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Rating Action:

Moody's assigns Ba2 rating to Telefonica's proposed undated hybrid securities

18 Sep 2019

Madrid, September 18, 2019 -- Moody's Investors Service ("Moody's") has today assigned a Ba2 rating to Telefonica Europe B.V.'s proposed issuance of undated, deeply subordinated, guaranteed fixed rate reset securities (the "hybrid debt"), which are fully and unconditionally guaranteed by Telefonica S.A. (Telefonica) on a subordinated basis. The outlook is stable.

"The Ba2 rating we have assigned to the hybrid debt is two notches below Telefonica's senior unsecured rating, of Baa3, 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.

Telefonica plans to use the net proceeds for general corporate purposes, including supporting its liquidity cushion and preserving its layer of hybrid capital.

RATINGS RATIONALE

The Ba2 rating assigned to the hybrid debt is two notches below the group's senior unsecured rating of Baa3.

The two-notch rating differential reflects the deeply subordinated nature of the hybrid debt. The instrument: (1) is perpetual; (2) is senior only to common equity; (3) provides Telefonica with the option to defer coupons on a cumulative basis; (4) steps up the coupon by 25 basis points (bps) at least ten years after the issuance date and a further 75 bps occurring 20 years after the first call date; and (5) the issuer must come current on any deferred interest if there are any payments on parity or junior instruments. The issuer does not have any preferred shares outstanding that would rank junior to the hybrid debt, and the issuer's articles of association do not allow the issuance of such shares by the issuer.

In Moody's view, the notes have equity-like features that allow them to receive basket "C" treatment, i.e., 50% equity and 50% debt for financial leverage purposes (please refer to Moody's Hybrid Equity Credit methodology published in September 2018).

Telefónica S.A.'s (Telefonica) Baa3 rating reflects (1) the company's large scale; (2) the diversification benefits associated with its strong position in its key markets; (3) its rich TV content and bundled offerings, which provide it with a competitive advantage in Spain; (4) the ample fibre roll-out of its high-quality network in Spain, Brazil and specific areas in Latin America; (5) management's track record of executing a well-defined business strategy; (6) the company's continued access to debt capital markets and its good liquidity risk management; and (7) management's commitment to reduce debt gradually.

However, Telefonica's rating also reflects (1) fierce competition in the low-end residential mobile segment in Spain; (2) the intense competition in the UK, despite the fact that O2 UK benefits from the largest customer base, lowest churn and good commercial performance; (3) the fact that Mexico and Germany remain competitive, despite Germany being a more rational market with competitors keeping moving into larger data bundles propositions; and (4) uncertainties related to Drillisch's plans after its spectrum acquisition in the German market and how it might affect Telefonica. In addition, the rating factors take into consideration the company's exposure to emerging market risks, foreign-currency volatility particularly in Argentina and Venezuela and the fact that Telefonica does not own 100% of all of its consolidated subsidiaries.

RATIONALE FOR STABLE OUTLOOK

The stable outlook on Telefonica primarily reflects its broadly stable operating performance, coupled with management's willingness to continue reducing debt and achieve its deleveraging plan organically over time. Moody's expects Telefonica to operate in a challenging domestic market, with tough competition and weaker underlying economic conditions, which could challenge its revenue growth.

WHAT COULD CHANGE THE RATING UP/DOWN

As the hybrid debt rating is positioned relative to another rating of Telefonica, either: (1) a change in Telefonica's senior unsecured rating; or (2) a re-evaluation of its relative notching could affect the hybrid debt rating.

A rating downgrade could result if (1) Telefónica were to deviate from its financial strengthening plan, as a result of weaker cash flow generation; and/or (2) the company's operating performance in Spain and other key markets were to deteriorate, with no likelihood of short-term improvement in underlying trends. Resulting metrics would include the ratio of retained cash flow to net adjusted debt of less than 15% and/or the ratio of net adjusted debt to EBITDA of 3.75x or higher with no expectation of improvement.

Conversely, Moody's could consider an upgrade of Telefónica's rating to Baa2 if the company's credit metrics were to strengthen significantly as a result of improved operational cash flow and debt reduction. More specifically, the rating could benefit from positive pressure if it became clear that the company were able to achieve sustainable improvements in its debt ratios, such as a ratio of adjusted retained cash flow to net debt above 22% and a ratio of adjusted net debt to EBITDA comfortably below 3.0x.

LIST OF AFFECTED RATINGS

Assignments:

..Issuer: Telefonica Europe B.V.

....BACKED Preference Stock Preference Stock, Assigned Ba2

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Telecommunications Service Providers published in January 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

COMPANY PROFILE

Telefónica S.A. (Telefónica), domiciled in Madrid, Spain, is a leading global integrated telecommunications provider, with significant presence in Spain, Germany, the UK and Latin America. In 2018, Telefonica generated revenue and EBITDA of €48.7 billion and €15.6 billion, respectively.

REGULATORY DISCLOSURES

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.

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
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

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