Latin America Keeps Telefonica Afloat

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MADRID – Telefonica may be forced to realize that its Latin American arm can loosen the noose around its neck.

The world’s sixth largest telecommunications company by market capitalization, the leading integrated operator in Europe, and the telecommunications company of reference in the Spanish and Portuguese-speaking market, Telefonica is experiencing up close the economic free fall in Spain– its country of origin and main market.

That infallible barometer of market moods, the country’s stock exchange, has fallen out of love with the “telco” that’s directed by Cesar Alierta. In the first five months of this year, Telefonica’s shares plummeted by 31.8 percent, from 13.66 euros each to 9.3 euros.  Intense market turmoil is not even a new development for the company. Telefonica shares fell by 21 percent in 2011. Is the market punishing the company’s management? Alierta and his team can rest easy on this point.

Market analysts concur that the downturn is a result of widespread declines in European markets on the back of the sovereign debt crisis, along with uncertainty over the financial stability of peripheral countries. But Spain’s bleak national outlook also is adding to the drama.  Unemployment –now standing at about 25 percent– and Spaniards’ current fear of losing their jobs, along with a loss of purchasing power, are forcing customers to cut back on expenses, including telephone calls. Today, Spaniards use cellular phones only when absolutely necessary.

To make matters worse, Telefonica’s Movistar cellular telephone subsidiary has been losing customers to virtual low-cost operators. The same is true for Vodafone and Orange, two other big players in the Spanish market.

Telefonica isn’t accustomed to a shrinking user base; the company had doubled its customer base from 2005. And the reversal has not passed unnoticed by Standard & Poor’s. On May 24, the American credit rating agency reduced the rating on Telefonica’s credit notes to BBB from BBB+.

But as the European and Spanish divisions of Telefonica suffer through a dismal economic climate, its business in Latin America has proved a locomotive powerful enough to pull the rest of the train. The numbers speak for themselves: Telefonica Latinoamerica now drives the group’s growth, accounting for 48.5 percent of its consolidated revenues of 15.511 billion euros (US$19.618 billion) in the first quarter of this year, even as the group’s net profit fell by 53.9 percent to 748 million euros (US$946 million). Another comparison, no less telling: Telefonica Latinoamerica increased year-over-year revenue growth by 8.3 percent at a time when revenues were falling by 6.6 percent in the company’s European operations, according to this year’s first quarter results.

The Latin American engine, with first quarter revenue of 7.519 billion euros (US$9.510 billion), posted a 7.8 percent increase in billing compared with the fourth quarter of 2011, showing clearly that it’s far from losing steam.

“With the data from the first quarter of 2012, Latin American is consolidating its role as the engine of growth for Grupo Telefonica,” said a highly-placed company source who requested anonymity. The source told Latin Trade that for the first time, Telefonica Latinoamerica represents more than 50 percent of the group’s consolidated OIBDA (operating income before depreciation and amortization).

“Telefonica Latinoamerica’s customers add up to more than 206 million subscribers, 66 percent of the group’s total subscriber base, and what’s more, the company is leading in growth in the mobile market, and in the adoption of broadband services in Latin America. Our unique portfolio in Latin America is definitely a differentiating factor and a strong platform for future growth,” the source said.

Such a performance cannot be explained by the region’s “economic spring” alone. Money invested by Telefonica in the Latin American market has played a fundamental role. Accumulated investments since it entered the region total more than 110 billion euros (US$139.130 billion), split between acquisitions and infrastructure development, according to the company’s headquarters in Madrid.  A closer look at investment policy reveals the central role Telefonica has assigned to Latin America: In 2011, a horrible year for its Spanish business, Telefonica invested 5.3 billion euros (US$6.703 billion) in the region, “including the acquisition of spectrum in Brazil, Costa Rica and Colombia,” said the source.

Brazil, the Crown Jewel
In Madrid there is no doubt: “Brazil is the main market for Telefonica in Latin America.”

There’s plenty of evidence to sustain this view: “That country generates half of the company’s revenues in Latin America and 23 percent of the group’s consolidated revenues,” the source said. In fact, he added, “In terms of revenues, its weight is almost the same as Spain’s in the group’s results, and it will soon become the company’s most important revenue source.” The source also said Brazil accounts for almost 30 percent of Grupo Telefonica’s customers. This translates into more than 90 million subscribers and makes the South American giant Grupo Telefonica’s biggest market in terms of the number of users.

