Telefonica: Where are Activist Hedge Funds When You Need Them?

Friday, June 01, 2012

TMM were looking at the Ibex again and the slotting thereof and wondering – just where does this end? Looking at its components we see the following.

33.5% consists of banks which are part of the sovereign/financial system #REF loop that has been covered extensively elsewhere. 10.7% is Inditex, which judging from what the Mrs Macros have to say is not having any problems anytime soon and trades as such. Then, there is Repsol which has been receiving the gaucho grill, a bunch of utilities and Telefonica. As Telefonica is by no means small we thought we’d discuss it in detail.

Telefonica is big telco that derives its income from a great many places – not least of all Latin America. As you can see below it is primarily a Latin American business and by all means should be able to get by in a deflationary domestic episode pretty well given that the Spanish business consists of a moribund fixed line business and a mobile business which is growing, but not growing anything like Latin America.

So why does Telefonica’s equity and its longer dated USD bond performance look like this?

The way to look at Telefonica in TMM’s opinion is to break it up into its various business and look how it is funded. Firstly, lets look at the Spanish business in light of the serious risk of having hard currency debt (Euros) and the risk of having to move back to a local currency at what TMM estimate would be a 15-20% devaluation. Surely this is unprecedented, right?

For those with a sense of history there have been Telcos that have lived through massive devaluations and there is no better example than Telecom Argentina. As can be seen below a 70% devaluation and an 80% drop in operating income in hard currency terms tends to lead to bad stuff – like bond defaults.

Bondholders did ok even here though as you can read here. Recoveries were 85-90c which is pretty remarkable and the equity was largely OK as can be seen below. In Telefonica’s case, bondholders would likely go for the equity so the emerging market equity wrangle probably doesn’t work here. Nonetheless, this is a lot of asset recovery for a 70% devaluation, so why is Telefonica looking so distressed when it would face, at worst, a 20% devaluation?

TMM think they have the answer and as per usual it’s in the cash flow statement. Telefonica is the first company they have seen that thinks it’s a good idea to increase leverage in a financial crisis which is, you know, kind of odd if not crazy. Note the amount of cash being ripped out of this company by creditors and equity holders per year. It is not small. 100% of cash from operations plus cash from financing is being pulled and there appears to be a large shift in the lender base.

With regards to which creditors are stepping in and stepping out Telefonica looks like it is the usual story in Europe – bank balance sheets out (revolvers, term loans) retail and real money investors in (bonds and notes). No surprises there.

What is surprising are the dividends which keep increasing per share as can be seen below, along with the buyback – who owns this company anyway and thinks it’s a good idea to lever up in the teeth of a crisis?

These guys. When you are a cash cow and your lenders are distressed and also your biggest shareholders, you are going to be under pressure to pay out a lot of dividends to them, pay back a lot of loans to them and try and issue a lot of bonds to other people.

The problem of course is that this strategy is the quintessence of short term greed. BBVA and Caixa may need that money yesterday but it is not in the interest of the other 89% of Telefonica’s shareholders to pay out 7.5bn of dividends, equal to a third of OIBDA when credit markets are saying “no mas”. Not least of all when Telefonica looks cheap – really cheap – compared to regional peers and its listed Brazilian subsidiary looks the same since everyone expects them to sell of more of the crown jewels to keep a couple of banks afloat for a few months more.

TMM took a pivot table of Telefonica’s debt to work out what needs to be done here. It is shown below:

Telco’s tend to fund themselves in local currency where they can to avoid a mismatch of funding and income, though in Telefonica’s case there is a lot more Euro borrowing at the Spanish holding company than would be justified by OIBDA in Spain. At present there are about 14bn of bank borrowings in Euro which TMM presume sit mostly with their Spanish lenders / shareholders. TMM think this has got to go and be replaced by funding matched to income, likely in BRL. Note that this is a large sum, some 16bn but it is only two years of dividends and buyback, both of which could be suspended immediately if management worked for anyone but a couple of Spanish banks. TMM think that if Telefonica paid these down, replaced some Euro borrowings with BRL and left about 14bn of EUR bond and note debt on ~4bn of Europe it would be hard to argue that Telefonica has a problematic balance sheet or one with major exposures to a currency union breakup.

But in the interim, TMM see headlines like this about them selling off their German unit and think this is mad and bad and it is high time someone did something about it.

