Telefonica Debt Ratings on Review for Possible Downgrade
The debt ratings agency, Standard & Poor's has put Telefonica and related subsidiaries in the Czech Republic and Chile on CreditWatch with negative implications. The CreditWatch placements follow the lowering of the ratings and the assignment of a negative outlook to the Spanish government.
S&P said that they think the deteriorating sovereign environment in Spain could intensify the economic and competitive challenges that Telefonica already confronts. They also think it could restrict, or make more expensive, the access to capital markets for Spanish issuers, and tighten availability of bank credit.
Under their criteria, the long-term rating on Spain doesn't at this stage cap Telefonica's long-term rating. This is because they consider that Telefonica has "moderate" exposure to Spain, and that the sensitivity of the telecoms sector to Spain's country risk is "moderate".
S&P is 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.
S&P anticipates at this stage that Telefonica will generate only moderate discretionary cash flow, at potentially less than EUR2 billion annually in 2013-2014 in the base-case scenario. While they 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 UK 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, S&P could lower its assessment of the group's business risk profile, if they expect increasingly adverse effects on Telefonica from its domestic market or a thinner cushion provided by its activities in overseas markets than in the base case. S&P currently projects 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, based 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.
The group's financial risk profile, which S&P assesses as "significant," continues to constrain the ratings. They consider that Telefonica has relatively high leverage (measured by debt to EBITDA), weak free cash flow protection measures, and heavy debt maturities
The debt ratings agency intends 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 forecasts.