises investors sell Telefonica shares. “The next thing we may hear from the company is a profit warning next year because the earnings guidance is too high.”

Further Cuts?

Telefonica may lower its forecasts when it announces earnings Feb. 24, and a further dividend reduction may follow late, Saeed Baradar, a telecommunications sales specialist at Societe Generale in London, wrote in a note.

The shares fell as much as 1.9 percent and traded 1.3 percent lower as of 10:38 a.m. in Madrid, the worst performer in Spain’s benchmark IBEX 35 Index. The stock is down 23 percent this year.

Telefonica has forecast annual revenue growth of 1 percent to 4 percent through 2013. Next year, sales may increase 0.6 percent, accelerating to 1.6 percent in 2013, according to analyst estimates compiled by Bloomberg.

The operator is sticking to its 2011 financial targets, Finance Chief Angel Vila said yesterday. The dividend decision, taken unanimously by the company’s board, “wasn’t driven by liquidity problems,” Vila said on a conference call.

The average dividend yield of European telecommunications companies is 7.8 percent, according to data compiled by Bloomberg. Telefonica’s yield of 12.1 percent is the third- highest after Cable & Wireless Communications Plc and Portugal Telecom SGPS.

Portugal Telecom, Belgacom

Portugal Telecom, France Telecom SA and Belgacom SA are most likely to take note of Telefonica’s cut because of their “uncomfortably high” payout ratios, said James Britton, an analyst at Nomura Holdings Inc.

Standard & Poor’s cut Telefonica’s debt rating in August by one level to BBB+, the third-lowest investment grade, citing lower expectations for cash flow and debt reduction and calling the company’s dividend policy “aggressive.”

The 2012 dividend will amount to 1.50 euros a share, including 1.30 euros in cash and the rest via buybacks. That compared with a previous forecast for at least 1.75 euros. Telefonica still plans a 2011 dividend of 1.60 euros. In the late 1990s, Telefonica replaced its dividend with bonus shares to conserve cash for its expansion in Latin America and a payout was suspended briefly in 2001, Bloomberg data showed.

Job Cuts

“This turnaround in shareholder remuneration policy shows how Telefonica is losing its magic touch of dividends,” said Francisco Salvador, a strategist at FGA/MG Valores in Madrid. “Investors also value the company’s growth outlook in different markets and its different profile compared to other European peers.”

Chief Executive Officer Cesar Alierta is increasingly relying on economic growth in Latin America, which accounted for 47 percent of Telefonica’s third-quarter revenue. He is also slashing the Spanish workforce, has halted major mergers and acquisitions and this year folded the shrinking Spanish unit into a European division.

The company’s broadband market share dropped below 50 percent in October for the first time since the phone market opened to competition in 1996, Spain’s CMT regulator said today in a monthly report.

‘Myopic Focus’

The dividend cut “suggests that management is now looking at a longer time horizon versus what looked like an increasingly myopic focus,” said Robin Bienenstock, a London-based analyst at Sanford C Bernstein. “For the last two years there has been an increasing whiff of ‘eat, drink and be merry, for tomorrow we die’ to Telefonica’s dividend promise.”

Spanish Prime Minister-elect Mariano Rajoy has pledged “important decisions” when his Cabinet meets for the first time on Dec. 23 as the economy will need structural changes as well as austerity moves to exit a three-year slump.

Rajoy is seeking to prevent Spain from following Greece, Ireland and Portugal in seeking a bailout amid surging borrowing costs and an economy poised for contraction with unemployment at 23 percent, the highest rate in the European Union.

“Markets haven’t clearly recognized our shareholders’ remuneration efforts and we realized we need more flexibility,” Vila said yesterday.

The dividend cut doesn’t affect Telefonica’s intention to sell some assets, Vila said. Telefonica shelved an initial public offering for its call-center unit Atento in June because of insufficient investor demand.

“Cutting the dividend is an action that’s in their control whereas asset disposals is not,” said Guy Peddy, an analyst at Macquarie Securities in London. “It was inevitable that at some stage they would have to cut it. It’s the timing that is a surprise rather than the event itself.”

--With assistance from Jonathan Browning in London and Todd White in Madrid. Editors: Kenneth Wong, Simon Thiel

To contact the reporter on this story: Manuel Baigorri in Madrid at mbaigorri@bloomberg.net;

To contact the editor responsible for this story: Kenneth Wong at kwong11@bloomberg.net


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