Since 1998, when Telefonica started operations in Brazil, the company has invested 57.4 billion reales (US$27.9  billion) there. “This  figure will grow to a cumulative 82 billion reales (US$39.8 billion) by 2014, if we include the forecast made public last year when Telefonica announced the group’s investment plan for Brazil, which assumes a total of 24.3      million reales (US$11.8 billion) between 2011 and 2014,” the source said.

Asked how the company had become so successful in Brazil, he added: “Telefonica Brasil maintains its leadership in the Brazilian market thanks to the strength of its distinctive assets, the benefits derived from being an integrated operator, and its leadership in the highest value segments.”

Then the  source underscored the decision to commercialize all Telefonica Brasil products and services beginning April 15 under the umbrella of the Vivo brand, “which strengthens the company’s position in the country with an integrated offer of services.”

At the same time, Telefonica is leading a market transformation in Brazil by expanding 3G coverage to encourage customers to use mobile Internet, with a selective deployment of fiber optics that enable it to offer the highest speeds on fixed broadband.

How is all this reflected on the balance sheet? In the first quarter of this year, the net gain was 3.2 million subscriptions, contributing to an increase of 83 percent year-over-year, thanks to a level of new clients that stands at 8.8 million– a figure that represents year-on-year growth of 31 percent.

Argentina, Trouble Spots
There is also plenty of good news from other Latin American markets where Telefonica operates, although there are a few trouble spots, especially in Argentina.

Telefonica’s Latin American operations and investments could be affected by risks related to economic, political and social conditions. For one, there is the risk of expropriation or the nationalization of assets.  In this area, the example that strikes fear into investors’ hearts is that of  YPF, seized by the Argentine government in May from the Spanish Repsol.

There are also concerns over Telefonica’s open television channel, Telefe, which may not meet the requirements outlined in the Law of Audiovisual Media. The law caps foreign capital at 30 percent for such entities, and doesn’t allow a public service company to hold a controlling interest in a media company.

Nor was the fine that the Argentine government levied on its subsidiary Movistar for an April 2 service blackout welcomed. The sanction consisted of two parts: a flat fine of 6.75 million pesos (US$1.5 million at the official exchange rate) plus a compensation for clients equivalent to 10 pesos (US$2.21) per line. That added up to a record sum, the maximum allowed under law, according to Argentine analyst Enrique Carrier.  Besides, there were differing viewpoints on the causes of the incident.  “Upon reflecting on this difference relating to possible causes of the incident, at first glance it would seem the government’s decision was made hastily,” he said.

In Mexico, meanwhile, year-over-year mobile subscriptions declined by four percent, as the company introduced more restrictive criteria for both high and low-end service options. The Telefonica source explained that the new criteria resulted from the company’s strategy of securing a solid high value customer base, with the aim “to improve their experience with us.”

Betting on Intelligent Mobiles
Telefonica also leads Latin America in the revolution of the mobile telephone data transmission business. The company source ties the explosion of this market to several factors, including the massive influx of intelligent devices, especially smartphones, “in an area that is enthusiastic for technology.”

During his participation in a round table at the World Mobile Congress, Telefonica Latinoamerica President Santiago Fernandez Valbuena highlighted the importance of being able to offer intelligent mobile telephones for less than $100 in markets like Latin America.

Market forecasts indicate that over the next five years, emerging countries will overtake developed ones in the proliferation of smartphones, and that IP traffic will multiply by a factor of seven in Latin America.

For Valbuena, Latin America offers huge commercial advantages compared to Europe, where the market is already reaching saturation.

Analysts say Telefonica still has many challenges before it, especially in the digital arena. With the acquisition of Tuenti, the popular Spanish social network for adolescents, Telefonica is putting itself at the forefront of a business that will depend on the same young demographic to lead the way in expanding mobile Internet services.

“We see a future in which the users will be permanently connected. Soon we will have all the details,” Telefonica told Latin Trade.

We’ll be waiting and watching.