In the interests of disclosure - yes, TMM do own some of this stuff! Finally we apologise for the blurriness of some of those screen shots. At the moment that's the best we can do.

nemo incognito

Posted by Polemic at 9:02 AM  


OK, you have convinced me. Ready to go BOLIVIAN on this as soon as Spain goes back to the peseta. I just read yesterday that Matthew Lynn thinks that Spain will leave the Eurozone before Greece.

Anonymous said...
12:04 PM  

Matthew Lynn, haha...he's one of those reverse indicators that Bloomberg thoughtfully provides us with.

15-20% deval strikes me as highly optimistic, though...I would have thought the number would be quite a lot higher, at least initially...fitting to the same model that puts 30yr Germany at 1.7% etc...the raw, stinking, primal fear model.

VandalsStoleMyHandle said...
12:24 PM  

--When you are a cash cow and your lenders are distressed and also your biggest shareholders,--

Not only nailed TEF, but the entire Spanish ecconomy. Any move made to clear up a sector or company ends up having to also move incredible amounts of deadweight baggage.

Fractally scalable oligopolies and cartels from top to bottom.

Charles Butler said...
1:05 PM  

When you are a cash cow and your biggest shareholder disdistressed...that sound like some BRIC(S) Coal India..let's sell only 10% for gzillions...not that they should revise their subsidy programmes and start collecting taxes which mostly benefit the rich.

Anonymous said...
1:38 PM  

interesting post TMM, thanks for focusing on the debt side as the equity research I read on TEF seems oblivious to that aspect.

Indeed TEF is a cash cow (though I have my doubts longer term about the whole industry)

now that BRL is lowering rates could be even cheaper funding ;-)

I think the really great 'tell' for a buy is when the ADR (VIV) has a nice spike down.

abee crombie said...
1:59 PM  

Wonder how Paul Giamatti's oatmeal tastes this morning? Oh that's right, they saw this coming months ago while retail kept get longer...

Anonymous said...
2:12 PM  

1:38 Anon you are absolutely right on coal india. On the other hand, sans subsidies the chinese steel sector is a donut. There's a whole lot of what Australians call "productivity reform" that needs to happen in EM sooner rather than later. We are reaching if we have not reached the end of the 2009-2012 credit expansion there.

Nemo Incognito said...
3:28 PM  

OK, LB, you are my go-to guy on this stuff. Should I be filling my boots with TBT now, or are we still in widowmaker mode?

Anonymous said...
5:08 PM  


As a long time arms length reader of your posts, who comes back here almost daily because of your valuable insights, I've got to say this is the first time I can recollect that I've seen you personalise something to such an extent i.e. by spending an entire article on a single - presumably bad - position.

That would not normally be a good sign, methinks....


Anonymous said...
5:40 PM  

s&p at the 200 day. grasping here but I need something

abee crombie said...
6:01 PM  

Regarding TEF, the selling of almost every stock in the IBEX has been about the same proportion in the last few weeks. So we have clearly been seeing wholesale liquidation and/or naked shorting via ETFs. Not the easiest time to do fundamental analysis of any company.

Regarding short bond vehicles, LB would rather poke his plonka into a paddling pool full of piranhas at the moment. There will be plenty of time ahead for the steepener, but right now the bond markets are insane, so why not just stay away until the tank stops thrashing around?

There was a nice interview with Doug Dachille on Bloom last night where he explained that a lot of the super smart Real Money knobs have quite large steepeners on, in an to attempt to control the rate risk in their portfolios, and that the last few days insurance companies, pension funds and the like have been frantically covering as the red ink has piled up, fueling the panic buying in USTs. Another story of hedges gone bad, essentially....

Oddly enough, I have become a gold bug these last few weeks. It's temporary. I think....

Watching European energy companies trade at P/E 6 and offer 7% has me feeling BOLIVIAN today.

Leftback said...
6:10 PM  

3:28 Nemo,

"Productivity reform". LOL!

India = Greece.

Anonymous said...
6:22 PM  

The interesting game being played on a parallel chessboard is its competing Dutch telco KPN being targeted by an activist hedge fund, no wait, the richest man in the world.

Anonymous said...
6:40 PM  

Time for nominal GDP targeting? This QE nonsense obviously is getting the world nowhere.

