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Rating Action:

Moody's assigns Ba1 rating to Telefonica's proposed hybrid security; negative outlook.

06 Sep 2013

Madrid, September 06, 2013 -- Moody's Investors Service has today assigned a Ba1 long-term rating to Telefonica Europe B.V. 's proposed issuance of "Perpetual Securities" (the "hybrid debt") fully and unconditionally guaranteed by Telefonica S.A. (Telefonica) on a subordinated basis. The outlook on the rating is negative. The size of the hybrid instrument remains subject to market conditions. All other ratings of Telefonica and its guaranteed subsidiaries as well as the negative outlook remain unchanged.

"The Ba1 rating we have assigned to the hybrid instrument is two notches below Telefonica´s senior unsecured rating of Baa2, primarily because the instrument is deeply subordinated to other debt in the company´s capital structure", says Carlos Winzer, a Moody´s Senior Vice President and lead analyst for Telefonica.

RATINGS RATIONALE

The Ba1 rating assigned to the hybrid instrument is two notches below the group's senior unsecured rating of Baa2. The two-notch rating differential reflects the deeply subordinated nature of the hybrid debt. The instrument (1) is a perpetual instrument; (2) is senior only to common equity; (3) provides Telefonica with the option to defer coupons on a cumulative basis; and (4) has no step-up prior to year 10 and only 100 basis points (bps) thereafter.

In Moody's view, the notes have equity-like features to allow them to receive basket "C" treatment, i.e. 50% equity and 50% debt for financial leverage purposes (please refer to Moody's Rating Implementation Guidance "Revisions to Moody's Hybrid Tool Kit" of July 2010).

Moody's notes that the proposed issuance of the hybrid instrument is done for general corporate purposes and to partially fund Telefonica's recent announcement of an agreed deal for the acquisition of a controlling equity stake in E-Plus, the German subsidiary of Koninklijke KPN N.V. (Baa2 negative) for a total consideration of EUR8.5 billion.

The transaction is subject to obtaining all regulatory and shareholder approvals and is not expected to close before the end of Q2 2014. Moody's expects the deal to be subject to a high degree of scrutiny by regulators, since previous precedents of mobile market consolidation in Europe have required substantial remedies to be approved.

The transaction is structured in such a way that it avoids a meaningful deterioration in Telefonica's credit metrics. In fact, Moody's expects the transaction itself to have a neutral effect on the company's credit metrics in 2014. The EUR5.0 billion cash payment to KPN will be funded by a combination of (1) EUR900 million in cash from Telefonica Deutschland Holding AG's minority shareholders via a rights issue; (2) 50% to 60% through the hybrid instrument with a substantial equity component; (3) 20% to 30% through a mandatory convertible; and (4) the remaining amount will be financed with debt. As a result, Telefonica's financial ratios will be only marginally affected after globally consolidating E-Plus.

Telefonica's Baa2 rating primarily reflects (1) the group's large size and scale; (2) the diversification benefits associated with its strong positions in many different markets; (3) management's track record and ability in terms of executing a well-defined and concise business strategy; and (4) its operating cash flow generation and management's stated commitment to maintain its reported net debt/EBITDA ratio below 2.35x.

Telefonica's Baa2 rating also continues to reflect the following assumptions: (1) management's ability to continue to execute a strategy that offsets Spain's challenging macroeconomic environment and contraction in consumer spending, which will continue to affect Telefonica's domestic revenues and exert pressure on credit metrics; (2) the group will deliver the financial policy (including cash preservation measures and a non-core assets disposal programme) that management has publicly committed to, which supports its deleveraging and strategy to strengthen its finances; and (3) Telefonica will maintain its access to the debt capital markets and as such retain adequate liquidity, supported by recent bond issuances and asset sales. Telefonica does not have the undisputed domestic strength or the geographic diversity to isolate itself completely from the current and future credit environment implied by the sovereign rating (Baa3 negative).

RATIONALE FOR NEGATIVE OUTLOOK

The negative outlook on the ratings reflects Moody's expectation that the group will continue to operate in a challenging domestic market (Spain). Despite the fact that Telefonica's international diversification enhances its credit profile, the group's exposure to the Spanish market puts it at risk given the weak macroeconomic conditions in Spain, exacerbated by the contraction in consumer spending resulting from austerity measures.

WHAT COULD CHANGE THE RATING UP/DOWN

As the hybrid rating is positioned relative to another rating of Telefonica, either (i) a change in the senior unsecured rating of Telefonica or (ii) a re-evaluation of its relative notching could affect the hybrid rating.

Although not currently expected in light of the negative outlook, the weak macroeconomic conditions in Spain and constraints related to the sovereign rating, Moody's could consider a rating upgrade to Baa1 if Telefonica's credit metrics were to strengthen significantly as a result of improvements in its operational cash flows and a further reduction in debt. Provided sovereign-related concerns were to abate, the rating could benefit from positive pressure if it became clear that the group would achieve sustainable improvements in its debt ratios, such as an adjusted retained cash flow (RCF)/net debt ratio above the mid-twenties in percentage terms and adjusted net debt/EBITDA comfortably below 2.5x.

Conversely, a rating downgrade could result if (1) Telefonica deviates from its financial-strengthening plan, as a result of weaker cash flow generation or the incurrence or assumption of further substantial debt in conjunction with the pursuit of acquisitions or more aggressive shareholder distribution policies; and/or (2) the group's operating performance in Spain and other key markets continues to deteriorate and there is no likelihood of an improvement in underlying trends in the short term. Resulting metrics would include deviation from management target metrics or an RCF/net adjusted debt ratio of less than 18% or a net adjusted debt/EBITDA ratio trending towards 3.0x. In addition, a rating downgrade could result if Moody's were to downgrade the sovereign rating.

PRINCIPAL METHODOLOGIES

The principal methodology used in this rating was the Global Telecommunications Industry published in December 2010 and Updated Summary Guidance for Notching Bonds, Preferred Stocks and Hybrid Securities of Corporate Issuers published in February 2007. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Telefonica S.A. 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. Telefonica is also one of the world's leading telecommunications carriers, with some 317 million customers worldwide. Approximately 76.9% of group revenues (total reported revenues amounted to EUR59.9 billion for the last twelve month period ending June 2013) and 67.5% of group EBITDA (total reported EBITDA amounted to EUR20.2 billion for the last twelve month period ending June 2013) were generated outside Spain for the last twelve month period ending June 2013.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain 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 certain 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 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 rating action, and whose ratings may change as a result of this 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.

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

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
SUBSCRIBERS: 44 20 7772 5454

Paloma San Valentin
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 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
SUBSCRIBERS: 44 20 7772 5454

Moody's assigns Ba1 rating to Telefonica's proposed hybrid security; negative outlook.
No Related Data.
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