Telefonica - Banco BPI

BPI

Back to growth(Price Target raised from € 9.40 to € 12.50; Recommendation upgraded from Reduce to

CoRe Buy)

4 More visibility in Spain. The last two quarters revealed an improving trend for

TEF Spanish operations powered by strategic decisions taken in 2012 (no

subsidization and convergent offers). The risks of ARPU dilution are being

more than compensated by the savings experienced and the transformation of

the market towards convergence which is bound to be a structural competitive

advantage for TEF. Also the commitment to improve efficiency is becoming

evident in the company's results and should help sustain an improving OIBDA

evolution in the coming quarters.

4 Organic OIBDA likely to post growth in 2013. We upgraded our consolidated OIBDA

estimates for 2013 by 4.7% following our more optimistic view on the evolution

of the Spanish market. Following a flattish organic evolution of consolidated

OIBDA in the last two quarters we now expect the company to post positive

organic growth in 2013 ahead of the guidance provided. Aside from this, and

following the announced divestments we now believe that TEF is already on

track to meet its FY net debt guidance.

4 Upgrading our recommendation to CoRe Buy. We have updated our estimates,

reflecting our revised macro assumptions, including the cut in the Spanish

Rf+CrP from 5% to 4.1%, and raised our YE13 Price Target to € 12.50 (+33%).

An improving trend in TEF Spanish operations, an astonishing delivery in balance

sheet deleverage and a still enticing outlook for Latam are compelling arguments

to be positive on the investment case. Aside from this we anticipate some

tailwinds from European regulation that could be particularly beneficial for

TEF given the intense competition witnessed currently in Spain. CoRe Buy.

Stock data

Price (24th May): 10.73 Price Target: 12.50

No. of shares (mn): 4 551 Market Cap.(€ mn): 48 810

Reuters/Bloomberg: TEF.MC/TEF SM Free-Float: 89%

Net Debt/EBITDA '13: 2.34 ROE '13: 20%

EPS Growth ('11-'14): 7.4% Avg. Daily Turnover [€ '000]: 344 933

Major shareholders: BBVA (5.753%); Criteria: (5.596%); Blackrock (3.895%)

Estimates 2011 2012 2013F 2014F 2015F 2016F

EPS Adj. (€) 1.60 0.86 1.01 1.03 1.07 1.19

P/E Adj. 6.7 12.4 10.6 10.4 10.0 9.1

Dividend Yield 14.2% 7.7% 3.4% 7.0% 7.0% 9.0%

FCF yield 14.1% 11.2% 10.8% 10.4% 10.6% 11.1%

EV/EBITDA 5.0 5.2 5.3 5.3 5.2 5.0

TEF vs IBEX 35 vs DJ Stoxx 600

EQUITY RESEARCH

TelefonicaTelecoms

CoRe BuyMedium-Risk

31st May 2013

Spain

Source: Bloomberg.

Historical Recommendation

Date Recommendation

18-Oct-11 Hold

22-Oct-12 Reduce

Source: BPI Equity Research.

Analysts

Pedro Oliveira

[email protected]

Phone (351) 22 607 3194

João Urbano

[email protected]

(351) 22 607 3221

Available on our website:

www.bpiequity.bpi.pt, BPI Online,

and Bloomberg at NH BPD

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Equity Research 4 Telefonica 4 May 2013

BPI vs. Consensus

Company: Telefonica

Sector: DJ Euro Stoxx Telecom. € Pr

Valuation monitor

Relative Valuation 2013 2014 2015

EV/EBITDA

BPI 5.3 5.3 5.2

Consensus 4.9 4.7 4.5

Sector 6.5 6.3 6.0

P/E

BPI 10.8 10.7 10.4


Sector 11.6 11.0 10.4

PBV

BPI 2.1 2.1 2.0


Sector 6.9 2.7 2.3

Dividend yield

BPI 3.4% 7.0% 7.0%

Consensus 7.0% 7.0% 7.0%

Sector 6.9% 7.0% 7.2%

P&L and B\S monitor

BPI estimates/Consensus 2013 2014 2015

Revenues 0.0% -1.3% -1.7%

EBITDA 0.6% -2.9% -3.6%

EBIT -0.2% -7.0% -5.7%

Net Profit -3.3% -7.9% -8.3%

Net Debt -1.3% 0.6% 1.4%

Capex 1.3% 6.3% 1.4%

Profitability monitor

EBITDA Margin

BPI 34.3% 33.8% 34.2%

Consensus 34.2% 34.4% 34.8%

EBIT margin

BPI 16.9% 16.2% 16.9%

Consensus 16.9% 17.2% 17.6%

Net Profit margin

BPI 7.9% 8.1% 8.4%

Consensus 8.2% 8.6% 9.0%

Key leverage ratios

Net Debt/EV

BPI 0.46 0.45 0.44

Consensus 0.49 0.47 0.46

Net Debt/EBITDA

BPI 2.45 2.45 2.32

Consensus 2.38 2.25 2.09

Stock Momentum

Price Performance Forward P/E and EV/EBITDA

Market Price Rating (€) Market Recommendations

Fair Value Comparison (€) CAGR 2012-15

EBITDA Consensus (€mn) EPS Consensus (€)

Source: Factset, Bloomberg and BPI Equity Research.

0% 5% 10% 15%

YTD

3 M

1 Y

Telefo nica DJES Telecom

-10

0

10

20

30

40

50

93 95 97 99 01 02 04 06 08 10 11 13

-20

0

20

40

60

80

100

Fo rward P /E

EPS Gro wth

0

4

8

12

16

Jan-12 M ay-12 Sep-12 Jan-13 M ay-13

P rice

P rice Target Consensus

P o sit ive40%

Negative24%

Neutral36%

-10% -5% 0% 5%

Revenues

EB ITDA

EB IT

Net P ro fit

A dj. EP S

B P I Consensus

19 000

21 000

23 000

25 000

Jan-11 No v-11 Aug-12 M ay-13

FY13

FY14

FY15

1.0

1.4

1.8

2.2

Jan-11 Nov-11 Aug-12 May-13

FY13

FY14

FY15

12.60

8.02

11.8112.50

0

6

12

18

P/E PBV Consensus BPI

Current M arket Price

3


Telefónica at a Glance

Revenue Organic Growth (yoy) Operational Cash Flow breakdown (FY13F)

Source:Telefónica. Source: BPI Equity Research.

