TSP Telecomunicacoes de Sao Paulo S.A. - Telesp

Spanish telecom giant Telefonica (TEF) reported first quarter 2011 earnings per share of €0.36 (49 cents per ADS), flat with the year-ago earnings.

Net income dipped 1.9% year over year to €1.624 billion ($2.22 billion) due to stiff competition in the company’s home market and increased operating expenses. Following the earnings release, the shares dropped 1.61% to $23.85, its four-month low.

Consolidated revenue rose 10.8% year over year to €15.435 billion ($21.1 billion) in the reported quarter. Despite weaker operations in Spain, Latin America and Europe drove the double-digit revenue growth.

Consolidated operating expenses climbed 12.8% year over year to €10.176 billion ($13.91 billion). Operating income before depreciation and amortization (OIBDA) increased 9% to €5.574 billion ($7.62 billion), resulting in OIBDA margin of 36.1%, down 60 bps.

Segment Results

Telefonica Espana: The operator’s Spanish revenues fell 5.6% year over year to €4.372 billion ($5.98 billion), hurt by declines in both wireline and wireless businesses. Wireline revenues dropped 5.3% year over year to €2.679 billion ($3.66 billion) due to lower access, voice and Internet broadband revenues.

Revenues from wireless operations fell 5.5% to €1.978 billion ($2.70 billion) on account of lower mobile service revenues, resulting from a reduction in mobile termination rates.

Telefonica Europe: Revenues from Europe increased 8.4% year over year to €3.892 billion ($5.32 billion), buoyed by strong performance in UK and accelerated growth in Germany, partially offset by strong competition in the Czech Republic and continued economic uncertainty in Ireland.

Revenues from UK increased 9.4% year over year to €1.788 billion ($2.44 billion) in the reported quarter. Revenues from Germany showed a substantial 14.4% increase to reach €1.228 billion ($1.68 billion), while Ireland and Czech Republic declined 11.5% and 0.5% to €187 million ($256 million) and €528 million ($722 million), respectively.

Telefonica Latin America: Latin America posted healthy results in the reported quarter and remained one of the best performing regions. Revenues leaped 26% year over year to €7.006 billion ($9.58 billion), driven by solid subscriber accretion. Brazil remained the largest contributor to revenue, followed by Argentina (11%), Chile (8%), Venezuela (7%), Peru (7%) and Mexico (6%).

Revenues in Brazil (the largest market) increased 6.2% year over year to €3.515 billion ($4.8 billion) backed by strong economic growth. Telefonica’s Brazilian wireless subsidiary, Vivo Participacoes (VIV) posted revenue of €2.12 billion ($2.9 billion), up 13.6% year over year primarily attributable to strong mobile service revenues. Moreover, revenues from Telefonica’s Brazilian wireline subsidiary, Telesp (TSP), inched up 1.75% to €1.756 billion ($2.4 billion).

Subscriber Statistics

In the reported quarter, total customer access reached approximately 290.5 million, up 6.3% year over year, with 8% and 6% year-over-year growth in Latin America and Europe, respectively.

On an annualized basis, mobile access rose 8% to 223.1 million customers and mobile broadband access increased to 26.5 million. Total retail fixed broadband access grew 9% to 17.4 million, driven by the rapid adoption of bundled services (voice, broadband, and television). Pay TV access reached 2.9 million, up 10% year over year. Fixed telephony access dipped 2% to 40.9 million subscribers in the first quarter.

Liquidity and Capital Expenditure (CapEx)

Telefonica exited first quarter with net debt of €54.220 billion ($74.11 billion), down from €55.593 billion in 2010.

CapEx shot up 30.2% year over year to €1.551 billion ($2.12 billion) in the reported quarter. Free cash flow reduced to €0.966 billion ($1.32 billion) from €1.225 billion in the year-ago quarter.

Our Analysis

Telefonica continues to sustain its top-line performance in 2011, as the momentum at Latin America and Europe is expected to outpace revenue in Espana. Thus, Telefonica is confident that annual revenue will grow at least 1% to 4% through 2013. Telefonica’s strong performance in Latin America –– especially in Brazil, increased the adoption of mobile broadband and continued investments in growth and transformation projects are also expected to fuel earnings going forward.

We believe the integration of Vivo enables Telefonica to offer full competitive bundled services and strengthens its competitive position against America Movil (AMX). Further, Telefonica’s dominance in the Spanish telecom market and strength in Brazil make the stock attractive for investment.

On the other hand, we believe Spain is not working in favor of Telefonica. The economic downturn as well as ongoing reduction in mobile termination rates in that country has been more than expected and is likely to drag the company’s future profits and liquidity. In addition, the company’s highly leveraged balance sheet, increasing competition (especially in Brazil and UK) and regulatory involvement might limit the upside potential of the stock.

Hence, we have a Neutral rating for the long term. For the short term, the company has a Zacks #3 Rank (Hold).

 
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