Opportunities And Risks For Telefónica's Latin America IPO


Spanish incumbent Telefónica is reported to be considering options to list its Latin American operations in New York in 2013. The move would follow the company ' s successful listing of part of its German operations. Telefónica ' s EUR56bn debt is driving a number of cost - cutting decisions at the telecoms operator, as the Spanish company is affected by ongoing economic and financial difficulties in Spain. While BMI has a generally positive outlook for Latin American telecoms markets, there are opportunities and risks for potential investors in Telefónica ' s Latin American operations.

Telefónica combined the result of its home operations with the rest of its European holdings in Q112, making the European unit the largest revenue generating division of the company. However, in Q312, Telefónica Latinoamérica became the largest unit of Telefónica, accounting for 49% of revenues, compared with 47.9% for Telefónica Europe. The strength of Telefónica's Latin American operations meant the 6.8% y-o-y decrease in revenues in Europe in Q312 was largely offset by a 3.8% increase in Latin America. T he operator's total revenues decreased 1.6% in Q312. The ongoing impact of the financial crisis in Europe continues to weigh heavily on Telefónica performance in the region.

Telefónica announced plans to reduce its debt to EUR50bn by the end of 2012 and said in its Q312 results that listing the Latin American division was an option. Telefónica's CEO of Latin American operations, Santiago Fernandez Valbuena, said he did not see the benefit of launching operations separately, and BMI believes that a regional holding company would hold greater value for Telefónica to list. Telefónica successfully listed 23.17% of Telefónica O2 Deutschland in October 2012, generating EUR1.449bn for the company. The company added an incentive to possible wary investors by guaranteeing EUR500mn in cash dividends from 2012 earnings (see our online service October 16 2012, 'Telefónica Deutschland IPO: Premium Presents Investor Opportunity').

Although the company says it is still only considering the option, BMI believes Telefónica has few other options for paying down its debt. Analysts from Sanford C Bernstein previously estimated Telefónica's Brazil operations to be worth EUR47bn alone, 8.9 times the 2011 OIBDA figure. BMI believes Brazil is considered a more valuable operation, so the multiple would likely be lower for the entire Latin American operations, but will still value the holding company highly. Telefónica Latinoamérica reported OIBDA of EUR10.94bn in 2011, meaning that a smaller share, such as 20-25% of Telefónica Latinoamérica, would still make a significant dent in the group's debt burden.

Whether investors will require incentives to acquire a stake in Telefónica's Latin American operations remains to be seen, but the parent company and Spain's economic outlook will likely remain concerns for investors. Nonetheless, we believe the Telefónica Latinoamérica IPO will have a significant impact on the parent company's debt, lowering it to a level that will help the company renegotiate its remaining debt at more favourable rates.

Greater Potential In Latin America
Regional Mobile Growth Rates (%)

Opportunities

With Latin American operations continuing to offer growth, Telefónica's move is timely and BMI believes it will attract considerable interest. Telefónica has fixed and mobile operations across 15 markets in the region, including holding the top spot in mobile markets in Brazil and Peru , and owning several incumbent fixed-line operators. It competes with a variety of local operators as well as regional mobile leader América Móvil . While mobile penetration rates are already high, BMI still sees good growth potential in the region over our five-year forecast period 2012-2017 . Certainly, Latin American markets offer greater potential for growth , compared with Europe, and especially Spain which accounts for the largest share of revenues in the latter region.

BMI forecasts continue d growth for these markets, although we do note that the heavily prepaid make-up of the market may hide a number of inactive connections. Nevertheless, there is room for continue d subscriber growth. BMI ' s core view that mobile broadband will drive growth in emerging markets is playing out well in Latin America, providing new growth opportunities for mobile operators that are looking for the next wave of growth.

Much of Latin America's mobile subscriber growth is already in the past, but mobile broadband will help drive up subscriptions in future. There is also growing interest in smartphones in the region, providing the impetus for mobile content and value-added services (VAS) to grow. BMI sees great potential for new mobile-based services such as mobile banking, telecare, e-education and e-government services, and Telefónica's ubiquitous presence across the region's wireless and wireline networks puts it in a strong position to take advantage of this.

