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Rating Action:

Moody's affirms Telefonica's Baa3 rating; stable outlook

12 May 2020

Madrid, May 12, 2020 -- Moody's Investors Service, ("Moody's") has today affirmed the ratings of leading global integrated telecommunications provider Telefonica S.A. (Telefonica) and its guaranteed subsidiaries, including the Baa3 senior unsecured rating, the (P)Baa3 senior unsecured EMTN program and shelf program ratings, the Ba2 ratings on Telefonica's hybrid debt instruments, and the Prime-3 (P-3) short-term ratings. The outlook remains stable.

This rating action follows the announcement of the agreement between Telefonica and Liberty Global plc (Liberty, Ba3 stable) to combine their operating businesses in the UK into a 50-50 joint venture (JV) [1].

"The JV between Telefonica UK and Virgin Media Inc. (Virgin Media, Ba3 negative) in the UK enhances Telefonica's market positioning and scale in the country, supporting convergence and potential for significant synergies. Although we expect Telefonica will use around GBP 5.5-5.8 billion of cash proceeds to reduce debt at group level, this deal does not contribute to de-leveraging, because the UK asset will be deconsolidated from Telefonica's consolidated accounts, and pro rata consolidated leverage will marginally increase as the JV will be highly levered," says Carlos Winzer, Senior Vice President and lead analyst for Telefonica.

"We have affirmed Telefonica's Baa3 rating with a stable outlook to reflect the company's strong positioning in its core four countries of operation, Spain, Brazil, Germany and UK, which should mitigate the headwinds on cash flow generation derived from the weakness of Latin American currencies and declining revenue in Spain, due to increasing competitive pressures and economic recession," adds Mr. Winzer.

A full list of affected ratings is provided towards the end of this press release.

RATINGS RATIONALE

The JV agreement with Liberty is marginally credit positive for Telefonica, as the company is trading full ownership of a mobile-only asset, for partial ownership in a stronger converged mobile/cable business. The combination of Telefonica UK and Virgin Media will create the second largest integrated player in the UK, with combined revenues and EBITDA of around GBP11 billion and GBP3.5 billion, respectively. In addition, the combination will provide significant cross-selling opportunities for B2B, B2C and wholesale with convergent capabilities and will create a platform with enhanced infrastructure and a technological advantage over peers.

The companies expect the transaction to generate revenue, capex and opex synergies of about GBP6.2 billion (net present value, after integration costs). Of these, 65% are related to opex, mainly owing to the migration of Virgin Media's mobile traffic to Telefonica UK's network. The balance are revenue synergies (20%) and capex synergies (15%).

Virgin Media will be contributed with a net debt balance of GBP11.3 billion while Telefonica UK will be contributed on a debt free/cash free basis. Liberty will pay GBP2.5 billion to Telefonica in order to equalize its stake in the 50/50 JV. However, the JV will be targeting a leverage ratio of 4.5x-5.0x EBITDA and will be raising new debt to reach this target leverage, with proceeds to be distributed equally between Telefonica and Liberty. Moody's expects Telefonica to receive a one-time dividend from this recapitalization exercise of around GBP2.0-2.3 billion. However, since Telefonica UK will be deconsolidated from Telefonica's consolidated accounts, Moody's expects leverage to marginally increase to 3.4x from an expected 3.3x for the first full year after closing.

Moody's expects Telefonica's revenues and Moody's adjusted EBITDA in 2020 to decline by around 8% and 5%, respectively, mainly driven by the impact of the coronavirus outbreak as well as the deterioration of Latin American currencies, in particular the Brazilian real. Although the telecom industry is robust and is not directly exposed to the coronavirus in the way other sectors are, it is not immune to its effects on the economy.

In Spain, Telefonica will continue to suffer pressure on revenues mainly driven by lower retail revenue on the back of the slowdown in non-convergent communications revenue and the difficulty to pass on price increases. Wholesale revenues are expected to continue to grow, partially mitigating handset and B2B revenue declines.

Moody's expects a slightly negative to flat operating cash flow from the Spanish business in 2020, as the company's performance will be significantly impacted by the contraction in GDP. Data traffic is growing exponentially, but more so mobile voice. However, given the flat tariff schemes in place, this does not have a positive effect on revenue per se.

Moody's expects intense competition in the lower end of the market in Spain, driven by low-cost offerings from Vodafone Group Plc (Vodafone, Baa2 negative) and Masmovil Ibercom, S.A. (B1 stable), Spain's fourth-largest operator.

Telefonica announced in November 2019 a new action plan aimed at prioritizing markets where the company sees long-term sustainable growth, leveraging infrastructure and improving efficiency [2]. This new action plan includes: (1) the spin-off of part of its Latin American businesses and prioritization of Spain, Brazil, UK and Germany; (2) the creation of "Telefonica Tech" unit to enhance its value proposition in the B2B segment and focus on cybersecurity, IoT and BigData, and cloud; and (3) the creation of "Telefonica Infra" unit, with Telxius as the first asset, to focus on the development and monetization of towers, data centres, greenfield fibre projects, among others.

In addition, Telefonica confirmed the announced €0.4/share dividend for 2020, with the payment of the second tranche of 2019 dividend and the first tranche of 2020 being done through voluntary scrip dividend [3]. Moody's believes this decision will help preserve the company's free cash flow in 2020, especially given the upcoming 5G spectrum auctions in 2020-21 (including Spain, the UK and Brazil) and the deterioration of the company's EBITDA.

