The rise and fall of TelefónicaThe rise and fall of Telefónica
Worth $370 billion in 2006, Spain's biggest telecom operator is valued at just $25 billion today.
February 25, 2021
Telefónica boss José María Álvarez-Pallete López, whose princely name befits a man paid about €5.4 million ($6.6 million) in 2019, must survey what's left of the Spanish operator's once-sprawling empire each morning and wonder what to sell next.
In the 1990s and early 2000s, Telefónica turned conquistador, sailing its networks into Latin America before marching into European countries, including the UK and Germany. In 2007, the year after it completed its takeover of the UK's O2, its market capitalization hit $370 billion, about the same as Walmart now. Today, after years of retreat, the Spanish operator is worth just $25 billion. That puts it on a par with Cellnex, whose only job is to rent space on masts to European telcos.
Figure 1: Telefónica's CEO oversees a shrinking and heavily indebted business.
The rise and fall of European telecom is a story best told through reference to the Spanish incumbent. The mobile-phone revolution of the 1990s swept Telefónica and others into power, delivering a sales boom that lasted years. Then came the mobile Internet and the seeds of Telefónica's decline. More fleet-footed Internet companies did not have to spend billions on access networks or telecom licenses to reach customers. They could do it through Telefónica. Splashing about in their turbulent wake, Telefónica could not sustain the buoyancy it had previously enjoyed.
Retrenchment combined with investor gloom mean Telefónica's debts now exceed its value by around $18 billion, an uncomfortable situation for any shareholder. That seems to have consumed the attention of Álvarez-Pallete ever since 2016, when he took over from long-serving César Alierta, the Hernán Cortés of telecom. Divestment has become the number-one priority.
Álvarez-Pallete's first move has been to abandon markets in Latin America. He has already sold a small business in Costa Rica to Liberty Latin America and is reportedly in talks with other prospective buyers. KKR, an investment company, this week bought a controlling stake in Telefónica's Chilean fiber assets. Other parts of what Telefónica has separated into its "Hispam" unit could follow.
But Álvarez-Pallete has shown he will not stop at Latin America. In a surprise move, he has also recently sold the entirety of Telefónica's majority stake in Telxius, a Cellnex rival that owns more than 30,000 sites in Germany, Spain and four Latin American markets. That decision means Telefónica has given up control of the infrastructure that hosts its mobile network equipment. It is a move that Germany's Deutsche Telekom, France's Orange and UK-based Vodafone are not prepared to make.
Figure 2: Telefonica's share price in New York ($) Source: Google Finance.
On the cards is a merger of its O2 business in the UK with Virgin Media, that country's main cable operator. Pending regulatory approval, this would obviously dilute Telefónica's stake in a UK telecom business but support its goal of debt reduction. Like the towers divestment, it looks risky. While the merging parties insist operators need both fixed and mobile networks to challenge market leader BT, integration could hinder the new-look firm. O2 has a good reputation for customer service. Virgin does not. And a mountain of debt could make cutbacks the priority.
The financial pressure on Telefónica was apparent today when it cut its dividend payments by one quarter, to €0.30 per share. Revenues last year fell €5.3 billion ($6.5 billion), to about €43.1 billion ($52.7 billion), with coronavirus blamed for wiping out €1.9 billion ($2.3 billion). Cutbacks included the elimination of more than 4,000 jobs, about 4% of the company total, leaving Telefónica with around 113,000 employees last year. But they could not halt the slide in operating income, down 10.7%, to €13.5 billion ($16.5 billion). And Telefónica's underlying net income sank 13.7%, to about €3.1 billion ($3.8 billion).
The only real positive was a reduction in Telefónica's colossal net debt, down €2.5 billion ($3.1 billion) last year, to roughly €35 billion ($42.8 billion) in December. Unfortunately, chipping away at this figure means sacrificing dividends or curtailing investments. Capital expenditure fell a third last year, to about €5.9 billion ($7.2 billion). "Effective management" was responsible, said Telefónica. But any sign it is investing less than rivals would unnerve anyone who cares about its long-term health.
Telefónica Tech to the rescue
The recent Telxius sale to American Towers for €7.7 billion ($9.4 billion) should put a big dent in the debt. But can anything else be sold? Aside from other networks, the likeliest candidate is probably Telefónica Tech, a newish unit that had success in the markets for cybersecurity, cloud, big data and IoT (Internet of Things) services, growing its revenues by 13.6% last year, to €1.5 billion ($1.8 billion). In the future, says Álvarez-Pallete, it will be a "fully operational and autonomous unit," using the kind of language that precedes deal-making.
If the valuations attached to other cloud companies are anything to go by, the sale of even a minority stake in Telefónica Tech could raise billions. Danielle Royston, an independent consultant and the former CEO of software company Optiva, has noted that cloud companies like Salesforce are typically valued at ten times their revenues. That multiple would make Telefónica Tech worth about €15 billion ($18.3 billion), more than 70% of Telefónica's market capitalization.
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A sale would be fraught with risk and complication, though. Telefónica Tech would have to be fully disentangled from the rest of Telefónica, for starters. Investors would be entering a business that looks increasingly reliant on partnerships with tech giants such as Google. That could be a deterrent unless buyers are convinced those partnerships will always be symbiotic. The decline that European providers have suffered in the region's cloud market is a potential worry. Their share of business has fallen from 26% to 16% since 2017, according to the Synergy Research Group.
Any divestment would also dilute Telefónica's stake in a business that Álvarez-Pallete appears to regard as the operator's future. In a late-2019 interview, he told the UK's Financial Times that time was up for the "traditional formula" of selling smartphones and contracts. Telcos needed to become "massive data factories," he said, evolving from telecom into technology firms.
Telefónica's fortunes show he is right about the broken formula. As for massive data factories, a few of those have already evolved in Silicon Valley, emerging from the primordial Internet slime back when Telefónica had an empire. And they have not left much space for rivals.
— Iain Morris, International Editor, Light Reading
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