Telefonica Chairman's M&A Ambitions Face Old Debt Challenges
The Spanish phone carrier is looking for diverse ways to simplify its structure by buying out partners in joint ventures and reorganizing certain operations to make itself more flexible for potential deals in the European telecommunications industry. Executive Chairman Marc Murtra, who took over in January, has ordered a strategic review to be unveiled in the second half of the year.
But even after cutting net debt by €23 billion ($26 billion) over nine years, the company is still one of the most leveraged large telecom carriers in Europe and holds the lowest investment-grade credit rating from three major ratings firms — limiting its ability to raise funds. Murtra has said repeatedly that maintaining investment grade is a must.
'The problem is they don't have a lot of flexibility,' said New Street Research analyst James Ratzer. 'The leverage situation is not great.'
Telefonica declined to comment.
A dividend cut could help free up funds, but the company hasn't signaled that's under consideration. Major shareholders, including the Spanish government and CriteriaCaixa SA, are open to considering a capital increase to pay for acquisitions or cut debt, Bloomberg has reported.
Murtra has accelerated long-standing plans to divest most Latin American operations and pledged to focus on Europe and Brazil. He is looking at ways to potentially buy out partners in at least two joint ventures - the VMO2 carrier in the UK and a Brazilian fiber-broadband operator, Bloomberg has reported.
By selling Latin American assets, Telefonica can focus more on core operations, which 'could support higher leverage than the previous configuration of the group,' Chief Financial Officer Laura Abasolo said this month. 'More free cash flow coming from other geographies improves credit quality,' she said.
Murtra says consolidation would help Telefonica and European rivals gain much needed scale in its existing markets — this means doing deals in the UK, Germany and Spain.
Telefonica owns 50% of VMO2 and a hypothetical acquisition of Liberty Global's 50% stake would put its debt ratio at about 4.3 times earnings before interest, taxes, appreciation and depreciation, Ratzer estimates. Since the two partners created VMO2 in 2021, they have struggled to retain market share in both broadband and mobile.
'There's no way the company can live with that type of leverage,' Ratzer said, adding that a rights issue to fund such a deal would be 'very material' at '€18 billion or so' and still wouldn't significantly reshape the UK market. Genuine consolidation would require buying smaller upstart fiber broadband operators.
In Germany, Telefonica could potentially try to buy 1&1 AG, but its main shareholder hasn't shown interest in selling in the past. Local operations have struggled with strong competition, especially over the last few quarters.
In Spain, potential targets could include Digi Communications NV's local unit and Vodafone Espana, owned by British buyout firm Zegona Communications Plc, although Telefonica said May 21 that there were no negotiations for Vodafone. The business has been struggling to grow profit in the country for years and has long been posting sales growth below inflation.
So far, the few signals about Murtra's plans have yet to convince creditors. Several Telefonica bonds led by a 1.715% note due in 2028 traded wider than normal relative to peers in the days after the news of the VMO2 plans. The company's five-year senior credit default swaps widened by the most in more than five years on May 14.
'Many investors seem comfortable with the name, this is also reflected in the solid market capitalization,' said ING's Technology, Media and Telecommunications credit strategist Jan Frederik Slijkerman. 'However, spreads moved strongly wider on the headlines about potential acquisitions. This shows that investors are not really open to the idea of Telefonica taking on more debt.'
More stories like this are available on bloomberg.com
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