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Telefonica, with operations in Venezuela, Argentina, Chile, Peru, Ecuador, Colombia, and Mexico, is on the verge of “junk,” and the ECBholds some of its debt. 

By Nick Corbishley, for WOLF STREET:

Telefonica, the telecommunications and internet giant headquartered in Spain and with operations in numerous countries and burdened by enormous debts, has announced plans to stage a historic retreat from one of its core markets, Latin America, in a bid to generate much-needed funds. Like many of its peers, Europe’s fourth-largest telecoms company is finding it difficult to achieve consistent profit growth while its debt load remains dangerously high. Its shares recently hit their lowest level in more than two decades, and are down by 9% this year and by around two thirds over the last decade.

In a broadly unexpected move on Wednesday evening, Telefonica announced that the company was going to prioritize four key markets — Spain, the United Kingdom, Brazil and Germany — while spinning off its operations in eight Latin American countries: Argentina, Chile, Uruguay, Peru, Ecuador, Colombia, Venezuela and Mexico, where it faces stiff opposition from Carlos Slim’s America Movil and AT&T.

“The geopolitical, macroeconomic and regulatory uncertainties, and high competition in the sector require an increasingly demanding allocation of capital,” said Telefónica CEO, José María Álvarez-Pallete, in a press conference. “If in the past the low penetration of voice and data services assured future growth, the current maturity of the markets and the appearance of new competitors subject to different rules demand a highly focused strategic approach.”

After offloading its subsidiaries in Latin America, the company hopes to boost revenues from the creation of a new unit, Telefonica Tech, to group together cybersecurity, the Internet of Things, and cloud computing. It will also create a new unit to hold its portfolio of communications towers and other infrastructure assets, which have gained in value in recent years.

“It is a new era, with questions for which we have no answers,” said Álvarez Pallete, at a press conference. “Nobody is asking us for change, but we can’t not change.”

There are myriad reasons Telefonica needs to change. Top of the pile is its massive debt overhang, much of which dates from its $31.4 billion acquisition of British telecoms provider O2 in 2005. In the third quarter of 2019, Telefonica reported net debt of €45 billion. During the same period the company registered earnings (a loss actually) before interest, taxes, depreciation and amortization (EBITDA) of €-0.3 billion, a 114.84% declineyear-over-year, and for the twelve months ending September 30, 2019 of $6.301 billion, a 28.16% decline year-over-year.

Like many large, heavily indebted companies in Europe, Telefonica is at the low end of the investment-grade scale. Moody’s rates it just one notch above “junk” (Baa3), Fitch and S&P rate it two notches above “junk” (BBB) (here’s our cheat sheet for corporate credit rating scales by S&P, Moody’s, and Fitch in plain English). If it were to lose its investment grade status, some institutional investors would be forced to shed those bonds, which in turn would sharply raise Telefonica’s borrowing costs.

One of the biggest holders of Telefonica’s debt is the ECB, which as of last week held 19 issues of Telefonica bonds on its balance sheet — a legacy of the central bank’s last bond buying program, in which it acquired around €180 billion of investment grade corporate debt.

While the ECB discloses the names of the companies whose bonds it has acquired, it never discloses the amounts acquired, so there’s no way of knowing just how much of Telefonica’s debt is sitting on the ECB’s balance sheet. According to estimates by Wolfgang Bauer, manager of the retail fixed income team of London-based M&G Investments, the five European firms that benefited the most from Mario Draghi’s corporate debt purchase program are Anheuser-Busch InBev, Daimler, EDF, Telefonica and Eni.

Thanks to the ECB, those five companies — and many others — managed to record historic lows in the coupons offered on their new debt issues. According to Telefonica’s director of finance and control, Laura Abasolo, since June 2016, the month the ECB launched its corporate bond buying program, the telecoms giant has refinanced more than €32 billion of its debt, with much longer maturities. Again, we have no idea how much of that new debt is now sitting on the ECB’s balance sheet.

In the last couple of years Telefonica has tried to whittle down its massive debt load, mainly through divestments, with a certain degree of success. Now, it is looking to sell off almost all of its Latin American operations. Ten years ago, many of those operations, in the region’s fast-growing emerging economies, were a godsend as opportunities in the mature markets in Europe dried up in the wake of the Global Financial Crisis. But today, as Telefonica desperately needs cash while instability in Latin America rises, these operations an encumbrance.

Few international companies are more exposed to Latin America than large Spanish ones like Telefonica. And some of them are beginning to reduce their exposure to the region. Last year, Spain’s second largest bank, BBVA, sold its Chilean subsidiary to Canada’s Scotiabank for €2 billion while Spain’s biggest lender, Grupo Santander, is in the process of divesting its retail banking subsidiary in Puerto Rico, Santander Bancorp, for around a billion euros.

Telefonica already divested all of its subsidiaries in Central America (Guatemala, Salvador, Panama Nicaragua and Costa Rica) earlier this year in exchange for just over €2 billion. According to the Spanish financial daily El Economista, selling off the remainder of its subsidiaries in Spanish-speaking Latin America could raise a further €22 billion for the company, which would wipe out roughly half of the group’s net debt. More modest numbers were offered by analysts cited by El País: the Latin American subsidiaries Telefonica is looking to sell could be worth as little as €11 billion to €12 billion, and that’s not even taking into account their €4.5 billion of debt.

The problem is that now is not exactly a good time to sell businesses in Latin America, where political and economic crises have engulfed one country after another.

Four of the eight countries Telefonica wants to divest from (Chile, Ecuador, Colombia and Venezuela) are facing political upheaval while both Venezuela and perennial credit-basket-case Argentina have a litany of economic problems to deal with, including in the case of Argentina very high inflation of around 50% and the possibility of yet another sovereign debt default, and in the case of Venezuela hyper-inflation of around 40,000%. As such, finding buyers for these assets at anything but heavily knocked down prices is not going to be easy. By Nick Corbishley, for WOLF STREET.


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