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Fitch: Telefonica Offer For GVT Would Add Synergies Not Debt

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Telefonica's EUR6.7bn offer for Brazil's Global Village Telecom would be credit positive because it would further diversify revenues and strengthen its position in a core market without adding leverage, says Fitch Ratings.

The absence of further leverage is critical to Telefonica maintaining its 'BBB+' rating. The Negative Outlook reflects this risk.

Telefonica would fund the BRL11.96bn (EUR3.92bn) cash portion of the deal via a series of capital increases at Telefonica Brasil and parent company Telefonica. Vivendi would also receive a 12% stake in the newly combined Telefonica Brasil and GVT.

The credit-positive approach to M&A is consistent with Telefonica's recent deals. Telefonica Deutschland's E-Plus acquisition was also positive for similar reasons. In that deal the company will benefit from a significantly stronger operating profile thanks to greater operational scale and expected synergies, without taking on additional leverage.

Like the E-Plus acquisition, a GVT deal would increase Telefonica's regional earnings diversification, which is already a strength compared to similarly rated peers including Deutsche Telekom and Orange. Spain only accounts for 45% of Telefonica's operating cash flow, with Latin America accounting for 43%. The GVT acquisition is unlikely to change this position dramatically at first as it is still investing in the country. But the industrial logic and stronger strategic profile in Brazil would be clear.

The diversification protects Telefonica against structural shifts and regional trends, but also exposes earnings to currency volatility. The appreciation of the euro against Latin American currencies last year removed the benefits of Latin American operations' top-line growth and solid underlying performance.

The transaction would improve Telefonica's competitive position in the Brazilian market with a larger and more integrated business. The combination of GVT's fixed broadband assets with Telefonica's own broadband and mobile operations will allow it to offer both services to a larger audience, in line with the likely direction of the market. The combined entity would also benefit from limited overlap of existing customer bases. GVT's customers are largely outside Sao Paolo whereas Telefonica Brasil's fixed broadband business is largely inside it.

The combination would in our view also create synergies in operating and capital expenditure. Telefonica Brasil has already integrated fixed and mobile operations, adding to the offer's industrial logic.

The acquisition is by no means certain. The offer is likely to face regulatory scrutiny due to the proposed consolidation of the number two and three in Brazil's broadband market. But GVT operates in fixed-line broadband, where market penetration and regulatory sensitivity are likely to be lower than for further consolidation of the mobile market.

Vivendi's position on GVT is also not clear. Selling GVT would appear to fit with its strategy of disposing its telecommunications businesses to focus on media assets, and the price is comparable to the EUR7bn it aimed for when it tried to sell GVT in March 2013. But since then GVT's earnings have grown and the new company chairman has said Vivendi may keep it. Vivendi says it will consider Telefonica's offer at its next board meeting.

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Tags: telefonica  gvt  fitch ratings  Brazil