The Wrong Call on Telefonica?


The links tying Telefonica to Latin America seem to be a little too strong for the market's taste. Fearing that Argentina's mounting economic crisis would rattle Spain's telephone giant, investors have pushed Telefonica (TEF) stock down 14% in six trading sessions. With this descent, Telefonica falls in line with Europe's other battered phone companies, which have seen their stocks fall an average of 60% in the last year.

Telefonica may yet prove to be the exception. The Spanish company has steered clear of the onerous debt now haunting the majority of European telecoms. In a press conference preceding its stockholders meeting on June 13, President and CEO Cesar Alierta crowed: "We have the lowest debt-to-price ratio [of the European telecoms] and are in best position in Latin America."

Portfolio managers like what they see but remain jittery about the Argentina connection. Recently, Argentina Finance Minister Domingo Carvallo partially untied the peso from the dollar, sparking fears of a devaluation and resulting crisis that could spread through other Latin American economies. That would hurt Telefonica, which derives 50% of its revenue from the region.

PERIL AND POTENTIAL. Worse, unsubstantiated rumors swirled on June 18 that Motorola had short-sold its Telefonica options, stirring speculation that the American company would dispose of its 3% stake as soon as possible. Motorola's holding dates to Telefonica's purchase last year of Motorola's Mexican and Latin American operations in an all-stock transaction worth $2.6 billion. Concerns that Motorola was bailing out of Telefonica led to an investor exodus last week.

Telefonica has a strong position in Latin America, a market less stable than Europe's, but with more growth potential. While fixed-line phone service is a flat market in the U.S. and Europe, it's still a frontier in Latin America, where penetration is 13% compared with 61% in Europe. And Telefonica has grown from 35 million clients in 1999 to 40.5 million in the first quarter of 2001.

The Spanish company is also pushing mobile telefony in Latin America. As for the phone business, analysts say it could easily weather a devaluation. "Investors aren't looking at the macroeconomics of the situation," says analyst Alfredo Tennenbaum of ABN Amro. "A devaluation in Argentina wouldn't hurt Telefonica as they provide services, not goods, and a devaluation usually sparks a period of fast growth."

UNDERVALUED? Telefonica boasts other strengths -- $24.2 billion in sales, with profits of $2.1 billion in 2000. By staying out of those high-stakes European auctions for wireless spectrum licenses, Telefonica kept its debt to $25.3 billion dollars -- less than half the levels of Deutsche Telekom and France Telecom. Additionally, Telefonica's Standard & Poor's A+ debt rating is higher than those of other operators.

"Telefonica is not a financially risky company, especially in comparison with its European competitors," says analyst Bosco Ojeda of UBS Warburg. "They're trading at 6 to 7 times their cash flow, while competitors are trading at 8. The stock is undervalued right now."

The bottom line: While investors are generally leery right now about European telecoms, Telefonica's basic business looks solid, despite the current jitters in Latin America. The telecom is assured of revenues from its Latin American subsidiaries, thanks to their leadership positions in most of their markets.

True, the recent drop in Telefonica's stock price is a setback for the company, which is trying to shore up investor faith and distinguish itself from other European telecoms. But if the Latin American crisis passes quickly -- or better yet, fails to materialize -- Telefonica could rebound faster than its fellow Europeans. By Philip Schmidt in Madrid


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