Telefónica Records 40.0% Y/Y Increase in End-2006 Net Profit on Strong Operating Results

Telefónica, the leading telecoms group in Spain and Latin America, posted a 40.0% year-on-year (y/y) increase in its full-year net profit to 6.23 billion euro (US$8.20 billion) in 2006, from 4.45 billion euro in the previous year, with a 41.5% y/y jump in the group revenue to 52.90 billion euro, from 37.38 billion euro, respectively. Its underlying core operating profit—measured as operating income before depreciation and amortisation (OIBDA)—was up by 26.7% y/y to 19.12 billion euro in 2006, from 15.10 billion euro in 2005. OIBDA is the company's preferred measure of profitability, equivalent to earnings before interest, taxes, depreciation and amortisation (EBITDA). Full-year pretax profit amounted to 6.76 billion euro, against 6.61 billion euro in 2005. Its mobile division, Telefónica Móviles, generated 18.40 billion euro in end-2006 revenue, up by 11.4% y/y, while newly created Telefónica O2 Europe contributed 13.16 billion euro to the group revenue. Its Latin American operations posted 9.54 billion euro in end-2006 revenue, up by 14.2% y/y.

Full-year results are not directly comparable with 2005 as they include consolidated acquisitions. These included the United Kingdom's mobile group, O2, and the Czech fixed-line incumbent, Cesky Telecom, as well as more than 1.5 billion euro in capital gains from the sale of its directories unit, TPI, to the United Kingdom's directories company, Yell. Capital expenditure (capex) stood at over 8.0 billion euro in 2006, up by 55.3% y/y, largely directed at developing the broadband business in Spain and Latin America and expanding its 2G and 3G networks in Europe. Increased investments did not affect Telefónica's free cash flow, which was up by 12.3% y/y to 11.12 million euro at end-2006.

In the fourth quarter alone, however, Telefónica posted a 12.2% y/y decrease in the group net profit to 1.05 billion euro, from 1.19 billion euro a year earlier, due to the consolidation of its recent acquisitions. Fourth-quarter OIBDA stood at 4.47 billion euro, up by 4.6% y/y from 4.27 billion euro. Revenue rose by 37.4% y/y to 14.19 billion euro in the last quarter of 2006, from 10.33 billion euro in the same period last year.

Outlook and Implications

Solid Operating Performance: The group's total access lines rose by 32.4% y/y to 203.2 million, with more than 145.1 million mobile customers. This compares with organic growth, which reached 7.8% y/y, and was the strongest in the European telecoms sector. The telco saw its broadband internet connections increase by 41.1% y/y to 8 million at end-2006. Telefónica capitalised on dynamic mobile and broadband growth in Europe and Latin America. This is reflected by the geographical make-up of its customer base, with 44.2 million access lines in Spain (including 21.4 million mobile customers), 39.2 million in the rest of Europe (including 35.2 million mobile customers) and 114.7 million in Latin America (including 83.3 million mobile customers).

Domestic Business: Telefónica reported the largest organic growth in the European sector, with revenues up 7.8% y/y also thanks to sustained growth on its domestic market. Its domestic unit, Telefónica de España, posted a 1.8% y/y growth in revenue to 11.96 billion euro in 2006. Wireless growth in Spain accelerated slightly in the fourth quarter, despite tougher competition. For comparison, at end-2006, Spain represented 37.9% of consolidated revenues (13.6 percentage points less than in 2005), Latin America took 34.7% (6.9 percentage points less than in 2005)—with Brazil's contribution down to 14.4% (against 18.4% at end-2005)—and Europe had a 26.5% share (20.9 percentage points more than in 2005 following the incorporation of the O2 Group in February)—with the United Kingdom at 12.8% (flat on the previous year) and Germany at 6.4% (up from 1.0% in 2005).

European Expansion: The incorporation of the 02 Group and Telefónica O2 Czech Republic, Telefónica Telecom and Iberbanda contributed 32.1 percentage points to the group's annual growth. Telefónica O2 Europe comprises the O2 Group, since 1 February 2006, as well as Telefónica O2 Czech Republic and Telefónica Deutschland, from 1 January 2006. In the course of last year, Telefónica O2 strengthened its position in Central and Eastern Europe. The telco plans to invest up to 20 billion koruna by 2010 in the Czech Republic, where it acquired the state's 51.1% stake in the incumbent group, Cesky Telecom (now rebranded as Telefónica O2 Czech Republic) for 82.62 billion koruna in March 2005. Following its success at winning the third mobile licence in neighbouring Slovakia in August 2006, Telefónica O2 launched commercial operations in February this year. It plans to invest between 15-18 billion koruna (US$573-688 million) by 2010 to expand its mobile network, with a vision to explore opportunities in the Slovak fixed-line segment (see Slovakia: 26 February 2007: Telefónica O2 Plans to Invest US$688 mil. in Slovakia by 2010 and Slovakia: 2 February 2007: Telefónica O2 Launches Commercial Services). Currently, Telefónica is considering an acquisition of a minority stake in Olimpia, which controls Telecom Italia, however, no decision has been reached yet. Olimpia is controlled by the Italian group, Pirelli. The move would give Telefónica access to Europe's largest 3G market with 17 million 3G subscribers at end-2006 (see Italy: 19 February 2007: Telecom Italia Plans US$8.8 bil. Network Modernisation by 2016; Telefónica Eyes 12-14% Stake in Olimpia). The telco is also considering the sale of its non-core media asset, Endemol Entertainment, in which it holds a 75% stake. Endemol is currently valued at 2.5 billion euro (see Spain: 23 January 2007: Telefónica Readies for Endemol Sale).