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Moody's assigns Ba1 rating to Telefonica's new GBP hybrid debt

Staff writer |
Moody's Investors Service has assigned a Ba1 long-term rating to Telefonica Europe B.V.'s proposed issuance of "Undated Deeply Subordinated Reset Rate Guaranteed Securities in GBP" (the hybrid debt), which are fully and unconditionally guaranteed by Telefonica S.A. on a subordinated basis.

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The outlook on the rating is negative. The size of the hybrid debt remains subject to market conditions. All other ratings of Telefonica and its guaranteed subsidiaries, as well as the negative outlook on those ratings, remain unchanged.

The Ba1 rating assigned to the hybrid debt is two notches below the group's senior unsecured rating of Baa2. The two-notch rating differential reflects the deeply subordinated nature of the hybrid debt. The instrument is a perpetual instrument; is senior only to common equity; provides Telefonica with the option to defer coupons on a cumulative basis; and has no step-up prior to year 10 and only 100 basis points (bps) thereafter.

In Moody's view, the notes have equity-like features that allow them to receive basket "C" treatment, i.e., 50% equity and 50% debt for financial leverage purposes (please refer to Moody's Rating Implementation Guidance "Revisions to Moody's Hybrid Tool Kit" of July 2010).

Moody's notes that Telefonica plans to use the hybrid debt for general corporate purposes and to partially fund the group's recently announced acquisition of a controlling equity stake in E-Plus, the German subsidiary of Koninklijke KPN N.V. (Baa2 negative), for a total consideration of EUR8.5 billion.

The transaction is subject to obtaining all regulatory and shareholder approvals and is not expected to close before the end of Q2 2014. Moody's expects the deal to be subject to a high degree of scrutiny by regulators, since previous precedents of mobile market consolidation in Europe have required substantial remedies to be approved.

Moody's notes that the transaction is structured in such a way that it avoids a meaningful deterioration in Telefonica's credit metrics. In fact, Moody's expects the transaction itself to have a neutral effect on the company's credit metrics in 2014.

The EUR5 billion cash payment to KPN will be funded via: EUR900 million in cash from Telefonica Deutschland Holding AG's minority shareholders via a rights issue; 50%-60% through the hybrid debt with a substantial equity component; 20%-30% through a mandatory convertible; and he remainder with debt. As a result, Telefonica's financial ratios will be only marginally affected after globally consolidating E-Plus.

Telefonica's Baa2 rating primarily reflects the group's large size and scale; the diversification benefits associated with its strong positions in many different markets; management's track record and ability in terms of executing a well-defined and concise business strategy; and its operating cash flow generation and management's stated commitment to maintain its reported net debt/EBITDA ratio below 2.35x.

The negative outlook on the ratings reflects Moody's expectation that Telefonica will continue to operate in a challenging domestic market (Spain). Despite the fact that Telefonica's international diversification enhances its credit profile, the group's exposure to the Spanish market puts it at risk given the weak macroeconomic conditions in Spain, exacerbated by the contraction in consumer spending resulting from austerity measures.

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