Mobile Revenue Market Share in Spain (4Q12) Wireline Revenue Mkt Share in Spain (4Q12)

Source:Telefónica. Source: CMT & BPI Equity Research.

DPS evolution (€) FY13F Op. CF Margin per division

Source: Telefonica and BPI Equity Research. Source: BPI Equity Research.

Debt maturity at FY12 (€ mn)

Source:Telefónica.

Financial Struture

(€ bn) 1Q13

Net Debt (1) 53.9

Avg cost of debt 5.22%

% debt in Eur 78%

% debt in Latam 11%

% debt in other 11%

Rating(S&P/Fitch) BBB/BBB+

Source:Telefónica.

-10.5%

6.8%

-16.3%

-1.6%

-20% -15% -10% -5% 0% 5% 10% 15%

Telefó nicaEuro pe

Telefó nicaLatino américa

Telefó nicaEspaña

Co nso lidated

1Q2011 2Q2011 3Q2011 4Q12011 1Q2012 2Q20123Q2012 4Q2012 1Q2013

Telefó nica Latam

45%

Telefónica Europe

12%

Telefónica Spain43%

Vo dafo ne28%

M ovistar(Telefó nica)

38%

Others7%

Yo igo5%

Orange22%

Ono15%

Jazztel9%

Orange7%

Vo dafo ne5%

Other8%

Telefonica56%

0.82

1.49 1.40 1.60

0.75 0.75

0.000.0

0.4

0.8

1.2

1.6

2.0

2008 2009 2010 2011 2012 2013 2014

18.8%

16.1%

9.6%

18.8%

37.0%

0% 10% 20% 30% 40%

Spain

Brazil

Other LaTA m

Euro pe

Co nso lidated

10 2457 850

11 4199 774

27 565

15% 12% 17% 15% 41%0

10000

20000

30000

2013 2014 2015 2016 >2016

4


MARKET SEEMS OVERLY CONSERVATIVE IN SPAIN

Results of the change in strategy more visible now

TEF launched during 2012 several structural changes in its strategy for the Spanish

market with important impact in financials. Of those we highlight the following:

i) End of handsets subsidization

ii) Progressive elimination of the loyalty program

iii) Launch of a convergent offer

i) End of handsets subsidization

TEF announced in the first quarter of last year the end of handsets subsidization.

Orange decided not to follow while Vodafone tried to pursue the same policy.

Nonetheless, a few months down the road VOD introduced again subsidization

due to the intense competition from Orange, Yoigo and the MVNOs. The decision

to eliminate subsidization had a powerful impact in TEF’s financials (more visible

in the last three quarters) reducing significantly commercial costs through lower

volume of handsets sales as well as through lower subscriber acquisition costs.

ii) Progressive elimination of the loyalty program

The loyalty program consisted in attributing points based on the level of consumption

that could be used as discounts in the renewal of equipments. The loyalty program

was a major source of subsidization as operators frequently offered additional points

at the time of the renewal of equipment. TEF decided first to eliminate the offer of

points at the time of the renewal of equipment and then in a second stage migrate

clients to packages that did not offer points for consumption like the convergent

offer "Movistar Fusion".

iii) Launch of a convergent offer

TEF launch of Movistar Fusion last October has been a huge success and kicked a

structural transformation of the market particularly meaningful for the mobile

segment. We believe that this offer empowered by FTTH connections provide TEF

a strong competitive advantage and reinforces the commitment to reduce commercial

expenses by reducing churn and by using the wireline service as the tool to attract

mobile customers (instead of handsets subsidization).

Movistar Fusion Movistar Fusion

customers (k) new customers / gross adds (%)

Source: Telefonica.

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Due to the lag of implementation, the impact of these initiatives only revealed

profitability improvements in the last two quarters. However, since the 3Q last

year, when TEF reported handsets revenues down 38% yoy (+6.4% and + 2.7% in

the previous two quarters) the effects in financials started being noticeable.

Handset revenues in Spain (€ mn)

Source: Telefonica.

The main risk of Movistar Fusion is its ARPU dilutive nature as its main selling

point is savings for the user in the telecommunication monthly cost. At the same

time, the end of subsidization and loyalty program implies an important loss of

subscribers and one could argue that it is also ARPU dilutive. Therefore pressure

in customer revenues from TEF’s new policy is unavoidable.

Mobile customer revenues evolution in Spain (yoy)

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Source: TEF & BPI Equity Research.

Despite the anticipated pressure, mobile customer revenues have improved in the

last couple of quarters due to the impact of the loyalty program. The points attributed

under this program (both on a monthly basis as well as those attributed at the

renewal of the handset) are recorded as minus revenues. Excluding this effect we

believe the underlying trend has been relatively stable and should improve in the 2H of the

year as comparables become more benign. It is worth highlighting that 2Q results

should still reflect the positive impact of the loyalty program.

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Service revenues evolution in Spain (yoy)

Source: Telefonica.

While it is always difficult to assess how good a strategic shift has been because we

never know the results of the alternative scenario, it seems that ending the loyalties

program has been the right strategy. TEF apparently did not erode the underlying

trend and still benefited from the savings (which were previously recorded as minus

revenues) of the implied subsidization. 3Q will likely be clean of the loyalty program

impact and therefore more depressed but, it is also true that the subscriber base

has reduced significantly the number of subscribers willing to churn to find the

best handset offer. Moreover, the first wave of convergent offers has been very

strong boosting churn levels. As soon as the first wave of convergence fades, churn

will likely come down and stabilize at lower levels than before.

