TEXT-S&P: Telefonica 'BBB/A-2' ratings on watch neg on Spain downgrade
(The following statement was released by the rating agency) Overview
-- We lowered our sovereign ratings on Spain to 'BBB-/A-3' from 'BBB+/A-2' and assigned a negative outlook to the long-term rating on Oct. 10, 2012.
-- We consider that Spain-based telecommunications operator Telefonica S.A. is exposed to sovereign-related risks, including the weakening Spanish economy and potentially increasingly difficult or expensive refinancing.
-- We are placing our 'BBB' long-term and 'A-2' short-term ratings on Telefonica and three of its subsidiaries, and our issue ratings on Telefonica and six of its subsidiaries on CreditWatch negative.
-- The CreditWatch reflects the possible one-notch downgrade of Telefonica if we anticipate a risk that its liquidity could erode over time or if we lower our assessment of its business risk profile.
Rating Action On Oct. 12, 2012, Standard & Poor's Ratings Services put its 'BBB' long-term and 'A-2' short-term corporate credit ratings on Spain-based telecommunications operator Telefonica S.A. and related subsidiaries Telefonica Czech Republic AS, Telefonica Moviles Chile S.A., and Telefonica Chile S.A. on CreditWatch with negative implications. At the same time, we also placed our issue ratings on Telefonica and six of its subsidiaries on CreditWatch negative.
The CreditWatch placements follow the lowering of the long- and short-term sovereign credit ratings on the Kingdom of Spain to 'BBB-/A-3' from 'BBB+/A-2' and the assignment of a negative outlook (see "Spain Ratings Lowered To 'BBB-/A-3' On Mounting Economic And Political Risks; Outlook Negative," published Oct. 10, 2012). The CreditWatch on Telefonica's three subsidiaries reflect that on the parent, given the considerable control Telefonica exercises over these subsidiaries' business strategies and financial policies, together with our subsequent analytical decision to cap their ratings at the level of Telefonica's under our parent-subsidiary links criteria (see "Corporate Criteria--Parent/Subsidiary Links; General Principles; Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link To Parent," published Oct. 28, 2004).
We think the deteriorating sovereign environment in Spain could intensify the economic and competitive challenges that Telefonica already confronts. We also think it could restrict, or make more expensive, the access to capital markets for Spanish issuers, and tighten availability of bank credit.
Under our criteria, the long-term rating on Spain doesn't at this stage cap Telefonica's long-term rating. This is because we consider that Telefonica has "moderate" exposure to Spain, and that the sensitivity of the telecoms sector to Spain's country risk is "moderate" (for further details, see "Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," published June 14, 2011).
We are concerned, however, that the extent and pace of refinancing that Telefonica needs to maintain to adequately tackle massive annual maturities of outstanding debt and back-up facilities could prove increasingly challenging or onerous to achieve, given Spain's tough economic and financial conditions. At this stage, we don't fully rule out a scenario where Telefonica's coverage of liquidity needs by available means would gradually erode in the future and eventually fall short of our criteria for our current assessment of the group's liquidity as adequate, which is a criteria requirement for an investment-grade rating.
We anticipate at this stage that Telefonica will generate only moderate discretionary cash flow, at potentially less than EUR2 billion annually in 2013-2014 in our base-case scenario. While we acknowledge the group's aggressive cost cutting to defend its domestic EBITDA margins, and its ability to generate robust free cash flow from its diversified asset base, a significant share of free cash flow could be used to acquire additional spectrum, such as in the U.K in 2013, and pay dividends in our view. Telefonica could consequently have only modest capacity to trim debt from internally generated funds and continue to face large refinancing needs given its annual debt maturities in the EUR7billion-EUR8 billion range in the next few years.
In addition, we could lower our assessment of the group's business risk profile, if we expect increasingly adverse effects on Telefonica from its domestic market or a thinner cushion provided by its activities in overseas markets than in our base case. We currently project overall flat revenues and low- to mid-single digit annual EBITDA declines at Telefonica in 2012-2014.
At the moment, Standard & Poor's continues to assess Telefonica's business risk profile as "strong," which underpins the current rating. We base our assessment on the group's large scale, leading competitive positions in fixed and mobile telecoms markets, and its wide geographic diversification across Europe and Latin America. These business strengths are mitigated, in our view, by the depressed domestic economy (accounting for roughly one-quarter and one-third of consolidated revenues and EBITDA, respectively), which exacerbates intense price competition in the telecoms market. Additional weaknesses are the telecoms sector's heavy capital intensity, ongoing regulatory constraints, and Telefonica's exposure to various country and currency risks.
The group's financial risk profile, which we assess as "significant," continues to constrain the ratings. We consider that Telefonica has relatively high leverage (measured by debt to EBITDA), weak free cash flow protection measures, and heavy debt maturities
The short-term rating on Telefonica is 'A-2'. We assess Telefonica's liquidity as "adequate," according to our criteria, based on the following elements:
-- Our estimate of 1.35x coverage of liquidity uses to available sources for the 12 months to end-June 2013.
-- Our estimate, irrespective of group projections, of consistent and robust annual free cash flow generation of more than EUR6 billion on average over 2012-2014, before outlays for spectrum acquisitions.
-- Solid and diversified bank relationships and access to geographically diversified sources of funding.
