Telefonica may need to do more to counter its financial ties to Spain. The phone company's credit ratings and funding costs are suffering as the country totters, even though three-quarters of sales are abroad.
Capital-hungry European telecoms have traditionally relied heavily on bonds. But as the euro crisis shuts corporate borrowers in weaker countries out of the market, maturing debts may need to be covered by bank loans or existing cash resources.
OTE, Greece's former telephone monopoly, is raising funds by selling units in Bulgaria, and has already exited Serbia. Portugal Telecom belatedly halved its dividend and, like some domestic peers, will now issue new bonds to Portuguese retail investors rather than Europe's institutional bond buyers.
But the big worry is Madrid-based Telefonica: a far larger company, with €7-billion to €8-billion ($8.7-billion to $10-billion) of debt to refinance every year. Moody's, Telefonica's toughest critic among the rating agencies, rates Spain at the bottom of investment-grade and Telefonica only one notch higher, at Baa2. It may cut both again. Yields on Telefonica's five-year euro bond, which stood below 4 per cent in March, spiked at 7.5 per cent in late June, and now stand above 5.8 per cent.
Other agencies are slightly more generous. But two "junk" ratings – a possibility if Spain is downgraded further – would render Telefonica debt unpalatable for many investors. That would mean a lot of new debt for Europe's smallish high-yield bond market to digest. Telefonica's banks would honour credit lines, but replacing expiring ones would become more expensive. New bond debt would prove costly and limited.
So what can Telefonica do? It began a big self-help program in late May. It is raising cash by selling down in China, cutting debt in Colombia, exploring partial floats for units in Germany and Latin America, and switching to paying dividends partly in stock. All that is good as far as it goes – but may not be enough.
Structural financial fixes are troublesome. For example, bonds issued through a ring-fenced unit in Britain, or backed by network assets, could win higher ratings. But borrowing like this would further crimp the parent's creditworthiness, by reducing the cash available to meet its own obligations.
The most obvious lever to pull would be to build on the dividend curb, which looked both timid and slow. A complete end to cash payouts may soon be needed. That could save more than €4-billion a year. Telefonica's hefty forward dividend yield – nearly 8 per cent, on Starmine estimates – already suggests investors are skeptical about the payout's sustainability.