In the wireline, we expect the trend to continue improving throughout the year

empowered by increasing penetration of convergence and FTTH connections that

constitute an important leverage vis-à-vis the competition. All in all, we expect Spanish

service revenues (including wireline and mobile) to fall 9.8% in FY13 vs. 12% in Q1.

The devil is in the details!

We continue to witness some excessive conservativeness in margins estimates, in

our view. The company revealed a strong optimism on its ability to continue to trim

down costs across the board in its last results' conference call and the trend seems

enthusiastic.

Opex quarterly evolution

1Q12 2Q12 3Q12 4Q12 1Q13

Personnel 576 574 539 544 559

-8.2% -9.4% -9.1% -13.3% -3.0%

Commercial 663 571 431 486 411

-9.4% -16.9% -27.7% -24.1% -38.0%

Other 1 063 1 038 1 008 958 830

-8.3% -10.0% -12.5% -25.1% -21.9%

Total Opex 2 302 2 183 1 977 1 988 1 799

-8.6% -11.8% -15.5% -22.0% -21.8%


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Spanish GDP quarterly yoy

evolution (%)

Source: Bloomberg.

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

1Q12 3Q12 1Q13E 3Q13E

7


Commercial costs have been the main source of Opex cuts, reflecting the new

strategic approach of the company for Spain. To better scrutinize this caption we

prefer to look at it net of handset sales to better understand the trends in

subsidization (by cutting handset sales it is possible to improve margins but only

improves OIBDA if subscriber acquisition costs [SAC] decreases).

Commercial costs evolution (€ mn)


Looking in detail we believe that commercial costs will be a source of pressure in the

OIBDA yoy trend in the coming quarters. The reason behind is that churn levels were

very low in the 2Q and 3Q last year (1.7%) and unlikely to be repeated this year

given the intense competitive environment. Moreover, in the 1Q results comparables

were somewhat benign as churn in 1Q12 stood at 2.8% (dropping to 2.3% in

1Q13) and still SACs only dropped by 5% indicating an increase in SAC per gross

add. Our reading is that the competitive environment does not allow TEF to reduce

much more its levels of SACs. Finally we expect some acceleration in handset revenues

following some promotions by TEF, as users start to get acquainted with the leasing

model. Although this trend is likely to pressure commercial costs, it should have a

meaningless impact in OIBDA. We expect commercial costs and handset revenues

to fall yoy in 2013 by 18.3% and 44.5%, respectively (37.8% and 67.5% in the

1Q13).

Personnel costs with room for surprises… Telefonica is currently underway with its

restructuring plan and we estimate that around 5K employees have already left the

company under this program. When analysing the numbers reported in the 1Q

personnel costs seem oddly high, dropping only 3% which compares with 13%

and 9% falls in previous quarters. Considering that the program to cut down

employees is still not finished (around 2k still expected to accept early retirement)

and that the impact drags for a few quarters, we believe 1Q evolution does not

reflect the expected trend for the FY. We estimate a 6.9% fall in 2013.

-10%

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-22%

-20%

-5%

-5%

+14%+18%

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Aside from commercial and personnel costs the company anticipates further

efficiencies from insourcing and deepening in simplification. From the recent

evidence of other operators in distressed markets, we believe TEF still has room to

improve its efficiency levels. Moreover, we believe that Movistar Fusion, by

concentrating several RGUs in a single client’s account, will simplify and optimize

customer care and as the company walks through the learning curve of tackling

the market as an integrated player we expect further efficiencies delivered. TEF

booked a € 233mn Opex ex-commercial while personnel expenses decrease in 1Q

and we expect a € 718mn fall in the FY.

Opex anual evolution

2010 2011 2012 2013F 2014F

Personnel 2 658 2 482 2 233 2 079 2 053

-6.6% -10.0% -6.9% -1.3%

Commercial 2 933 2 656 2 151 1 758 1 870

-9.5% -19.0% -18.3% 6.4%

Other 4 838 4 742 4 066 3 349 3 177

-2.0% -14.3% -17.6% -5.1%

Total Opex 10 430 9 880 8 450 7 186 7 100

-5.3% -14.5% -15.0% -1.2%

Note: 2011 figures are adjusted of the € 2.6bn provision for restructuring plan.


All in all we believe that OIBDA yoy trend might worsen slightly in the next quarter

due to tough comparables, on the back of low churn levels in 2Q12, but the trend

should improve in the 2H.

OIBDA 1Q evolution


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The improvement in service revenues for the 2H of the year coupled with room for

further Opex cuts lead us to expect OIBDA to fall by 7.1% in 2013 vs. a fall of 8.2%

in 1Q13 (-6.3% in organic terms) with room for positive surprises. Looking to

consensus, it seems to be pointing towards a double digit fall in OIBDA for the FY

which we deem as overly conservative leaving room for possible upgrades in the

coming quarters.

OIBDA FY evolution


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UPGRADING ESTIMATES

We have raised our estimates supported by a strong upgrade for TEF’s Spanish

operation. As described before we see an improving trend and more clarity on

TEF’s strategy which, in our view, provides room for upgrades in profitability despite

the additional pressure in top line.

