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Fitch: Peripheral Telco Problems Highlight Need for Further Dividend Cuts

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Fitch Ratings says that eurozone redenomination scenarios are weighing heavily on investors' minds and peripheral telcos have to demonstrate plans to mitigate potential near term liquidity shortages caused by weakening access to debt markets.

A series of recent investor meetings with Fitch's EMEA Telecoms team in London underlined investor concerns that continued macro uncertainty surrounding countries like Spain, Italy and Portugal is causing investors to question what Telefonica, Telecom Italia and Portugal Telecom are doing to prepare for a prolonged period of domestic austerity and expensive or at worst prohibitive access to debt markets.

Fitch say that the key issues for investors to address a severe short term liquidity shortage appear to be dividend cuts and asset sales. However if the situation were to deteriorate further then investors may begin to question redenomination scenarios and what companies might do to mitigate such an eventuality. This includes assessing the legal implications for their holdings, the potential for raising of debt outside peripheral zoned countries (albeit with structural subordination implications) and finally shifting corporate domiciles away from the periphery to higher rated countries.

Fitch's base case does not envisage these countries leaving the eurozone and the agency continues to guide investors on the underlying credit quality of the relevant telcos while taking into account weakening domestic situations as evidenced by the Negative Outlooks in place on all peripheral telco credits. Fitch reiterates that these companies are strong independent incumbents with solid and defensible cash flow generation over the long-term and, absent any possible chaotic eurozone exit scenario, are capable of weathering a prolonged period of domestic austerity.

Fitch continues to believe that these companies will be able to access international debt markets under its base case scenario albeit at a higher cost. Domestic debt markets are also an option as witnessed by Portugal Telecom's EUR250m recent domestic retail bond issuance. Fitch reiterated to investors in these meetings that Telefonica is best positioned structurally having the undoubted flexibility of generating more than 50% of its cash flows from operations outside Spain, while Portugal Telecom and Telecom Italia are much more domestically focussed thus their credit profiles will be more affected by what happens within each entity's domestic economy.

Fitch recognises that liquidity is the primary concern and it continues to press management on contingent strategies that they are putting in place to deal with the severity of the situation. Fitch believes that more aggressive dividend cuts are a possible short-term liquidity fix and favour this over potential asset sales and/or IPOs of entities within the group. Both these latter measures take time and are possibly not optimal in terms of valuation in times of weak capital markets.

By way of illustration, in the potential hypothetical event of a sovereign exit scenario, forgoing a year's normalised dividend would save Telefonica approximately EUR6bn, Telecom Italia EURc.1bn and Portugal Telecom EURc.600m which combined with on-going operational controls around cost cutting programs and a slowdown on domestic capex spend provides these entities with valuable extra liquidity in terms of debt service. In addition all three entities currently have undrawn committed banks lines they could tap prior to the exit event.

Fitch believes the combination of these factors would ensure that the companies have sufficient liquidity through 2014.

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