Anonymous said...
6:43 PM  

All big European energy companies are stuffed up to their neck in long-term gas import contracts @ oil parity which are a) tens of billions OTM even without shale gas and b) not marked to market.

That, and negative margins on every power generation asset.

Anonymous said...
6:45 PM  

Thanks LB! I will keep my plonka out of the paddling pool of pirhanas and my dinero out of TBT for the moment ;-).

Anonymous said...
7:12 PM  

Alternatively anon 5.08, you could give that money to Cousin Chuck from Miami (or dare I say, Las Vegas) for him to put down on a 3.7% 30yr fixed, in exchange for the upside/downside.

Dee Dee Humberside said...
8:07 PM  

mxp, zar, starting to get jiggy, along with the rest of EM FX

we need to bounce monday or else this market is toast.

short luxury products? they can only hold up for so long if EM is falling apart, at some point they will too.. richemount set for a break

the india short looks to be on hold for a while

getting harder and harder to decipher these words to post

abee crombie said...
9:09 PM  

@DeeDee -- there you go, Vegas baby!

Anonymous said...
11:18 PM  

To the above about TBT... when the time comes, you might be better off buying puts/shorting UBT.

The leveraged ETF's have a tendency to drift lower. Better to be in one you're already hoping goes down.

chancee said...
3:20 AM  

Fuller disclose: some of TMM own TEF pa for their sins. Others own it versus a short TEF CDS position.

Argument right now is that if Telecom Argentina can pay 85c shorting these bonds makes little sense. The issue is what happens to the equity - shorting the dividend strip / long underlying equity is a bet on the management doing the right thing whereas shorting the equity outright is a bet on idiocy and a continued neglect of shareholders' long term interest.

And that folks, is the real question - for whose benefit are Spanish corporates run, zombie cajas or the shareholders?

Nemo Incognito said...
3:36 AM  

C says'
Ha Golminer the smell of burning shorty in the air!

As you go to great lengths to point out it's quite a Latin American entity in business terms. Consequently,when you ask whose benefit is it run for I think you also need to include govt involvment,or should I say exposure to govt risk S. American style.Those countries need no introduction when it comes to considering how experienced they are at taking cash cows and butchering them for theirown needs.
Until they change their nature ,or hell frezes over,which ever comes first,then I always have that consideration front and centre as well.Not unakin to allowing (without consultaion),in days gone by, for my young nephews to be allowed to play with my collection of LP's on vinyl.

Anonymous said...
6:13 AM  

C' , understood but Brasil is way better than Argentina or similar. The Petrobras div yield and debt load increase is something to consider.

Nemo Incognito said...
7:03 AM  

C says'
Nemo,Brasil is little different conceptually,or shoudl i say the differences are subtle. Argentine and Venny are simply clods,rip it off ,it's mine,no excuse really needed other than they need the money t prop up their regime of the moment.
Brasil however,is basically socialist with finesse. By that I mean they will actually use policy in a perfectly legal manner to drain equity returns to underpin their socialist aims. They won't do this as a matter of course when things are running well because their boat is being globally floated. However, when time get tough watch out.Can you spell winfall taxes ,or state ownership purchase at below market valuation.

We may disagree of course,but I'll rest comfortably on experience of human nature on this one.I know i am a cycnical bastard (sorry anon ;)). Essentially of course I am really saying what is happening in Spain is just as likely to happen in Brasil.Actually i can't even envisage why we might disagree on that given te underlying similarities.

Anonymous said...
9:13 AM  

True Anon, though I think PBR is a hell of a long way from an equity recap and its in pretty good yield territory. Brasil banks and the sovereign are miles away from Spain despite in a pinch probably being six and half a dozen the other.

Nemo Incognito said...
10:10 AM  

C says'
Just for clarity.The point I was trying to make was not that Brasil is similar to Spain on sovereign debt etc.Nor that REF and Spanish banks had a specifically similar relationship were TEF to go Brasilian.
I was talking about behavioural similarities to how problems will get resolved if matters go titsup.
That is ,Brasil is socialsit.Brasil has enjoyed a global boom. When Brasil does not enjoy a global boom I expect them to look for solutions to keep govt revenue flowing by looking to private sector cash cows.In that sense the Brasilian govt would occup the same conceptual relation as a Spanish bank currently occupies by being in a shareholder relationship with TEF.
Namely we should not ignore political risk in Brasil in my view.

