MOODY'S DOWNGRADES TO A3/P-2 TELEFONICA´S LONG-TERM SENIOR UNSECURED AND SHORT-TERM RATINGS
Total Debt Securities Affected Amount To Approximately Euro 7 billion
Madrid, December 02, 2002 -- Moody's Investors Service today downgraded to A3 from A2 the senior unsecured
long-term debt ratings and to Prime-2 from Prime-1
the short-term ratings for Telefónica S.A (Telefonica)
and its fully guaranteed subsidiaries. The downgrade reflects the
change in the perceived prospective business risk of Telefonica,
resulting from the increased volatility in Latin America, especially
in Brazil and Argentina. The rating outlook is stable and factors
Moody´s expectation that Telefonica´s management will minimize
any further investments in Latin America and continue to strengthen the
group's operating cash flow. This rating action concludes
Moody´s review for possible downgrade of Telefonica's ratings,
as initiated on August 2, 2002.
According to Moody's, the A3 and Prime-2 ratings reflect
better the prospective balance between Telefonica's financial and
business risks in light of the increased volatility in Brazil (B2) and
Argentina (Ca) -- even though Telefonica's free cash flow is
expected to strengthen.
Moody's notes that Telefonica will continue to be significantly
exposed to Latin America, where approximately 30% of the
future free cash flow is expected to be generated. The rating agency
anticipates that, in the near to medium term, management will
continue to pursue a conservative financial strategy by de-leveraging
through the use of internal free funds, and finance Latin American
operations with liabilities in local currency. Even though the
exposure to Latin American volatility risk will continue to be partially
offset by hedging mechanisms as well as management's track record,
Moody´s believes that this risk is commensurate with an A3 and Prime-2
ratings -- especially when compared to the expected free cash flow
and gross group debt.
Although Telefonica will continue to benefit from growth in its wireless
and data businesses, the adjusted ratings reflect the fact that
the saturation of the wireless subscriber market, the difficulty
in raising average revenue per user (ARPU) and the low increase in Internet
penetration rates will slow down the company's ability to continue
to grow operating cash flow from these businesses.
Also, while the fixed-line telephony business in Spain will
continue to be the strongest operating cash flow contributor to the group
for some time, Moody's notes that the ongoing effect of traffic
substitution from fixed to wireless, tariff reductions under the
annual price cap and slow growth in minutes of use will imply very modest
growth -- if any at all.
Moody's expects free cash flow to continue to underpin management's
determination to continue to improve debt protection ratios. Control
over costs, ongoing reduction in capex (by 52% as of September
2002) and expected further operating efficiency gains will contribute
to free cash flow strengthening. Nevertheless, Moody´s
questions Telefonica's ability to sustain very low levels of capital
expenditure of about 14% of revenues, while taking into consideration
the future needs to enhance the fixed-line broadband network as
well as the wireless network, including the soft roll-out
The rating downgrade also takes into account Telefonica´s challenge
to make further progress in the restructuring of its non-performing
and cash consuming internet and media assets (Terra-Lycos and Admira).
The expected economic slowdown and the recent slump in the advertising
market will continue to put pressure on these companies' weak operating
margins -- most notably in broadcasting operations, including
Via Digital, the domestic pay TV company. Nevertheless,
Moody´s noted that the possible merger of Via Digital with Sogecable,
approved by the Spanish Government on Friday last week with certain conditions,
is a positive development and could help in the execution of the restructuring
Moody's believes that Telefonica's liquidity risk is satisfactory.
The company is able to finance its debt maturities in 2003 from operating
cash flow, bank facilities, recently announced preferred stock
and relatively predictable sources without the need to access the capital
markets. The liquidity risk assessment also takes into consideration
the refinancing risk and back-up supporting the EUR3 billion CP
programs, which have a current outstanding of EUR1.4 billion.
Telefonica´s liquidity is supported by its ability to generate free
cash flow, the cash and short-term liquid assets on the balance
sheet, and undrawn committed bank facilities with a current average
maturity of about one year. Nevertheless, management is working
in extending the maturity profile towards the two-year average.
We believe Telefonica has a strong management team with a consistent strategy,
which includes (1) the global reorganization of the group along business
lines; (2) the maintenance of leadership in all core areas in the
Spanish market; (3) the consolidation of its leading position in
Latin America; and (4) the intention to further strengthen the capital
structure together with management's commitment to maintaining strong
debt protection ratios.
Moody´s noted that, although the underlying operating fundamentals
of Telefonica´s subsidiaries in Brazil are very sound and Telefonica
has upstreamed a significant amount of cash so far this year, the
rating downgrade reflects the potential impact on Telefonica SA´s
future free cash flow of the high volatility of the Reais.
Telefonica has invested some EUR24 billion in Brazil since 1998 --
of which EUR16.5 billion went towards acquisitions (EUR11.5
billion funded with equity) and the remainder as internal investment funded
by cash flow generated locally. The country's operations
contribute to approximately 22% of the EBITDA and free cash flow
of Telefonica SA.
Moody's acknowledges that Telefonica´s management has a long-standing
track record in managing businesses in highly volatile sovereign risk
countries and that it has put in place extensive hedging mechanisms in
Brazil to mitigate the impact of currency depreciation.
In addition, Moody's has taken into consideration Telefonica´s
recently announced decision to write-off UMTS in Germany,
Austria, Italy and Switzerland, with a significant implied
saving in future capex requirements. This decision, is positive
in the sense that it clarifies uncertainties in respect of a very difficult
business plan to execute, which would have involved significant
additional cash investments in the near term with very uncertain returns.
The ratings downgraded by Moody's today are as follows:
The long-term ratings of Telefónica SA´s senior unsecured
bonds and Telefónica Europe BV´s MTN and all drawdowns to
The long-term subordinated preferred stock of Telefónica
Finance USA LLC guaranteed by Telefónica SA to Baa2.
The short-term rating on Telefónica SA and Telefónica
Europe BV to Prime-2.
Headquartered in Madrid, Spain, Telefónica S.A.
is the second largest European telecommunications company by market capitalisation.
The company operates over 21 million exchange lines in Spain where it
is the leading provider of telecommunications, including wireline
and wireless voice, data transmission and Internet, yellow
pages directories services, paging and telephone equipment for rent
or purchase. Telefónica has significant investments in Latin
America, including CTC in Chile, TASA in Argentina,
CPT Telefónica del Peru, CANTV in Venezuela, TLD in
Puerto Rico, Pegaso in Mexico and in Brazil through CRT,
Telesp and Tele Sudeste Celular.
Moody's Investors Service Ltd.
44 20 7772 5454
Senior Vice President
Moody's Investors Service Espana, S.A.