Telefonica Upgraded to Outperform

We are upgrading our recommendation to Outperform from Underperform for Telefonica (TEF), the largest telecom carrier in Spain and Latin America. Currently, the stock has Zacks #2 (Buy) Rank.

We believe the overhang on the stock has been removed following Telefonica’s acquisition of its remaining 50% stake from Portugal Telecom (PT) in their Brazilian wireless joint venture, Vivo Participacoes (VIV). The increased stake will further promote diversification and increase Telefonica’s exposure to the growing Brazilian market. Telefonica will merge Vivo with its Brazilian fixed-line voice and broadband unit Telesp (TSP), which is struggling to perform.

Furthermore, first half 2010 earnings were higher than the year-ago levels. Consolidated revenue increased 5.4% year over year from strong growth in Latin America and Europe as well as a recovery in Spain. However, the company’s Spanish revenues declined 4.5% year over year in the first half.

While Telefonica’s Spanish revenues continue to be affected by the reduction in mobile termination rates and a soft economy, we believe the company’s dominant position in the Spanish telecom market, attractive growth prospects in Latin America, its strengthening position in the Brazilian market and healthy dividend payouts makes it attractive for investment. Moreover, Telefonica continues to register healthy net subscriber additions driven by strong business momentum across wireless, broadband and pay TV operating segments.

Telefonica continues to lead the Brazilian wireless market amid intense competition. France-based media company Vivendi SA, which has acquired the controlling stake in the Brazilian telecom operator GVT Holding, poses as an emerging threat. Telefonica’s biggest rival in Latin America, America Movil (AMX) is also reportedly integrating its Brazilian wireless and wireline assets. Nevertheless, by combining Vivo with its Brazilian fixed-line business, Telefonica is in a stronger position to compete with America Movil.

As an added advantage, Telefonica is particularly well positioned in Brazil and in Mexico, where its Telefonica Moviles (Movistar mobile phone division) is actively gaining market share from America Movil. Hence, we are expecting Telefonica to outperform market expectations and retain its leading position in the Brazilian market.

TELEFONICA S.A. (TEF): Free Stock Analysis Report

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