Changes in estimates breakdown

Old New Old New Old New

2013E 2013E Chg (%) 2014E 2014E Chg (%) 2015E 2015E Chg (%)

Revenues

Spain 13 540 13 238 -2.2% 13 321 12 583 -5.5% 13 525 12 604 -6.8%

Europe ex-Spain 14 635 14 141 -3.4% 14 796 14 242 -3.7% 14 998 14 436 -3.7%

UK 6 619 6 390 -3.4% 6 704 6 441 -3.9% 6 802 6 531 -4.0%

Germany 5 227 5 185 -0.8% 5 328 5 287 -0.8% 5 445 5 406 -0.7%

Czech Republic and Slovakia 2 099 1 892 -9.9% 2 105 1 869 -11.2% 2 122 1 880 -11.4%

Latam 27 680 29 279 5.8% 27 378 29 211 6.7% 26 783 28 957 8.1%

Brazil 12 957 13 151 1.5% 12 810 12 917 0.8% 12 443 12 528 0.7%

Total Revenues 55 855 57 463 2.9% 55 494 56 840 2.4% 55 306 56 802 2.7%

OIBDA

Spain 5 619 6 347 13.0% 5 544 5 779 4.2% 5 599 5 709 2.0%

Europe ex-Spain 3 895 3 843 -1.3% 4 036 3 907 -3.2% 4 199 4 036 -3.9%

UK 1 558 1 607 3.2% 1 659 1 666 0.4% 1 760 1 726 -1.9%

Germany 1 406 1 375 -2.2% 1 447 1 418 -2.0% 1 511 1 481 -1.9%

Czech Republic and Slovakia 888 730 -17.8% 886 696 -21.4% 894 704 -21.3%

LatAm 9 823 9 955 1.3% 9 683 9 975 3.0% 9 503 10 106 6.3%

Brazil 4 562 4 637 1.6% 4 520 4 693 3.8% 4 452 4 741 6.5%

Total OIBDA 19 139 20 029 4.7% 19 065 19 544 2.5% 19 103 19 734 3.3%


In Latam the upgrades are basically powered by Brazil where we expect a slightly

better outlook and more favourable €/BRL FX. TEF Brazil continues to strengthen

its competitive position in the mobile segment and become a clear winner in the

higher value added customers. The company is poised to lead data revolution in

Brazil and we still see room for higher efficiency in the post-merger process. On

the other hand, the wireline continues to be a concern as competition remains

tough and we fail to see decisive steps to empower the Pay-TV business.

Also worth highlighting are the downgrades in Chile (-10% in OIBDA13) and

Mexico (-26%) that posted disappointing results in the 1Q results. These downgrades

were offset by upgrades in Argentina (+23%) and Venezuela (+20%) due changes

in FX estimates in the first case and ability to partially offset the Bolivar devaluation

with price increases (ARPU in 1Q raised 13% in local currency) against our previous

expectation.

In UK, similarly to Spain, we also expect an improvement in profitability despite

having to cut our top line estimates. However, we have to stress that in this case

the improvement in top line trend is much clearer than in Spain. The main reason

behind our optimism in profitability is the company’s success in increasing its

TEF group change in estimates

(€ mn) 13F 14F 15F

Revenues 2.9% 2.4% 2.7%

EBITDA 4.7% 2.5% 3.3%

Op.Income 6% 4% 8%

Net Income 1% 6% 18%

Capex -7% -7% -5%

Op. Cash-Flow 17% 13% 10%


11


contract mix and decreasing churn which consequently reduces significantly

commercial costs. We expect commercial cost to decrease by 12% in 2013. The

German unit is being impacted by a high competitive environment that is pressuring

voice prices down which we attribute to the concentrated decrease of mobile

termination rates in 2013.

OIBDA organic evolution (yoy)

Source: Telefonica.

From a consolidated view the trend of the business seems to be improving for the

fourth consecutive quarter and is now presenting a flattish organic OIBDA growth.

We believe TEF will surpass easily its 2013 guidance of organic revenue growth

and lower decline in margins than in 2012. Indeed we believe revenue growth

should stand in line with expectations with slight growth (+0.4%) but margins

have room for positive surprises and should decrease only marginally (-0.1pp).

Therefore, we expect consolidated OIBDA to raise 0.3% organically, which implies

a slight improvement in the trend for the remaining of the year. We do not exclude

some upside risks to our estimates. On capex we remain conservative as the

company's challenges on this front are multiple, though acknowledging that recent

agreements for shared investments provide some optimism.

2013 guidance

TEF BPI (1)

Revenues Growth 0.4%

OIBDA margin Lower margin decline 35%

than in 2012 (-1.4pp) (-0.1pp)

Capex (ex-Spectrum) Similar Capex / 14.8%

Sales as in 2012 (14.1%)

Net financial debt < 47bn 46.8

(1) According to TEF guidance criteria.


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Regarding Net Debt, which has been one the investment case�s main caveats, we

believe that the announced divestments already ensures TEF is able to meet it�s FY

guidance. Nonetheless, TEF indicated that it will likely continue to de-leverage

which if confirmed will provide TEF with balance sheet flexibility and allow the

company to consider other value creation opportunities.

Net Debt evolution 2013 (E mn)


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VALUATION SUMMARY

Following the upgrade in our consolidated estimates, we have upgraded our valuation

by 33%. The main contributions to this upgrade were a 30% increase in the

valuation of the Spanish unit (+16% excluding the decrease of Rf+CrP from 5% to

4.1%) and a c. 25% raise in Latam brought mainly by upgrades in Brazil, Peru,

Central America, Argentina and Venezuela.

Telefonica Sum-of-Parts

(€ mn) Stake EV @ stake Weight Method WACC EV/Op.CF13F EV/EBITDA13F

Spain 100% 40 747 37.7% DCF 8.1% 8.3x 6.4x

Europe ex-Spain 21 998 20.4% 12.7x 6.7x

UK 100% 10 766 10.0% DCF 8.2% 13.7x 6.7x

Germany 77% 7 661 7.1% DCF 7.6% 13.6x 7.2x

Czech R. /Slovakia 69% 3 219 3.0% DCF 9.1% 11.2x 6.4x

Ireland 100% 352 0.3% DCF 11.2% 7.7x 3.4x

Latam 41 867 38.7% 9.8x 5.0x

Brazil 74% 18 461 17.1% DCF 8.8% 10.1x 5.4x

Argentina 100% 1 942 1.8% @ 4.5x OpCF - 4.5x 2.1x

Chile 99% 5 593 5.2% DCF 8.8% 12.6x 6.1x

Peru 99% 7 332 6.8% DCF 9.0% 13.7x 8.0x

Mexico 100% 2 053 1.9% DCF 9.3% 41.4x 5.1x

Venezuela 100% 2 644 2.4% DCF 14.8% 3.6x 2.5x

Colombia 70% 1 814 1.7% DCF 8.9% 12.8x 4.2x

Other Latam 1) 84% 2 028 1.9% DCF 9.6% 10.9x 4.9x

Tax credits 1 190 1.1% NPV

OIBDA non-contributing assets 2) 2 274 2.1% MV & BV

Total assets 108 075 100.0%

Attributable Net debt 3) 48 217

Other financial commitments 3 017

YE13 Equity value 56 841

# shares 4 551

YE13 price target 12.50


Notes to Sum-of-Parts:

1) This division includes Central America (Guatemala, El Salvador, Nicaragua,

Panama and Costa Rica) as well as Ecuador and Uruguay. TEF sold in April a

40% in Central America ex-Costa Rica for USD 500mn plus a variable amount

of up to USD 72mn.

