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Announcement:

Moody's affirms Telefonica Brasil at Baa1/Aaa.br; outlook remains stable

23 Oct 2012

Approximately BRL 2.0 billion in rated debt affected

Sao Paulo, October 23, 2012 -- Moody's Investors Service and Moody's America Latina (jointly Moody's) have affirmed the Baa1/Aaa.br issuer ratings of Telefonica Brasil S.A. (Telefonica Brasil). Concurrently, Moody's has also affirmed the Baa1/Aaa.br ratings on Telefonica Brasil's BRL 2 billion in unsecured debentures due in 2017. The ratings outlook is stable. The affirmations were based on the confirmation of Telefonica S.A.'s ratings at Baa2 with a negative outlook on October 18, 2012.

RATINGS RATIONALE

Moody's applies certain analytical considerations when positioning the rating of subsidiaries that have a credit quality that is stronger than the consolidated credit quality of its parent, which is reflected in the parent company's ratings. Specifically, Moody's has historically assessed that subsidiaries within a family could not materially exceed the rating derived from the consolidated business risk profile and financial condition of the group since the parent company has in effect total control of the capital structure of its subsidiaries.

When assessing the credit risk of Telefonica Brasil, Moody's considered the conditions that could substantially reduce the default probability of Telefonica Brasil in comparison with that of its parent company. Accordingly, ringfencing arrangements that reduce default risk of Telefonica Brasil vis-à-vis the default risk of its parent company include 1) restriction by the Brazilian corporate law on leverage and distributions to the parent, which help to maintain a capital structure for Telefonica Brasil that is consistent with its current ratings; 2) absence of intercompany loans or cash pooling policies between Telefonica Brasil and Telefonica S.A.; 3) limitation on share buy-backs at an annual maximum amount of 10% of total floating shares, which today represent 26% of capital; 4) prohibition by Telefonica Brasil's by-laws of all transactions between Telefonica Brasil and its parent company that are not in the ordinary course of business and on an arm's length basis; 5) absence of cross-default or cross-acceleration clause between any indebtedness of Telefonica Brasil and that of its parent of affiliates; and 5) absence of a financial or business dependence of Telefonica Brasil from Telefonica S.A. In addition, Moody's believes that the risk of Telefonica Brasil being dragged into the bankruptcy of its parent may be low as long as its credit profile remains strong and given Anatel's, Brazil's telecom regulator, oversight.

While there remains a linkage between the credit profiles of Telefonica Brasil and its parent, the stable ratings outlook reflects Telefonica Brasil's strong and stable cash flow from operations and Moody's expectations that the company will maintain a conservative financial profile, consistent with its current rating category. The stable outlook is also based on our expectation that Telefônica Brasil will continue to leverage its strong market position in a growing telecom market and balance its high dividend payout (recently at 95% of annual profits) with a conservative leverage policy and thus continue to invest in its network infrastructure to address growing regulatory pressures and competitive threats. Also supporting the stable outlook is Moody's expectation that Telefonica Brasil's will maintain its Total Adjusted Debt to EBITDA of around 1.0x over the foreseeable future. However, should the outlook or the ratings of Telefonica S.A. suffer downward pressure, the ratings or outlook of Telefonica Brasil could be negatively affected due to the linkage between the parent and its subsidiary.

Moody's understands that Telefonica S.A.'s intention to IPO a portion of its Latin American assets will not cause it to lose control of Telefonica Brasil.

Telefonica Brasil's ratings reflect the company's position as the largest integrated telecom company in Brazil in terms of revenue and number of wireless subscribers as well as its solid profitability level with adjusted EBITDA margin of 38% during LTM ended June 2012. Moreover, the ratings consider Telefônica Brasil's conservative financial profile, robust credit metrics, solid liquidity position, strong brands and good geographic diversification. On the other hand, the ratings are constrained by Telefônica Brasil's sizeable exposure to the wireline business, which accounted for 38% of total revenue during 2Q12, as Moody's expects revenue and profitability in this segment to continue to decline due to lines in service (LIS) disconnections and tougher competition arising from new entrants, such as Tim Fiber and GVT. Furthermore, the ratings are also constrained by the company's low free cash flow due to high capex and aggressive dividend payout ratio, which in Moody's view will be maintained during the next several years.

