This Telecom Provides Good News

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you follow my blog, you may already know Telefonica (NYSE: TEF) is part of the small equity portfolio I assembled a few weeks ago. This time, I am writing about this company because there was one highly significant event which -according to me- was not fully taken into account by the market. The event was that TEF decided to put on hold a plan to spin off 10% to 15% of its Latin American (LatAm) unit. As LatAm, which generates 48% of revenues and 47% of TEF's EBITDA, is Telefonica's growth engine; I think the decision is great news for shareholders.

The decision against the sale was followed by the improved market sentiment towards Spain. It was taken when TEF was able to successfully sell $2 billion of ten year bonds. The debt sale is not insignificant, even if it seems small next to Telefonica's $70 billion net debt. Now TEF, even if it is still trying to reduce its debt back to 2.35x EBITDA, will not have to rush and sell a chunk of its most precious asset anymore. According to Mr. Vila (TEF's CFO), the group will do the sale only if the price tag is the right one to increase shareholder value.

TEF, which was for years in aggressive expansion mode, has already raised almost $2 billion by selling a stake in its German business, as well as selling a stake in high growth China Unicom (NYSE: CHU) and offloading its Atento call center division. Maybe the sale of 4.56% CHU, made at $1.6 billion, could be compared to selling LatAm. I think selling China is better than selling LatAm for one key reason: TEF has less experience in Asia than in LatAm and specific country (or regional) expertise is key in a highly regulated market such as telecommunications. Selling growth is never a good idea, but sometimes there are no available alternative options.

All in all, TEF is now a leaner operation and I think the direction taken by management is the correct one. I am sure the company is making the right call when it refuses (at current prices) to sell neither its 46% stake in Telco S.p.A, the main shareholder of Telecom Italia (NYSE: TI), nor any participation in its LatAm business. The reason not to sell TI is simple. The company is overly cheap trading at a 17% Free Cash Flow (FCF) yield, it has valuable investments in Brazil (TIM Brazil), and remains the main operator within the Italian market. Even if the Italian telecommunications market resembles the Spanish one (they are both suffering), they are also poised to recover and they should not be sold until that recovery materializes. I am not the only one thinking TI is going to recover: the company just sold bonds for $1.4 billion yielding just 4%.

As I stated before, life is not being easy for TEF nor any other indebted European enterprise but those companies are following the correct steps towards recovery. Equally important, it seems like they will have the time to fix their balance sheets without selling all the assets that should provide future growth. Companies such as TEF or TI that less than a year ago had the debt market window completely closed are now selling bonds at reasonable prices. Life goes on after all. I expect Telefonica to recover its top line growth trajectory and every day I am more convinced that we shall see cash dividends back by early 2015.

martinzaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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