14



4) Other financial commitments includes commitments related with workforce

reduction (€ 3bn), post-employment defined benefit plans (€ 2.3bn) deducted

from associated long term assets (€ 1.5bn), and tax credits arising from these

commitments (€ 695mn).

2) OIBDA non-contributing assets are detailed as follows:

OIBDA non-contributing assets

(€ mn) Method

China Unicom 1 009 MV

DTS, Distribuidora de Televisión Digital 488 Aq. Value

BBVA 266 MV

Telco (1) 0 MV

Loans to associates (2) 352 BV

Prisa convertible bond 100 BV

PTC 55 MV

Amper 2 MV

Total 2 274

1) Adjusting Telecom Italia BV for current market prices implies a negative BV for Telco

2) TEF reports €852mn of loans to associate companies. We deduct the €100mn Prisa

convertible bond detailed below and atribute a 50% loss (€400mn) to the loans

provided to Telco.

3) Considering that our total EV is already at stake we adjust the net debt

proportionally to TEF’s stakes in Brazil, Germany and Czech Republic (reduction

of € 382mn). Also, we attribute a 50% discount to the cash held in Venezuela

adding to the net liabilities in the SoP € 949mn. Finally, we consider the fair

value of short and long-term financial investments included in the net financial

debt (according to TEF’s annual report fair value of these investments should

be € 836mn lower than book value)

Net liabilities reconciliation Sensitivity of YE13 price target to

changes in Rf and G of the Spanish

businesses (€/share)

g

-1.00% 0.50% 1.00%

-1.00% 15.67 15.84 16.01

Rf 0.00% 12.35 12.50 12.63

1.00% 9.80 9.91 10.03


DCF Assumptions

EBIT

WACC Re Rf mg (1)

Spain 8.1% 11.1% 4.1% 31.1%

Europe

ex-Spain 8.2% 10.7% 3.4% 16.4%

UK

(mobile) 8.2% 11.0% 3.3% 14.4%

Germany

(mobile) 7.6% 10.2% 3.3% 16.0%

Czech Rep. and

Slovakia 9.1% 10.7% 4.3% 24.5%

Ireland

(mobile) 11.2% 12.3% 6.3% 9.6%

Latam 10.0% 11.9% 5.6% 23.1%

Brazil 8.8% 10.9% 4.7% 26.0%

Argentina 23.8% 24.8%19.7% 9.1%

Chile 8.8% 11.6% 4.2% 19.5%

Peru 9.0% 10.8% 4.6% 26.2%

Mexico 9.3% 11.3% 4.6% 11.5%

Venezuela 14.8% 14.8% 9.7% 33.1%

Colombia 8.9% 10.8% 4.6% 15.5%

Other 9.6% 10.9% 4.9% 14.0%

(1) Perpetuity.


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Spain Brazil UK

Venezuela Germany Others

Our valuation for the Latam unit implies a 9.8x Op.CF13 or 5.0x EV/EBITDA13 with

a weighted average real WACC of 8.1% and an Op.CF CAGR13-20 of 4.2% in

Euros. Brazil is the main asset of Latam and is worth 44% of the total value of the

Latam unit. Our DCF valuation for Brazil implies an upside to current market prices of

22%.

Latam countries overview

Population GDP per LT LT Tax Mobile Data non-SMS Mobile Mobile

(k) capita (USD) GDP (1) CPI (1) rate penetration penetration mkt share ARPU (€)

Brazil 201 420 12 079 4.2% 4.5% 34% 135% 20% 30% 8.5

Argentina 41 028 11 576 3.0% 10.1% 35% 145% 14% 30% 10.0

Chile 17 403 14 552 4.6% 3.0% 20% 149% 14% 39% 11.3

Peru 30 474 5 948 6.0% 2.0% 30% 86% 11% 58% 6.8

México 114 872 10 247 3.3% 3.0% 28% 92% 13% 19% 5.2

Venezuela 29 517 12 956 2.6% 20.0% 34% 110% 22% 29% 15.6

Colombia 46 598 7 855 4.5% 3.0% 33% 116% 21% 24% 6.9

1) IMF.

Source: Telefonica, IMF and BPI Equity Research.

We share the market view on the upside potential for Latam and the importance

mobile data should have to monetize this potential. Nonetheless, we diverge in the

valuation of Argentina and Venezuela units where we prefer to have a more

conservative stance given the underlying political risks added to the difficulties to

transfer funds out of these countries. We value these assets at 2.1x and 2.5x EV/

EBITDA, respectively.

After Brazil, Mexico is the second most important country in TEF’s latam coverage

and probably the one where TEF has more upside risks. The regulation changes

that are in process of being approved might reduce the hegemony of Carlos Slim’s

group and allow TEF to extract a lot more value from the country. Our valuation

reflects a conservative scenario in case this scenario materializes or an aggressive

one in case the status quo is maintained.

Following Brazil, Peru and Chile are the second and the third most valuable assets

in TEF Latam portfolio. Peru seems poised to prosper in the coming years with the

IMF anticipating the higher GDP growth in the region. The low levels of ARPU, a

reflection of the depressed GDP per capita coupled with very low levels of data

penetration lead us to anticipate strong growth ahead (Op.CF CAGR13-20 of 8.6%).

