Analyst Commentary

• Telefónica has largely blamed its home market for its poor performance in Europe, where economic uncertainty and austerity measures have forced it to cut prices amid a gruelling price war.

• With VoIP and messaging services cutting away at traditional mobile voice and SMS revenues, Telefónica is targeting data use and VAS to bolster a 13.7% drop in the Spanish wireless sector.

Today we focus on four developments:

• Telefónica has revealed its first-quarter revenues stayed relatively flat compared to the same quarter of 2011, rising just 0.5% year-on-year (y/y) to EUR15.51 billion (USD20.08 billion), as 8.3% y/y sales growth in Latin America was offset by a 6.6% y/y revenue drop in Europe. The Spanish incumbent saw notable double-digit revenue drops in Spain due to a weak mobile sector, while sales fell 3.9% y/y in the United Kingdom, with Germany seeing the only growth in the region, up 2.5% y/y. In Latin America, Telefónica's key Brazilian market saw 2.5% y/y revenue growth, boosted by double-digit gains in Argentina, Peru and Colombia, while Mexico saw a disappointing sales drop of 6.4% y/y.

• The group's operating income before depreciation and amortisation (OIBDA) fell 8.8% y/y to EUR5.08 billion, while operating income dropped 17.7% y/y to EUR2.51 billion. Telefónica also revealed its first-quarter net profit plunged 54% y/y to EUR748 million, due to a write-down of its 10% indirect stake in struggling Italian incumbent Telecom Italia, which announced this week that its own revenues grew 4.5% y/y, as double-digit growth in its Latin American markets offset declines at home (see Italy:10 May 2012: Analyst Commentary).

• The European Parliament has voted to approve the latest raft of regulation of mobile roaming rates, the fees telecoms operators charge customers for mobile use abroad, meaning the first round of cuts to the fees will come into effect on 1 July 2012. The agreement was adopted in the European Parliament with a massive 578 votes in favour, with just 10 against and 10 abstentions. The regulation must now be approved by the EU Council of Ministers in June, but this is likely to be a formality given the overwhelming support for the cuts. The European Commission (EC) approved the latest package of cuts in March, which are designed to prevent "bill shock", where mobile users return from trips abroad to find they have incurred excessive charges, often due to data use such as surfing the Internet or streaming music or video (see Europe: 29 March 2012: European Commission Approves Deep Cuts in Roaming Rates As Data Roaming Cap Introduced for the First Time). The latest round of legislation will see existing cap on voice call charges drop from EUR0.35 (USD0.45) per minute to EUR0.29 this year, then to EUR0.19 in July 2014—a drop of 46% over two years, while severe caps on mobile data roaming have been introduced for the first time, set at EUR0.70 per megabyte (MB) of data downloaded from July this year, and falling to just EUR0.20 per MB in 2014. The EC also plans to allow roaming customers to select which operator they use when travelling abroad, rather than the current system of roaming connection based on operator partnerships or network availability, paving the way for a new market of pan-European roaming specialists offering wholesale deals across the bloc to undercut the local players. The EU Vice-President and Commissioner for the Digital Agenda Neelie Kroes welcomed the cuts, saying by capping data use it has created a "roaming market for the smartphone generation", adding that the regulation has put an end to the "rip-offs" familiar to anyone who has used a mobile phone abroad. However, the cuts, along with other EU regulation on mobile termination rates, have provoked an escalating war of words between the EC and the larger operators, with Vodafone claiming over-regulation is damaging investment in the sector—particularly at a time when margins are tight and some heavy investment in LTE next-generation networks is expected.

• América Móvil's offer to raise its stake in KPN to 28% for some EUR2.64 billion has been rejected by the Dutch incumbent, who said that the bid "undervalues" the company. América Móvil owner Carlos Slim made the unsolicited offer earlier this week (8 May), in a significant attempt to move into the European market (see Netherlands: 8 May 2012: Analyst Commentary), and the company's Chief Financial Officer (CFO) Carlos García-Moreno has since been quoted by Dutch financial daily Het Financieele Dagblad as saying the Mexican giant will not raise its offer. KPN is reported to be concerned that the size of the stake being sought by América Móvil could give the conglomerate an uncomfortably large influence over its future strategy, especially as it struggles to reverse its fortunes in the face of increasing competition at home.

• TeliaSonera has announced that it has acquired an additional 7.87% stake in Teo LT from East Capital. This brings the Nordic operator's stake in the Lithuanian incumbent to 80.74%. This deal follows its acquisition of a 0.21% stake in Teo last October. Teo accounted for 3.1% of TeliaSonera's net sales before eliminations in 2011.

Our Take

Telefónica has largely blamed its home market for its poor performance in Europe, where economic uncertainty and austerity measures have forced it to cut prices amid a gruelling price war. Spain's economy, which sunk into a recession in the first three months of 2012, is not expected to grow again until the end of the year at the earliest. One of the reasons for Telefónica's dismal domestic performance has been the growth of the alternative operators at the expense of the incumbent. The largest alternative operator in Spain, Ono, has reported its first-quarter results, with revenues growing 5% y/y to EUR364 million. EBITDA grew 4.0% y/y to EUR186 million. Operationally, Ono reported that its cable subscriptions fell by 1.0% y/y to 4.03 million, but noted an increase in revenue generating units (RGUs) per customer to 2.25, leading to an increase in average revenue per user (ARPU) of 2.2% to EUR52.1. Its mobile service saw considerable growth, with 202,000 subscriptions, up 47.4% y/y, while the potential remains for it to launch a fully fledged LTE network with licences won in 2011 (see Spain: 1 August 2011: LTE Spectrum Auction Raises USD2.38 Bil. As Telefónica, Orange and Vodafone Take the Spoils).

Telefónica is reforming its mobile data offering in Spain, allowing for data plans to be shared across devices, while charging extra for VoIP services on all but it's highest tariffs (see Spain: 27 April 2012: Analyst Commentary). The operator is looking to push data use and VAS to bolster declining voice revenues, and has signed a deal with EA Mobile to distribute the publisher's mobile games to its European subscribers, with the potential for gaming subscription services to follow (see Europe: 18 April 2012: Telefónica Signs Content Deal with EA Mobile). Meanwhile, the Spanish regulator CMT has cut the price of wholesale access to Telefónica's broadband network by nearly 14%, saying the costs for the incumbent to offer these services to its competitors have declined, meaning current prices are outdated.

Alongside its first quarter results, Telefónica announced that it has sold its entire shareholding in Portuguese cable operator ZON Multimedia to Angolan investor Isabel dos Santos, increasing her stake to 15%. The amount paid for the shares was not disclosed, but Telefónica had previously mentioned its strategy of divesting non-core or underperforming assets. ZON has announced its first-quarter operating revenue stayed virtually flat at EUR214.2 million, while earnings before interest, taxes, depreciation, and amortisation (EBITDA) inched up by 0.2% to EUR79.7 million.

Telefónica has also announced the launch of its new communication service, TU Me. The data-based communication service takes aim at existing services such as WhatsApp. With VoIP and messaging services like WhatsApp cutting away at traditional voice and messaging revenues, Telefónica is hoping that the service, available to all users, will help to drive data revenues.