Anonymous said...
10:30 AM  

from Marctomarket blog:

I found it hilarious

Anonymous said...
3:00 PM  

LB ventured out today, sans tin foil hat, and looked up today but didn't get an eyeful of small fragments of sky. We'll see whether that pattern continues....

Overall quite happy to not be significantly involved in US equity, and especially fixed income, markets just now. Nothing good...

Leftback said...
4:12 PM  

One of the more independently minded US observers of the European credit markets ventures some thoughts on this week's ECB meeting (June 6).

Peter Tchir on June 6 ECB Meeting

Quite a lot of thoughtful, informed and variant opinion here, certainly relative to the now relentless doom and gloom that now constitute the prevailing views vented in the universe of the US financial media, blogosphere and now, by the very same Street sell-side sheep who were recently so full of the joys of the equity Spring. LB notes that yet again, Morning in America has segued all too quickly into Mourning in America...

..... care to follow up on this, TMM?

Leftback said...
4:50 PM  

oh the pain continues

we appear to be in free fall mode in the US equity markets.

abee crombie said...
5:37 PM  

Dollar, Dow, Gold and TLT all falling at the same time.....

Marc Faber told me there would be days like this. Actually I think this is the kind of low volume, correlation breakdown stuff that you tend to see near to an abrupt turn.

Euro rate cuts, printing and rescue, and an overnight global melt-up. You read it here first.

Watch out Mr Shorty. One day you will wake up in the proctology suite...

Leftback said...
6:26 PM  

lb, great link and interesting observations . There will be rip roaring bounce at some point. but just how much lower that is, well who knows...

looking like '98 again (wait wasnt that this past summer). we need a turn around tuesday to get some of those shorts squeezed

abee crombie said...
7:38 PM  

Reversal signals? Friday the MEFF introduced a 10-year bono contract. Their blurb practically touted it as a way to get long the 'risk premium'.

Charles Butler said...
8:28 PM  

Confidence is wearing thin, I feel,they can keep parading out in the print more initiatives , but its dawning upon them, finally, that the only way to keep the shitshow going due to an inadequate policy implementation and supervision in tandem with weak underlying growth is to intervene in areas of the market that players probably would have least expected.... now I don't know enough of how the Europe financial system operates, but there is no doubt these guys are holding back.

The Macro front in my 2012 view didn't expect the level of deterioration that we're at now until latter in the 3rd Qtr, and was expected to last throughout the remaining year.This was thought to be a due to limited intervention in 2012, all but PBOC.

Therefore the future seems to have caught up to the market quite aggressively when one was of the hope of staying quite literally isolated from world markets and the attention thats needed to be ahead of key global crisis when trading would've been so much easier had the prior plan worked, where you could've sold where ever the dart landed and gone and played golf.....

Amplitudeinthehouse said...
1:34 PM  

There is always a part of the summer where you get to go and play golf. LB is hoping they do something in time for us to all watch the footy.

I mean, priorities, meine Freunde .... you can get back to stuffing it up the impoverished masses of the mediterranean economies AFTER the tournament, right? Surely there is a need to make quite sure that Deutsche and SocGen don't go belly up in the middle of a match b/c of a Southern European bank failure? What if Schweinsteiger was about to take a penno against Spain and you had to deal with a margin call?

That would be quite absurd....... come on, bring on the rate cut, the promises of LTRO-3 and the new banking integration plans and recapitalization package. Then we can all reverse recent RORO positions, go and watch the telly and wonder about how to pay for it later....

Leftback said...
3:54 PM  

It seems we're assuming the reaction to LTRO3/recap/QE 'whatever you want to call it' will be the same as it's always been, though in hindsight the reactions to every bout of so-called 'easing' have been less and less one could argue.

To this end, I remember reading some time ago that the brain oftentimes begins to feel the effects of soon-to-be administered narcotics seconds BEFORE they are actually administered. Likewise, I fear for the day when massive QE or even coordinated monetary policy is quickly SOLD by a market already hopped up to its core as it realizes that there is no new, designer drug in the pipeline.