TEF dominant position in the country ensures a leading role in capturing this

growth potential, we think. Chile is probably the more stable economy in the region,

though still presenting interesting GDP growth expectations. The stability coupled

with a low tax environment enhances the value of the asset. Strong competition

and the current high ARPU levels cap, in our view, some of the growth potential.

We value Spain through a DCF with a 8.1% WACC, an Op.CF carg13-20 of -2.9%

and an EBIT margin in perpetuity of 31% yielding a 8.3x EV/Op.CF and a 6.4x EV/

EBITDA, 30% up from our last valuation. We cut our Rf+CrP from 5% to 4.1% and

adjust our cost of debt to reflect decreasing risk of Spanish economy but also TEF

Proportional OIBDA & OpCF

breakdown (2013E)


16


healthier balance sheet (down from 6.5% to 5.1%). Excluding this impacts our

valuation would have value raised by 14% or 16% only considering the changes in

Rf+CRP.

A DDM approach is also supportive of our positive recommendation

We decided to cross-check our valuation with a consolidated DDM approach. Our

methodology includes the NPV of the expected dividends in the explicit period

(until 2020) added of a perpetuity based on 2020 FCFE, assuming an implied

100% pay-out thereafter, updated to YE13. We use a blended cost of equity of

11.3% and a perpetuity growth rate of 1.5% on this approach. We then adjust the

equity value adding non-OIBDA and non-dividend contributing assets, tax credits

and deduct other commitments.

To calculate the FCFE released to pay dividends we exclude the listed subsidiaries

(Brazil, Germany and Czech Republic) plus Argentina and Venezuela contribution

and add the expected proportional dividends to be received by these units. We

assume zero dividends from Venezuela and Argentina.

FCFE calculation (€ mn)

2013 2014 2015

Consolidated EBITDA-Capex 10 804 10 396 11 360

(-) Listed subsiaries + Arg + Venez -4 793 -4 100 -4 975

Cancelation of commitments - 775 - 624 - 492

Net interest payment (1) -2 790 -2 616 -2 522

Payment for tax (1) 335 305 136

WK (1) 485 89 - 37

Dividends from subsdiaries 2 335 2 577 2 902

FCFE 5 600 6 027 6 372

(1) Excludes listed subsidiaries + Arg + Venez.

Dividends received (€ mn) [Proportional]

2013 2014 2015

Brazil 1 465 1 639 1 907

Argentina 0 0 0

Venezuela 0 0 0

Czech Republic and Slovakia 225 263 266

Germany 625 649 684

China Unicom 19 26 45

Total 2 335 2 577 2 902

Source: PT, BPI Equity Research (E).

The estimated dividends to be paid by TEF’s parent company are derived from

target leverage below 2x by the end of the explicit period, which we believe is a

long-term sustainable level. Dividends promised for 2014 yield a 7% return and

even under a conservative leverage assumption (<2.0x) we still see room for upgrades

beyond 2016 (inclusive). Our estimated dividend CAGR13-20 stands at 11.7%.

Effective interest rating (12

month rolling)

Source: Telefonica.

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FCFE vs. DY and leverage


Our DDM valuation seems also supportive of a positive recommendation as we reach a

€ 12.2 fair value per share, 2.8% below our base case. Moreover, we have to stress

that under this methodology Venezuela and Argentina are worth zero which in our

view is overly conservative. For the sake of completeness if we assume that both

Venezuela and Argentina start paying annual dividends beyond 2020 worth 50%

of the respective Op.CF our DDM Fair value would jump to € 12.6 per share.

Incumbents multiples

EV/EBITDA P/E

13F 14F 13F 14F

Telefonica (1) 5.3x 5.3x 10.6x 10.4x

P. Telecom (1) 5.0x 4.6x 16.1x 9.6x

Telecom Itália 3.3x 3.3x 5.4x 5.3x

Hellenic OTE 3.4x 3.4x 11.0x 10.9x

France Telecom 3.9x 3.9x 7.5x 7.8x

Deutsche Telek. 4.5x 4.4x 13.2x 12.5x

British Telecom 4.8x 5.0x 11.9x 10.8x

KPN 3.7x 4.2x 8.2x 9.6x

SwissCom 6.6x 6.9x 13.5x 13.2x

Telekom Austria 3.9x 4.2x 19.0x 16.6x

Telenor 7.1x 6.6x 12.5x 11.2x

Belgacom 4.5x 4.8x 9.4x 10.0x

TeliaSonera 7.1x 6.9x 10.8x 10.4x

Average 4.9x 4.9x 11.5x 10.7x

Source: Factset and BPI Equity

Research.

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DDM Valuation

(€ mn)

Discount DDM 55 863

Other adjust. (562)

Equity value 55 301

# shares (mn) 4 551

Fair Value (€ per share) 12.2


18


Revenues and EBITDA breakdown (€ mn)

