(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 TelefonicaS.A. is exposed to sovereign-related risks, including the weakening Spanisheconomy and potentially increasingly difficult or expensive refinancing.
-- We are placing our 'BBB' long-term and 'A-2' short-term ratings onTelefonica and three of its subsidiaries, and our issue ratings on Telefonicaand six of its subsidiaries on CreditWatch negative.
-- The CreditWatch reflects the possible one-notch downgrade ofTelefonica if we anticipate a risk that its liquidity could erode over time orif we lower our assessment of its business risk profile.
Rating ActionOn Oct. 12, 2012, Standard & Poor's Ratings Services put its 'BBB' long-termand 'A-2' short-term corporate credit ratings on Spain-basedtelecommunications operator Telefonica S.A. and related subsidiariesTelefonica Czech Republic AS, Telefonica Moviles Chile S.A., and TelefonicaChile S.A. on CreditWatch with negative implications. At the same time, wealso placed our issue ratings on Telefonica and six of its subsidiaries onCreditWatch negative.
The CreditWatch placements follow the lowering of the long- and short-termsovereign 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 subsidiariesreflect that on the parent, given the considerable control Telefonicaexercises over these subsidiaries' business strategies and financial policies,together with our subsequent analytical decision to cap their ratings at thelevel of Telefonica's under our parent-subsidiary links criteria (see"Corporate Criteria--Parent/Subsidiary Links; General Principles;Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; RatingLink To Parent," published Oct. 28, 2004).
We think the deteriorating sovereign environment in Spain could intensify theeconomic and competitive challenges that Telefonica already confronts. We alsothink it could restrict, or make more expensive, the access to capital marketsfor Spanish issuers, and tighten availability of bank credit.
Under our criteria, the long-term rating on Spain doesn't at this stage capTelefonica's long-term rating. This is because we consider that Telefonica has"moderate" exposure to Spain, and that the sensitivity of the telecoms sectorto Spain's country risk is "moderate" (for further details, see "NonsovereignRatings That Exceed EMU Sovereign Ratings: Methodology And Assumptions,"published June 14, 2011).
We are concerned, however, that the extent and pace of refinancing thatTelefonica needs to maintain to adequately tackle massive annual maturities ofoutstanding debt and back-up facilities could prove increasingly challengingor 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 coverageof liquidity needs by available means would gradually erode in the future andeventually fall short of our criteria for our current assessment of thegroup's liquidity as adequate, which is a criteria requirement for aninvestment-grade rating.
We anticipate at this stage that Telefonica will generate only moderatediscretionary cash flow, at potentially less than EUR2 billion annually in2013-2014 in our base-case scenario. While we acknowledge the group'saggressive cost cutting to defend its domestic EBITDA margins, and its abilityto generate robust free cash flow from its diversified asset base, asignificant share of free cash flow could be used to acquire additionalspectrum, such as in the U.K in 2013, and pay dividends in our view.Telefonica could consequently have only modest capacity to trim debt frominternally generated funds and continue to face large refinancing needs givenits annual debt maturities in the EUR7billion-EUR8 billion range in the next fewyears.
In addition, we could lower our assessment of the group's business riskprofile, if we expect increasingly adverse effects on Telefonica from itsdomestic market or a thinner cushion provided by its activities in overseasmarkets than in our base case. We currently project overall flat revenues andlow- to mid-single digit annual EBITDA declines at Telefonica in 2012-2014.
At the moment, Standard & Poor's continues to assess Telefonica's businessrisk profile as "strong," which underpins the current rating. We base ourassessment on the group's large scale, leading competitive positions in fixedand mobile telecoms markets, and its wide geographic diversification acrossEurope and Latin America. These business strengths are mitigated, in our view,by the depressed domestic economy (accounting for roughly one-quarter andone-third of consolidated revenues and EBITDA, respectively), whichexacerbates intense price competition in the telecoms market. Additionalweaknesses are the telecoms sector's heavy capital intensity, ongoingregulatory constraints, and Telefonica's exposure to various country andcurrency risks.
The group's financial risk profile, which we assess as "significant,"continues to constrain the ratings. We consider that Telefonica has relativelyhigh leverage (measured by debt to EBITDA), weak free cash flow protectionmeasures, and heavy debt maturities
The short-term rating on Telefonica is 'A-2'. We assess Telefonica's liquidityas "adequate," according to our criteria, based on the following elements:
-- Our estimate of 1.35x coverage of liquidity uses to available sourcesfor the 12 months to end-June 2013.
-- Our estimate, irrespective of group projections, of consistent androbust annual free cash flow generation of more than EUR6 billion on averageover 2012-2014, before outlays for spectrum acquisitions.
-- Solid and diversified bank relationships and access to geographicallydiversified sources of funding.