Telefonica Brasil is the largest Brazilian integrated telecom operator with revenue of BRL 33.5 billion (equivalent to USD 18.8 billion) during LTM ended in June 30, 2012; 11 million lines in service; 3.7 million fixed broadband access, 650 thousand pay TV access; and 76 million wireless subscribers. During the first quarter of 2012, Telefonica Brasil concluded its rebranding process consolidating all of its services under Vivo brand, which Moody's sees as positive as the company is now able to sell fixed and mobile services using the same stores, to enhance customer experience, to improve quality perception and to save costs on both communications and personnel sides.

The company has been able to partially offset the decline of long-distance and regulated interconnection revenues with growth in its data transmission business, which increased by 2.2% to 887 million in 2Q12 from 867 million in 2Q11. With the integration of the mobile company Vivo, the wireless business should help the integrated company's growth plans and sustainability of revenues and margins going forward.

Telefonica Brasil has a long track record of prudent financial management with low leverage and solid liquidity position. Total Adjusted Debt to EBITDA was 1.0 time at the end of 2Q12, in-line with historical average, while cash position was BRL 2.1 billion fully covering BRL 1.0 billion adjusted short term debt. The company's liquidity policy is to maintain cash plus projected free cash flow above short term debt. In addition, the company has a robust generation of cash flow from operations, which totaled BRL 11 billion in the LTM 2Q12, in addition to its ample access to financing from banks and capital market. Moody's expects Total Adjusted Debt to remain around 1 time over the next 12-18 months. Notwithstanding its strong cash flow from operations of BRL 11 billion during LTM 2Q12, capital expenditures of BRL 6.4 billion coupled with dividends payment of BRL 4.4 billion in the same period have reduced free cash flow to BRL 57 million. Even though it represents an improvement from the negative BRL 1,451 million in free cash flow (FCF) during 2011, the FCF will continue to be under pressure as Moody's expects Telefônica Brasil to invest around BRL 24 billion from 2012 to 2015 and continue its aggressive dividend practice of paying out 95% of net profit, as allowed by the Brazilian corporate law.

Upward pressure on Telefonica Brasil's ratings is deemed unlikely given the pressure on the Telefonica S.A.'s ratings. In addition, Telefonica Brasil's ratings are constrained by the highly competitive operating environment in Brazil in all segments and the still high revenue contribution of the mature/declining wireline business. Over the long term, increased revenue diversification into higher growth segments such mobile, data, broadband and video, while improving current debt protection measures and cash flow based metrics, could result in upward ratings pressure.

Telefônica Brasil's ratings could come under downward pressure if Telefónica S.A.'s credit profile and liquidity position deteriorate further or if competitive threats adversely affect Telefonica Brasil's operating performance more than expected, causing a meaningful decline on revenues and margins. Ratings would also be negatively impacted in case the company engages in a material debt financed return of capital or M&A activity, resulting in a Total Adjusted Debt to EBITDA above 2 times for an extended period.

Please see ratings tab on the issuer/entity page on moodys.com for information on Global Scale Rating.

The date of the last Credit Rating Action on Telefonica Brasil was September 11, 2012.

The principal methodology used in rating Telefonica Brasil was the Global Telecommunications Industry Methodology published in December 2010.

Moody's National Scale Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".br" for Brazil. For further information on Moody's approach to national scale ratings, please refer to Moody's Rating Implementation Guidance published in October 2012 entitled "Mapping Moody's National Scale Ratings to Global Scale Ratings".

Telefônica Brasil is the largest integrated telecom operator in Brazil with BRL 33.5 billion (USD 18.8 billion) in revenue during the last twelve months ended June 2012. Revenues from mobile and fixed services represented 62% and 38% of total, respectively, in the second quarter 2012. Spain-based Telefónica S.A. (rated Baa2 Negative) is the largest shareholder holding, directly and indirectly, 92% of voting shares and 74% of total shares.

REGULATORY DISCLOSURES

The Global Scale Credit Ratings on this press release that are issued by one of Moody's affiliates outside the EU are endorsed by Moody's Investors Service Ltd., One Canada Square, Canary Wharf, London E 14 5FA, UK, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history. The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Nymia C. Almeida
Vice President - Senior Analyst
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Moody's affirms Telefonica Brasil at Baa1/Aaa.br; outlook remains stable
No Related Data.
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