2011 2012 2013 2014 2015 2016

Revenues

Spain 17 284 14 985 13 238 12 583 12 604 12 724

Europe ex-Spain 15 524 15 010 14 141 14 242 14 436 14 704

UK 6 927 7 040 6 390 6 441 6 531 6 641

Germany 5 036 5 213 5 185 5 287 5 406 5 541

Czech Republic and Slovakia 2 130 2 010 1 892 1 869 1 880 1 894

LaTam 28 941 30 520 29 279 29 211 28 957 29 249

Brazil 14 326 13 618 13 151 12 917 12 528 12 390

Total Revenues 62 837 62 356 57 463 56 840 56 802 57 483

OIBDA

Spain 5 072 6 830 6 347 5 779 5 709 5 710

Europe ex-Spain 4 233 3 414 3 843 3 907 4 036 4 084

UK 1 836 1 602 1 607 1 666 1 726 1 737

Germany 1 219 1 351 1 375 1 418 1 481 1 514

Czech Republic and Slovakia 930 832 730 696 704 705

LatAm 10 891 11 103 9 955 9 975 10 106 10 384

Brazil 5 303 5 161 4 637 4 693 4 741 4 830

Total OIBDA 20 210 21 231 20 029 19 544 19 734 20 061

OIBDA margin

Spain 29.3% 45.6% 47.9% 45.9% 45.3% 44.9%

Europe ex-Spain 27.3% 22.7% 27.2% 27.4% 28.0% 27.8%

UK 26.5% 22.7% 25.2% 25.9% 26.4% 26.2%

Germany 24.2% 25.9% 26.5% 26.8% 27.4% 27.3%

Czech Republic and Slovakia 43.7% 41.4% 38.6% 37.3% 37.4% 37.2%

LatAm 37.6% 36.4% 34.0% 34.1% 34.9% 35.5%

Brazil 37.0% 37.9% 35.3% 36.3% 37.8% 39.0%

Total OIBDA 32.2% 34.0% 34.9% 34.4% 34.7% 34.9%

Capex Breakdown (mn)

Spain 2 914 1 692 1 455 1 521 1 676 1 718

Europe ex-Spain 1 705 1 770 2 484 1 681 1 707 1 573

UK 731 748 1 495 762 773 710

Germany 557 609 643 654 671 607

Czech Republic and Slovakia 229 248 314 235 236 229

LatAm 5 261 5 416 4 880 5 540 4 585 4 448

Brazil 2 469 2 444 2 160 2 ,833 2 058 1 850

Total Capex 10 224 9 458 9 225 9 148 8 374 8 145

Domestic KPI's (€ mn) 2011 2012 2013 2014 2015 2016

Mobile

# Subscribers 24 174 20 531 19 293 19 146 19 288 19 552

Net adds -135 -3,643 -1 238 -147 142 263

ARPU - customer bill 20.62 19.50 17.84 17.48 17.60 17.75

MOU 137.2 135.5 134.6 136.0 137.3 138.3

Handset sales 1 200 1 011 561 595 633 655

Data as % of service revenues 28.0% 32.0% 36.0% 40.1% 42.5% 44.6%

Wireline

# Subscribers (Fixed Voice) 12 305 11 723 11 582 11 663 11 745 11 827

# Subscribers (Broadband) 5 627 5 709 5 753 6 024 6 271 6 475

Broadband ARPU 32.2 26.7 23.5 21.8 21.8 22.2

Blended ARPU 62.8 54.9 49.2 45.6 44.9 44.4

Source: Telefonica, BPI Equity Research (E)

19


Income Statement

CAGR

(€ mn) 2011 2012 2013F 2014F 2015F 2016F 12-16F

Turnover (1) 63 576 63 178 58 326 57 747 57 754 58 482 -2%

EBITDA 20 210 21 231 20 029 19 544 19 734 20 061 -1%

EBITDA margin 31.8% 33.6% 34.3% 33.8% 34.2% 34.3% 0

Dep.+ Prov. 10 146 10 433 10 190 10 172 9 976 9,657 -2%

EBIT 10 064 10 798 9 839 9 372 9 759 10 404 -1%

EBIT margin 15.8% 17.1% 16.9% 16.2% 16.9% 17.8% 0

Net Financials 3 576 4 934 3 125 2 815 2 722 2 633 -15%

Extraordinaries 0 0 0 0 0 0 0

Income Tax 301 1 461 1 673 1 634 1 753 1 936 7%

Minority interest 784 475 428 246 411 441 n.s.

Net Profit 5 403 3 928 4 613 4 678 4 872 5 393 8%

(1) Includes capitalized expenses.

Balance Sheet

CAGR

(€ mn) 2011 2012 2013F 2014F 2015F 2016F 12-16F

Net Intangibles 53 171 50 041 50 041 50 041 50 041 50 041 0%

Net Fixed Assets 35 469 35 022 34 057 33 033 31 431 29 918 -4%

Net Financials 20 160 19 264 17 728 17 384 17 074 16 795 -3%

Inventories 1 164 1 188 1 095 1 083 1 082 1 095 0

ST Receivables 12 898 12 539 11 555 11 430 11 422 11 559 -2%

Other assets 0 0 0 0 0 0 n.s.

Cash & Equivalents 6 761 11 719 6 009 6 009 6 009 6 009 -15%

Net Assets 129 623 129 773 120 485 118 980 117 059 115 418 -3%

Equity & Minorities 27 383 27 661 29 897 30 392 31 179 31 564 3%

MLT Liabilities 69 662 70 601 69 825 67 453 65 267 62 131 -3%

o.w. Debt 57 244 58 247 58 247 56 500 54 805 52 064 -3%

ST Liabilities 32 579 31 511 20 763 21 134 20 614 21 722 -9%

o.w. Debt 10 652 10 390 234 653 179 1 251 -41%

o.w. Payables 11 973 11 929 11 594 11 567 11 592 11 612 -1%

Equity + Min. + Liab. 129 623 129 773 120 485 118 980 117 059 115 418 -3%

Cash Flow Statement

(€ mn) 2011 2012 2013F 2014F 2015F 2016F

+ EBITDA 20 210 21 231 20 029 19 544 19 734 20 061

- Chg in Net W.C. -173 283 485 89 -37 -114

- Income Taxes 301 1 461 1 673 1 634 1 753 1 936

= Operating Cash Flow 20 082 19 487 17 872 17 821 18 019 18 239

- Expansion Capex -1 171 930 864 550 507 0

- Recurrent Capex 11 395 8 528 8 361 8 598 7 867 8 145

= Cash Flow after Inv. 9 858 10 029 8 647 8 673 9 645 10 095

- Chg Net Fin. Inv. 1 849 -896 -1 536 -344 -310 -279

- Net Fin. Exp. 3 576 4 934 3 125 2 815 2 722 2 633

- Dividends Paid 6 860 2 866 1 643 3 413 3 413 4 399

+/- Equity 9 34 0 0 0 0

Other 2 881 1 811 -969 -1 460 -1 650 -1 674

=Change in Net Debt -463 -4 970 -4 445 -1 329 -2 169 -1 668

Net Debt 56 229 51 259 46 814 45 485 43 316 41 648

Source: TEF (2011, 2012) and BPI Equity Research (F).

