S&P Negative on Telefónica

LONDON -- Standard & Poor's Ratings Services said today it revised its outlook on Spanish telecommunications operator Telefónica S.A. to negative from stable. This follows today's announcement at the group's annual investor conference of a revised, more aggressive dividend policy. At the same time, Standard & Poor's affirmed the 'BBB+' long-term corporate credit, bank loan, and senior unsecured debt ratings and its 'A-2' short-term corporate credit and CP ratings on Telefónica.

"The outlook revision reflects Telefónica's continuing financial policy aggressiveness, as reflected by the announcement of an increase in its dividend distribution that will weaken the group's ability to deleverage," said Standard & Poor's credit analyst Leandro de Torres Zabala.

The dividend increase announcement follows recent acquisitions for a combined €32 billion, all in cash, including Colombia Telecom in April 2006, O2 in February 2006, and Cesky Telecom in July 2005.

Telefónica has confirmed its previous leverage target and capped net acquisitions for 2006 and 2007. Standard & Poor's is mindful, however, that the group's future cash flows are fully allocated and there are material execution and integration risks embedded in its deleveraging plan. Telefónica's debt levels are currently very high, with unadjusted gross debt of €63 billion (pro forma for the acquisition of O2) primarily located at the parent company. These higher-than-expected debt levels strongly expose the group to a potential crisis in Latin America (which represents 30% of the group's OIBDA). We note that any significant deterioration in the Latin American macroeconomic environment, albeit unexpected at this stage, could affect Telefónica's operating measures and have implications for its massive ongoing refinancing program.

"The long-term rating could be lowered by one notch if, over the next 18 months, Telefónica fails to show good progress in deleveraging toward its medium-term target of net adjusted debt to EBITDA of about 2.5x at group level," Mr. de Torres Zabala added. "Excluding Latin American operations, Standard & Poor's expects this ratio to move toward 3.5x."

Standard & Poor’s

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