-- The existence among 2012 debt maturities of EUR2 billion in perpetualpreferred shares issued by Telefonica Finance USA LLC (not rated) that thegroup 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 boostfinancing costs when the company's large annual maturities of both outstandingdebt and undrawn bank facilities are due.
-- Hefty annual long-term debt maturities of EUR7 billion to EUR8 billionannually in the next few years, as well as the need to renew a large part ofundrawn facilities in the next two years. Given the sheer size of the requiredrefinancing, capital availability could be affected, at least temporarily, bythe shaky financial environment.
-- Our expectations of modest, though positive, generation ofdiscretionary cash flow in the next two years, after dividends, and possiblesubstantial cash outlays for spectrum acquisitions this year or into 2013.This is likely to result in only limited absolute debt reduction capacitythrough organic cash flow generation.
While we acknowledge recent refinancing achievements, and the beneficialcash-saving impact of its decisions not to pay dividends in November 2012 andMay 2013, we think its heavy annual maturities of both drawn and undrawn debtinstruments, combined with our expectation of modest net cash-flows afterdividends and potential spectrum outlays (but before any additional disposals)continue to be a threat to its credit quality in the current capital andbanking environment.
We think that any persistent capital market turmoil, particularly affectingthe funding of southern European companies, could impede these companies toissue bonds on a large scale. We also believe that Telefonica, must competefor its large refinancing needs with an increasing number of large domesticborrowers 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 forthe next 12 months to end-June 2013 is based on:
-- About EUR7.5 billion of undrawn and committed facilities available atend-June-2012 and maturing beyond the next 12 months.
-- Around EUR5 billion of cash and cash equivalents and current financialassets, excluding cash held in Venezuela, at end-June 2012.
-- Our own forecast of positive discretionary cash flow, after therecently revised dividend policy.
-- Gross long-term and short-term debt maturities of about EUR11.1 billionin the next 12 months as of end-June 2012 (including about EUR2 billion incommercial paper; excluding EUR2 billion of preferred stock).
Pro forma for the cash proceeds to be derived from the disposal ofTelefonica's subsidiary Atento (announced today and subject to regulatoryauthorizations), we estimate that the ratio would increase to about 1.39x asof end-June 2012.
We are not aware of any covenants or ratings triggers in Telefonica's debtinstruments.
To our knowledge, there are no cross-default clauses between Telefonica S.A.and both its wholly owned issuing entities and its subsidiaries. Therefore, adefault by any of the group's subsidiaries would not trigger a default at thegroup level.
We intend to resolve the CreditWatch status by year-end 2012, after meetingwith Telefonica's management, reviewing the group's strategic and financialprospects, 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 intentionsregarding future dividends, and any update on further intended assetdisposals, including recently announced IPO plans for Telefonica's Germansubsidiary.
At this stage we could downgrade Telefonica by one notch to 'BBB-', unless wesee convincing prospects for Telefonica's liquidity to consistently remainadequate in the future, under our criteria. We believe a one-notch downgradecould also result from any downward revision of our assessment of Telefonica'sbusiness risk profile. At this point, we see a two-notch downgrade to 'BB+' ashighly unlikely given the group's recent refinancing track record, significantoperating asset diversity, and potential to improve discretionary cash flowand contain leverage.
Related Criteria And Research
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For GlobalCorporate Issuers, Sept. 28, 2011
-- Corporate Criteria--Parent/Subsidiary Links; General Principles;Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; RatingLink To Parent, Oct. 28, 2004
-- Key Credit Factors: Business And Financial Risks In The GlobalTelecommunication, Cable, And Satellite Broadcast Industry, Jan. 27, 2009
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
Ratings ListRatings Affirmed; CreditWatch ActionTo FromTelefonica S.A.Corporate Credit Rating BBB/Watch Neg/A-2 BBB/Negative/A-2Telefonica Chile S.A.Telefonica Moviles Chile S.A.Telefonica Czech Republic ASCorporate Credit Rating BBB/Watch Neg/-- BBB/Negative/--Telefonica S.A.Senior Unsecured BBB/Watch Neg BBBCommercial Paper A-2/Watch Neg A-2Telefonica Chile S.A.Senior Unsecured BBB/Watch Neg BBB
Telefonica Emisiones S.A.U.
Senior Unsecured* BBB/Watch Neg BBBTelefonica Europe B.V.Senior Secured* BBB/Watch Neg BBBSenior Unsecured* BBB/Watch Neg BBBCommercial Paper* A-2/Watch Neg A-2Subordinated 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 BBBTelefonica N.A. Inc.Commercial Paper* A-2/Watch Neg A-2
Complete ratings information is available to subscribers of RatingsDirect onthe Global Credit Portal at
. All ratings affectedby this rating action can be found on Standard & Poor's public Web site at. Use the Ratings search box located in the leftcolumn.(New York Ratings Team)