Moody's expects Telefonica's revenues to stabilise in 2021, and EBITDA to grow by around 1%-2%, supported by GDP recovery and cost savings. Moody's also expects Telefonica's key credit metrics to remain broadly stable in 2021 and 2022, with net adjusted debt/EBITDA of around 3.5x and Retained cash flow (RCF) to net adjusted debt of around 17%, both ratios within the boundaries for the Baa3 rating.

Telefonica's Baa3 rating reflects (1) the company's large scale; (2) the diversification benefits associated with its strong position in its key markets (Spain, Germany, UK and Brazil); (3) the company's strengthened position as an integrated player in the UK, after the announced JV with Virgin Media; (4) its rich TV content and bundled offerings, which provide it with a competitive advantage in Spain; (5) the ample fibre rollout of its high-quality network in Spain, Brazil and specific areas in Latin America; (6) management's track record; and (7) the company's good liquidity risk management.

Telefonica's rating reflects: (1) fierce competition in the low-end residential mobile segment in Spain; (2) the negative impact from the coronavirus outbreak and subsequent economic recession which will lead to weaker operating performance in 2020; (3) the company's exposure to emerging market risks, including significant foreign-currency volatility; (4) the increased complexity as the company fully consolidates subsidiaries that does not fully own, while maintaining off balance sheet highly levered JVs; and (5) the uncertainties related to Drillisch's plans after its spectrum acquisition in the German market and how it might affect Telefonica.

LIQUIDITY

Telefonica's liquidity is excellent and benefits from (1) cash and cash equivalents of €5.0 billion as of the end of March 2020; (2) robust external liquidity sources, with €13.7 billion of undrawn committed credit lines (of which €12.5 billion will mature beyond the next 12 months); and (3) annual funds from operations of around €12 billion. The above sources compare with (1) capital spending, excluding spectrum, of around €6.7 billion per year; (2) annual dividends of around €3 billion, including the scrip dividend for 2020, minority dividends and 50% of hybrid coupons; and (3) upcoming gross debt maturities of €9.7 billion in the next twelve months.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects the company's strong positioning in its core 4 countries of operation, Spain, Brazil, Germany and UK, which should mitigate the headwinds on cash flow generation derived from the weakness of Latin American currencies and declining revenue in Spain, due to increasing competitive pressures and economic recession.

The stable outlook reflects Moody's expectation that Telefonica's leverage will remain stable at around 3.5x over the next 2 to 3 years.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Moody's could consider an upgrade if the company's credit metrics were to strengthen significantly as a result of improved operational cash flow and debt reduction. More specifically, upward pressure could develop on the rating if Telefonica's adjusted retained cash flow/net debt rises above 22% and adjusted net debt/EBITDA sustainably improves below 3.0x.

A rating downgrade could result if (1) Telefonica deviates from its financial strengthening plan as a result of weaker cash flow generation; or (2) the company's operating performance deteriorates beyond Moody's expectations. More specifically, downward pressure on the rating could develop if adjusted retained cash flow/net adjusted debt drops below 15% or net adjusted debt/EBITDA rises above 3.75x, with no expectation of improvement.

LIST OF AFFECTED RATINGS

..Issuer: Telefonica S.A.

Affirmations:

....Commercial Paper, Affirmed P-3

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa3

Outlook Action:

....Outlook, Remains Stable

..Issuer: Telefonica Emisiones S.A.U.

Affirmations:

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa3

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa3

....Backed Senior Unsecured Shelf, Affirmed (P)Baa3

Outlook Action:

....Outlook, Remains Stable

..Issuer: Telefonica Europe B.V.

Affirmations:

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa3

....Backed Preferred Stock, Affirmed Ba2

....Backed Senior Unsecured Bank Credit Facility, Affirmed Baa3

....Backed Commercial Paper, Affirmed P-3

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa3

Outlook Action:

....Outlook, Remains Stable

..Issuer: Telefonica Finance USA LLC

Withdrawal:

....Backed Preferred Stock, Withdrawn, previously rated Ba2

Outlook Action:

....Outlook, Changed To Rating Withdrawn From Stable

..Issuer: Telefonica Participaciones, S.A.U.

Affirmation:

....Backed Senior Unsecured Conv./Exch. Bond/Debenture, Affirmed Baa3

Outlook Action:

....Outlook, Remains Stable

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Telecommunications Service Providers published in January 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1055812. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

COMPANY PROFILE

Telefonica S.A., domiciled in Madrid, Spain, is a leading global integrated telecommunications provider. The company delivers a full range of fixed and mobile telecommunications, serving some 344.3 million customers worldwide as of the end of December 2019. In 2019, the company generated revenue and EBITDA of €48.4 billion and €16.9 billion, respectively.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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 certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain 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.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

REFERENCES/CITATIONS

[1] Telefonica Press Release Published May 7, 2020 07-May-2020

[2] Telefonica Press Release Published November 27, 2019 27-Nov-2019

[3] Telefonica January-March 2020 Results Published May 7, 2020 07-May-2020

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.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Carlos Winzer
Senior Vice President
Corporate Finance Group
Moody's Investors Service Espana, S.A.
Calle Principe de Vergara, 131, 6 Planta
Madrid 28002
Spain
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Ivan Palacios
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Espana, S.A.
Calle Principe de Vergara, 131, 6 Planta
Madrid 28002
Spain
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2020 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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