EC set to block the Three-O2 UK proposed merger? Low visibility
Pending low visibility on the approval of the proposed Three-02 UK deal (per recent Telegraph and FT
press reports) we present a scenario analysis on TEF's deleverage profile.
O2 UK disposal is key for TEF deleverage process
The disposal of O2 UK is key for TEF de-leverage as it would contribute a €14bn cash-in (c€12.6bn in
2016 and c€1.4bn over the medium term), corresponding to an estimated >0.5x reduction in company
ND/EBITDA. Assuming no disposal of the UK, we calculate TEF's 2016 ND/EBITDA proportionate would
grow to 3.3x vs. our current estimate at 2.9x.
TEF has several alternative options to address de-leverage
That said, we think TEF has a number of strategic and funding options with which it could restore full
balance sheet flexibility while avoiding or limiting dilution for its shareholders (see page 2-3 for our
scenario analysis). We calculate that, over a two-year horizon (by 2017), the company could cover some
60% of the deleveraging shortfall arising from a possible blockage of the TEF UK disposal (see Option 1
in Figure 3). This could be achieved through the reduction of the cash DPS to €0.40 (~€3.4bn cumulated)
and asset disposals (more than €1bn from the BBVA and China Unicom stakes). We cannot rule out the
risk that the remaining gap (~€5.5bn, or c10% of TEF's market cap) may be covered through funding
instruments, which could imply some dilution for TEF shareholders (hybrid bond issuance, mandatory
convertible bonds, rights issue). However, we believe that, before assessing any dilutive option, TEF could
potentially consider the following: 1) partial disposal of the infrastructure company (ongoing); 2) a
disposal of O2 UK to a buyer other than Hutch (in line with management statements); 3) a zero-cash
dividend policy over a two-year horizon (see Option 2 in Figure 3).
Valuation: PT, SOP based, at €14.1 - BUY
The final outcome of the competitive review (decision expected by 19th May) represents the most
important catalyst for the Telefonica share price in our view. We confirm our positive stance on the
stock. TEF has built a strong competitive advantage both in Spain and Brazil (2/3 of EV). The stock is
trading at ~12x EV/OPCF (proportionate) and its performance relative to the European Telecom index is
close to the lows since 2001.