-- The existence among 2012 debt maturities of EUR2 billion in perpetual preferred shares issued by Telefonica Finance USA LLC (not rated) that the group has the option to extend beyond 2012, although at a higher coupon.
-- Some additional flexibility from a number of disposable assets, including equity accounted stakes. These strengths are mitigated, however, by the following elements:
-- Sovereign and bank-related negative market sentiment that could boost financing costs when the company's large annual maturities of both outstanding debt and undrawn bank facilities are due.
-- Hefty annual long-term debt maturities of EUR7 billion to EUR8 billion annually in the next few years, as well as the need to renew a large part of undrawn facilities in the next two years. Given the sheer size of the required refinancing, capital availability could be affected, at least temporarily, by the shaky financial environment.
-- Our expectations of modest, though positive, generation of discretionary cash flow in the next two years, after dividends, and possible substantial cash outlays for spectrum acquisitions this year or into 2013. This is likely to result in only limited absolute debt reduction capacity through organic cash flow generation.
While we acknowledge recent refinancing achievements, and the beneficial cash-saving impact of its decisions not to pay dividends in November 2012 and May 2013, we think its heavy annual maturities of both drawn and undrawn debt instruments, combined with our expectation of modest net cash-flows after dividends and potential spectrum outlays (but before any additional disposals) continue to be a threat to its credit quality in the current capital and banking environment.
We think that any persistent capital market turmoil, particularly affecting the funding of southern European companies, could impede these companies to issue bonds on a large scale. We also believe that Telefonica, must compete for its large refinancing needs with an increasing number of large domestic borrowers rated in 'BBB' category, including the Spanish government and banks, although it also has access to a diversified pool of capital markets.
Our expectation that liquidity uses will cover available sources by 1.35x for the next 12 months to end-June 2013 is based on:
-- About EUR7.5 billion of undrawn and committed facilities available at end-June-2012 and maturing beyond the next 12 months.
-- Around EUR5 billion of cash and cash equivalents and current financial assets, excluding cash held in Venezuela, at end-June 2012.
-- Our own forecast of positive discretionary cash flow, after the recently revised dividend policy.
-- Gross long-term and short-term debt maturities of about EUR11.1 billion in the next 12 months as of end-June 2012 (including about EUR2 billion in commercial paper; excluding EUR2 billion of preferred stock).
Pro forma for the cash proceeds to be derived from the disposal of Telefonica's subsidiary Atento (announced today and subject to regulatory authorizations), we estimate that the ratio would increase to about 1.39x as of end-June 2012.
We are not aware of any covenants or ratings triggers in Telefonica's debt instruments.
To our knowledge, there are no cross-default clauses between Telefonica S.A. and both its wholly owned issuing entities and its subsidiaries. Therefore, a default by any of the group's subsidiaries would not trigger a default at the group level.
We intend to resolve the CreditWatch status by year-end 2012, after meeting with Telefonica's management, reviewing the group's strategic and financial prospects, monitoring its third-quarter results, and updating our forecasts. The resolution will hinge mainly on our updated view on the group's liquidity, factoring in recent debt issues, our understanding of management's intentions regarding future dividends, and any update on further intended asset disposals, including recently announced IPO plans for Telefonica's German subsidiary.
At this stage we could downgrade Telefonica by one notch to 'BBB-', unless we see convincing prospects for Telefonica's liquidity to consistently remain adequate in the future, under our criteria. We believe a one-notch downgrade could also result from any downward revision of our assessment of Telefonica's business risk profile. At this point, we see a two-notch downgrade to 'BB+' as highly unlikely given the group's recent refinancing track record, significant operating asset diversity, and potential to improve discretionary cash flow and contain leverage.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Corporate Criteria--Parent/Subsidiary Links; General Principles; Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link To Parent, Oct. 28, 2004
-- Key Credit Factors: Business And Financial Risks In The Global Telecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
Ratings List Ratings Affirmed; CreditWatch Action To From Telefonica S.A. Corporate Credit Rating BBB/Watch Neg/A-2 BBB/Negative/A-2 Telefonica Chile S.A. Telefonica Moviles Chile S.A. Telefonica Czech Republic AS Corporate Credit Rating BBB/Watch Neg/-- BBB/Negative/-- Telefonica S.A. Senior Unsecured BBB/Watch Neg BBB Commercial Paper A-2/Watch Neg A-2 Telefonica Chile S.A. Senior Unsecured BBB/Watch Neg BBB
Telefonica Emisiones S.A.U.
Senior Unsecured* BBB/Watch Neg BBB Telefonica Europe B.V. Senior Secured* BBB/Watch Neg BBB Senior Unsecured* BBB/Watch Neg BBB Commercial Paper* A-2/Watch Neg A-2 Subordinated Debt* BBB-/Watch Neg BBB-
Telefonica Finance USA LLC
Preferred Stock* BB+/Watch Neg BB+
Telefonica Moviles Chile S.A.
Senior Unsecured BBB/Watch Neg BBB Telefonica N.A. Inc. Commercial Paper* A-2/Watch Neg A-2
Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at
. All ratings affected by this rating action can be found on Standard & Poor's public Web site at . Use the Ratings search box located in the left column. (New York Ratings Team)