20


Research

Bruno Almeida da Silva, CFA [email protected] (351) 22 607 4375

Iberia

Banking Carlos Peixoto [email protected] (351) 22 607 3141

Engineering, Manuel Coelho [email protected] (351) 22 607 3173

Capital Goods & Industrials

Food, Travel & Leisure João Safara [email protected] (34) 91 328 9853

Guilherme Macedo Sampaio [email protected] (351) 22 607 3179

Healthcare Ignacio Ortiz de Mendivil [email protected] (34) 91 328 9857

José Rito [email protected] (351) 22 607 3142

Infrastructures Filipe Leite [email protected] (351) 22 607 3136

Flora Trindade, CFA [email protected] (351) 22 607 4377

Retail, Pulp & Paper, Chemicals José Rito [email protected] (351) 22 607 3142

Bruno Bessa [email protected] (351) 22 607 3183

Ignacio Ortiz de Mendivil [email protected] (34) 91 328 9857

TMT's Pedro Oliveira [email protected] (351) 22 607 3194

João Urbano [email protected] (351) 22 607 3221

Utilities, Renewables, Oil Flora Trindade, CFA [email protected] (351) 22 607 4377

Gonzalo Sánchez-Bordona [email protected] (34) 91 328 9852

Macro & Strategy Tiago Veiga Anjos, CFA [email protected] (351) 22 607 3275

France

Utilities & Industrials Louis Boujard [email protected] (33) 1 4450 3343

Metals & Mining, Oil & Gas Alexandre Leroy [email protected] (33) 1 4450 3311

Stock Picking Pierre Bucaille [email protected] (33) 1 4450 3358

Consumer Hubert d'Aillières [email protected] (33) 1 4450 3326

Institutional Sales (Iberia) Ana Spratley Ferreira, CFA [email protected] (351) 22 607 3196

Diogo Rolo [email protected] (351) 22 607 3344

Francisco Pires [email protected] (351) 22 607 3296

Frederico Torre, CFA [email protected] (34) 91 432 1792

Javier Barrio [email protected] (34) 91 432 1793

Luís Sousa Pinto, CFA [email protected] (351) 22 607 3256

Pedro Prista Guerra, CFA [email protected] (351) 22 607 3218

Raquel Araújo Almeida [email protected] (351) 22 607 3243

Sérgio Godinho [email protected] (351) 22 607 3139

Institutional Sales (France) Pedro Prista Guerra, CFA [email protected] (33) 1 4450 3325

Alain Goldschild [email protected] (33) 1 4450 3318

Sales/Trading Luís Sousa Pinto, CFA [email protected] (34) 914 321 797

Carlos Gallego [email protected]

Francisco Chaves [email protected]

José Maria Alves [email protected]

Marta Brito e Cunha [email protected]

Pedro Moreira [email protected]

Ramon Blanco [email protected]

Xavier Estragués [email protected]

Publishing Maria do Céu Gonçalves [email protected] (351) 22 607 3137

Carla Gomes Alves [email protected] (351) 22 607 3160

Economics and Fixed Income Research

Paula Gonçalves Carvalho

Chief Economist [email protected] (351) 21 310 1187

BPI

BANCO PORTUGUÊS DE INVESTIMENTO, S.A.

Oporto Office Madrid Office Paris Office Cape Town Office

Rua Tenente Valadim, 284 Pº de la Castellana, 40-bis-3ª 31, Avenue de L'Opéra 20th Floor, Metropolitan Life Centre,

4100-476 Porto 28046 Madrid 75001 Paris 7 Walter Sisulu Avenue, Foreshore,

Cape Town, 8001 - South Africa

Phone: (351) 22 607 3100 Phone: (34) 91 328 9800 Phone: (33) 1 4450 3325 Phone: (27) 87 310 0800

Telefax: (351) 22 606 4183 Telefax: (34) 91 328 9870

INVESTMENT RATINGS STATISTICS

As of 30th April BPI Equity Research's investment ratings weredistributed as follows:CoRe Buy 8%Buy 23%Neutral 34%Reduce 22%Sell/Accept Bid 10%Under Revision/Restricted 3%Total 100%

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request.

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Swap Transaction), to cover the inherent risk in the acquisition of 6.64% of Sonae's share capital, at a price of €2.06 per share. In this contract, the

periodic repercussion over Sonae Investments of the amounts corresponding to Sonae share price changes relative to the above-mentioned price was

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had a maximum maturity of 3 years. In October 2010, the maximum maturity of this "Equity Swap"(covering at such date the inherent risk in respect

of 6.52% of Sonae's share capital) was extended up to 3 years, until November 2013. BPI entered into a liquidity provider agreement with Euronext

Lisbon for the Banco Popular Español shares, being such agreement effective from February 2008.

Banco BPI and/or Banco Português de Investimento participate or have participated, as a syndicate member and/or assisting the issuer, in the share

offerings of Pescanova, La Seda Barcelona and in the bonds offerings of Brisa, EDP, Portugal Telecom, Semapa, Sonae Investimentos, ZON Multimédia

and REN.

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Amongst the companies covered by BPI Equity Research, BPI Group has qualified stakes in Ibersol, Impresa, ZON Multimedia, Semapa and Sonae SGPS.

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INVESTMENT RATINGS AND RISK CLASSIFICATION (TOTAL RETURN IN 12-18 MONTHS):

Low Risk Medium Risk High RiskBuy/CoRe Buy >15% >20% >30%Neutral >5% and < 15% >10% and <20% >15% and < 30%Reduce >-10% and < 5% >-10% and < 10% >-10% and < 15%Sell < -10% < -10% < -10%These investment ratings are not strict and should be taken as a general rule.

Documents

Telefonica - Banco BPI