Telefónica's established networks and brands put it in a strong position to capitalise on the telecoms growth story. A major trend for the region, that Telefónica and América Móvil have led, is converged services, where operators offer combined fixed and mobile services, adding pay-TV and data to existing voice services and generating greater customer loyalty and new revenue streams.

Despite Low ARPUs, Latin America Still Offers Considerable Opportunities
ARPUs By Country (EUR)

Risks

Although Latin American prospects look stronger than Europe, the region has a distinct disadvantage because subscribers have lower disposable incomes. This has not prevented the mobile market from taking off, but does offer lower ARPU rates compared with Europe. Telefónica's position in Venezuela aside, ARPUs in the region are low and continue to fall in the majority of markets. Even markets where ARPUs are rising, we see additional pressures in the form of new entrants into the mobile market, rural growth and regulatory intervention as threats to continued ARPU growth.

BMI forecasts continued growth in Latin American mobile markets as we believe there are still significant numbers of inhabitants who do not have access to any telecoms services. The new subscribers entering the market will, however, be from lower income strata , limiting the revenue growth from each additional subscription. These subscribers are also likely to have limited demand for VAS, making return s on investment in new infrastructure a longer - term prospect.

Across its operations Telefónica has invested heavily in network infrastructure. However, this investment is never finished, with new technologies launching and subscribers demanding faster services. Capex is unlikely to decline significantly , in BMI 's opinion, as subscribers will continually demand the latest services.

In comparison to the eurozone financial crisis, opportunities look much stronger in Latin America. While many still like the consumer story in the region, it is not as strong as it once was, with economies slowing down, limiting the ability of subscribers to spend on new services. While BMI notes that the consumer story in Latin America is stronger than in Europe, the levels of growth seen in the past few years in the region are not expected to continue in the long run. This may slow the take-up rate of new services, which has implications for Telefónica's continued revenue growth.

Another pressure for Telefónica is its position in the fixed voice markets. The company acquired several former state-owned incumbent operators when privatisation began in Latin America, giving it a strong presence across the region. However, fixed-line growth is stagnant or declining, and we see no prospect of a return to growth in fixed-line services.

To some extent broadband and pay-TV will offset this decline, but this is not happening fast enough. Telefónica's fixed-line revenues in Latin America in Q312 declined 3.7% y-o-y, lower than the 5.6% y-o-y decline in Q212. This is currently countered by the strong growth in mobile services, 10.7% in Q312. However, to generate growth in these incumbents, Telefónica will need to invest in fixed infrastructure, which is costly and difficult to install. In addition, incumbent operators often have service requirements that alternative operators do not, further limiting the strategies of these companies. Differing regulations on rollout requirements and social programmes to bring communication services to rural areas, also adds to the pressure on Telefónica's network investments.

Positive Move

For Telefónica, selling off a share of its holdings in Latin America is a bold move, but one that BMI believes the company is forced to undertake. While Latin America does offer much greater subscriber growth potential, BMI believes difficulties lie ahead for Telefónica's operations. The strong consumer outlook for the region over the past 10 years has slowed and is not expected to pick up significantly. Nevertheless, with pared down debt and continuing along the convergence strategy it has implemented, we believe Telefónica is well placed to remain a key player in the region.

Telefónica Financial Performance, September 2012 (EURmn)
% Change
Source: Telefónica
9M11 9M12 Reported Organic
- Telefónica Latinoamérica 21,317 22,578 5.9 6.4
- Telefónica Europe 24,045 22,512 -6.4 -7.7
- Other companies and eliminations 1,310 1,429 9.1 na
Total Revenues 46,672 46,519 -0.3 -0.8
- Telefónica Latinoamérica 7,743 7,906 2.1 2.9
- Telefónica Europe 6,463 7,950 23 -12.8
- Other companies and eliminations 45 - 73 na na
Total OIBDA 14,251 15,782 10.7 -5.3
Net Income 2,733 3,455 26.4 na

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