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Announcement:

Moody's: Deadlock Over Vivo Purchase Is Ratings-Neutral for Telefónica and Portugal Telecom

22 Jul 2010

Madrid, July 22, 2010 -- Moody's Investors Service today said that the ratings of Telefónica (rated Baa1/positive) and Portugal Telecom (Baa2/stable) are unaffected by Telefónica's decision to drop its EUR7.15 billion offer to buy Portugal Telecom'stake in Brasilcel N.V. (unrated), their Brazilian joint venture.

Brasilcel owns a controlling equity stake in Vivo Participações SA, Brazil's largest mobile operator, which is important for both Telefónica and Portugal Telecom's growth prospects in Latin America given the pressured revenues in their respective home markets. Moody's says that it will continue to monitor the developments between Telefónica and Portugal Telecom over the Vivo transaction.

The reason why Moody's believes this development to be ratings-neutral for both telecoms operators is that Vivo will continue to make significant contributions to both companies' earnings. However, the rating agency's view could change if Telefónica decides to pursue other strategies that could eventually result in it gaining sole control of Vivo; or if other events lead Portugal Telecom to sell its stake in Brasilcel to Telefónica and consider an investment in an alternative Brazilian mobile operator.

Brazil remains a strategic market for both Telefónica and Portugal Telecom. In particular, the mobile business remains a segment of high-growth potential with a penetration of around 95% (versus 22% penetration in fixed-line services), some 185 million subscribers as of June 2010 and an annual subscriber growth rate of about 20%.

Moody's recognises that the acquisition of the remaining equity stake in Vivo would potentially give Telefónica full control and makes sense from a business perspective. It would also enable Telefónica to integrate its fixed and mobile businesses in Brazil, thereby creating a powerful integrated group. Specifically, the acquisition would also enhance Telefonica's competitive position as it would allow it to combine Vivo with Telecomunicações de São Paulo (Telesp, Baa2/stable), its Brazilian fixed-line operator. This would enable Telefónica to create a powerful integrated business that could offer bundled services and better compete with rivals such as Telemar Norte Leste S.A. (Baa2/stable), Claro (unrated) and Empresa Brasileira de Telecomunicações (Embratel, Baa2/stable), which are controlled by América Móvil (A2 stable). Vivo presently has a 30% share of Brazil's mobile market, while rivals TIM Brazil, Claro and Oi have 24%, 26% and 20%, respectively. Brazil contributes about 15% to Telefónica's revenues, with 10% coming from Telesp and 5% from Vivo.

For Portugal Telecom, Vivo is also a strategic asset, representing around 50% of its revenues and 35% of its EBITDA. Despite other international investments, Brazil is Portugal Telecom's growth engine and represents the company's biggest revenue contribution outside Portugal.

The power struggle over Vivo began in May when Telefónica launched a EUR5.7 billion offer for the remaining 50% of Brasilcel that it does not yet own. This offer was rejected outright by Portugal Telecom's board, which said it was too low. Telefónica, considering investors´ best interest, then raised its offer to EUR6.5 billion and finally, on the eve of the vote, to EUR7.15 billion, in a last-ditch attempt to win over Portugal Telecom's shareholders. On June 30, the majority of Portugal Telecom's shareholders voted to accept the offer, but the Portuguese government used its golden share to block the sale, arguing that it was not in the national interest. A week later, the European Court of Justice, Europe's highest court, ruled that the Portuguese government's golden share in Portugal Telecom was illegal because it restricted the free movement of capital and discouraged other EU operators from investing in the company. Telefónica subsequently extended the deadline for Portugal Telecom to accept its offer until midnight on 16 July. Portugal Telecom's board asked for an extension until 28 July, but Telefónica declined the request.

As mentioned in previous Moody´s reports, there is some headroom within Telefónica's Baa1 ratings to accommodate this transaction as previously envisaged, given the financial flexibility within Telefonica's group to digest a strategic investment of this nature. Although this would be an all-debt-funded transaction, it would impact Telefónica´s financial ratios to a limited extent, with metrics expected to remain consistent with the current rating level.

Headquartered in Madrid, Spain, Telefónica S.A. is the world's third-largest telecommunications company by access lines and one of the world's leading telecommunications carriers, with nearly 252 million customers around the world. Telefónica is the leading integrated telecommunications provider in Spain, delivering a full range of services and products, including telephony, data exchange, interactive content and information, and communications technology solutions.

Headquartered in Lisbon, Portugal, Portugal Telecom SGPS is the leading telecommunications operator in Portugal, supplying 4.3 million fixed lines and 7.2 million mobile phone customers (as of March 2010). The group has a nationwide presence, delivering a full range of services and products across Portugal, including mobile, fixed and Internet Protocol (IP)-based voice and data communications.

Madrid
Carlos Winzer
Senior Vice President
Corporate Finance Group
Moody's Investors Service Espana, S.A.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Paloma San Valentin
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's: Deadlock Over Vivo Purchase Is Ratings-Neutral for Telefónica and Portugal Telecom
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