Anonymous said...
4:13 PM  

That's an interesting point of view, anon, and I have seen that in many places. The idea of liquidity desensitization is interesting, but it just isn't very logical, and there isn't any evidence to support your frankly rather touchy-feely doomy-gloomy idea.

If there is real liquidity pumped into the financial system, it has to go somewhere. Some of it is likely to go into riskier and/or more productive assets, rather than all absorbed into Treasuries, JGBs and bunds.

Economics isn't physics (and to think it is in any way similar is sheer folly) but it does obey some laws of logic. If you think that massive waves of global printing will not elevate the levels of commodity and risky asset prices then you may be reading the book upside down.

By the way, I am by nature fairly bearish and risk averse, but I am not buying into theories and strategies that are primarily emotionally based, especially those based on fear, which manifest most often at short-term tops (fear of missing out) and bottoms (fear of greater losses).

Leftback said...
4:40 PM  

i am getting worried about this ECB meeting. Draghi seems bent on saying he has done enough and now it is the politicians turn. I agree. But no news on Thursday's meeting I think could start a heavy selling stampede again.

We are not even at 30 on the VIX yet

abee crombie said...
4:46 PM  

C says'
Please note Anon is not citing anything to with "Physics".Not quite sure wher you got that from. he is alluding to Behavioural psychology and the breakdown in conditioning. There is nothing mystical about this at all. Indeed the process he refers to must surely have been observed by all by now.How the 'pacebo' effect of intervention in whatever current form has been chosen has had increasingly transigent after effects. There really is no guarantee that further attempts at intervention that the market continues to perceive has inadequate will result in further RORO. As I have said before it appears to me that it is harder and harder to get Rovers attention using using 'bone' lookalikes.He wants the real thing, or woof off I'm not coming out of my kennel.

Anonymous said...
4:54 PM  

C says'
As an addendum,if you are interested you might do some reading on the concept of reinforcement and how it applies to this ongoing process of patchwork intervention and of course note how it can break down.

Anonymous said...
4:59 PM  

Here you go.Bit basic,but it will give you the idea.

Anonymous said...
5:02 PM  

One of the things that I find most irritating in this world is people treating me as though I have the imagination and intellect of a 5 year old. I think you can assume that I have in fact already considered the bloody obvious fact that the market is ready to whack peripheral equities again with a 2 x 4 if there were to be a lack of fudge, or more likely an underwhelming petit Eurofudge.

I am very familiar with the topic of conditioning, far more than you might believe. So familiar, indeed, are all of us these days with the concept of such conditioning in the markets that I think we all agree that a really enormous bazooka will be what is required AT SOME POINT to ultimately set off the absolutely inevitable market melt up.

Whether the big one is unveiled here or not isn't at all clear. However, we do know that there is going to be a vulnerable period between the ECB meeting and the Greek election. If there were to be a gradual unveiling of the nature and scale of the weapon under discussion, followed by a modest period of absolutely nothing deteriorating further, we might well see the markets reflect the process of shorts closing their trades and going away to enjoy the summer doldrums, as the spreads between "safe" and "unsafe" bonds begins to compress once again.

The fact that nobody thinks this is possible without some massive dislocation is extremely interesting. Tail risks are called that for a reason.....

Leftback said...
6:05 PM  

Anon, C, I understand the concept of reinforcement, but I agree w/ LB in that if they print (not just jawbone) then the liquidity has to go somewhere. Some asset will get bid up. I think to underestimate the need for institutions to meet mandated returns by putting the new liquidity to work in some risky way is to fight a losing battle.

Marshall Jung said...
6:10 PM  

C says'
No one is treating you as though you are an illiterate fool which is how your post reads. having ssid that, you will get no apology just a suggestion that you reread your own posts and consider have you accuately communicated your own views in line indeed with your last post. I for one don't think so which is why i advise you to have a reread.

Anonymous said...
6:38 PM  

Can't remember if it was mentioned here before or not... Was watching Krugman this weekend - the German word for debt is the same as the word for guilt..go figure.

Regarding the ongoing debate and stating the obvious, seems the bar has been set pretty high on this one. I'm holding out hope of being pleasant surprise, but I think the most likely outcome is one that is good, but not good enough. I mean it would be a new precedent if CBs prevented a crisis, wouldn't it?

Corey said...
7:35 PM  

Economics may not be physics, but so what? Price action is far more fractal than not, I'd argue, which in turn suggests market "behavior" is far more in tune with, and related to other natural phenomena than with the so-called "science" of economics.

Anonymous said...
8:28 PM  

Price action? - a numerical representation of the spread of gossip within a mob.

Charles Butler said...
10:57 PM  

Well stated, Charles.

Now, enough of our pontificating about what the ECB will or will not do. We should, I suppose, all remember that the ECB has been massively behind the curve ever since Trichet's spectacular error of judgment when he hiked rates in 2008 in a panic over the spike in oil prices, even as interbank lending was freezing all over the world. That was indeed Tricky. They are behind the curve again here.

Not to flog a dead horse but I feel I have to point out to the assembled Austrians, austerians, and advocates of latter day gold standards etc, that governments are frozen, firstly by gridlock in the US Congress, and secondly by a complete lack of understanding in Europe (especially Germany) about the nature of balance sheet recessions. The Germans are apparently completely unable to understand their essential complicit role in the Spanish housing boom, via easy money policies and their own banks.

In addition, the inflation-averse Germans now seem unable to understand that the imposition of austerity policies on their Southern European friends has resulted in a bank run, with the hot money flow ending up - in Germany, where it is likely to do what hot money does - contribute to domestic inflation!

US and Europe Have No Excuse

So with governments clearly unable to think their way out of a paper bag, it is clear that the only adults remaining are the central bankers. One can only hope that Draghi is able to think more clearly and act more decisively than was his hubristic and frankly feeble-minded predecessor.

Oh by the way, by the time you wake up you will all know that Hilsenrath has been told to "take a leak" about the Fed being "likely to do something..."

Leftback said...
4:00 AM  

C says'
In this period of political hiatus there have only beeen limited number of market outcomes.The meltup prior to a Greek ref was the least likely and remains that way for my money. A covering rally though is easily possible looking at how so called oversold we got and how the various key events are laid out prior to that ref.

As it stands though we are back in a position yet again where you have to think what is the likeliest option and a meltdown from here is not imo the most likely outcome because the market is once again too prepared for that judging by the moneyflow over the last couple of months.More likely in my view would at last be the sideways action posited earlier by Tmm.I mean if you wanted to sell out of European political mayhem how much notice do you need?Surely most people who wanted to have already 'run' to where they want their money to be.

Anonymous said...
6:55 AM  

"ECB leaves benchmark interest rate unchanged at 1.0 percent"

I don't know if that is accompanied by anythingelse ,but in isolation it's enough to send me into paroxyms of laughter.

Best taken with a mouthful of Weetabixs bent over a chart of the Euro ;)

Anonymous said...
12:54 PM  

The true "tail risk" is in China. Regardless of how the EU ponzi scheme is dealt with the market is not prepared for anything but a soft landing in China.

Anonymous said...
2:19 PM  

Good point on China.

Who's bending over this morning? A few of the London-based hedgies may have been over-enthusiastic of late in shorting Italy and Spain.

Fed chatter suggests they will announce a non-unwinding of Operation Twist, always one of the most likely scenarios for dealing with a summer swoon in the States. This means they retain the option of sinking a big QE into the MBS market if things were to really go pear-shaped in US housing/banking again.

Never short European equity markets going into a major international football tournament. This is an entirely empirical, yet apparently immutable law of markets. We all want to watch without having massively leveraged positions melting down during the game.

Leftback said...
4:58 PM  

LB wishes to nominate this guy for his prestigious Knob of The Week award. Basically, he is completely clueless, yet highly opinionated on Europe. If it is a down day he runs a EU collapse, sky falling, headless chicken, TEOTWAWKI column and then if it is an up day he tells you to buy, in this case, blue chip European shares, in other words, all the stuff that we were telling you to buy last week.

Matthew Lynn Is A Bit of a Knob

Leftback said...
5:41 PM  

"The Compression" trade is on.
(Long Spain 10y or 2y bonds: Short bunds/Schatz)

Spanish two-year notes advanced for a third day even after a report showed the nation’s industrial production fell the most in more than two years in April and after Draghi indicated another round of three-year funding for banks wasn’t imminent.

The yield on the securities tumbled 17 basis points to 4.55 percent. The nation’s 10-year rate declined three basis points to 6.28 percent.

Squeeze, anyone?

Leftback said...
6:20 PM  

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