Telefonica Chairman Takes No Chances as Activist Stalks Europe

(Bloomberg) -- The mere mention of Elliott Management Corp. is enough to rattle any telecom executive after the New York activist fund took on Telecom Italia SpA -- Europe's most indebted phone company -- and removed its CEO.

So when Elliott this month denied a media report it was targeting southern Europe's other debt-laden carrier, Telefonica SA, it seemed the Spanish company's Chairman Jose Maria Alvarez-Pallete had avoided a confrontation. Now Pallete may need to redouble efforts to convince investors his strategy is sound.

“The notion of people like Elliott watching, if anything, puts management under more pressure to really focus on deleveraging,” said Jerry Dellis, an analyst at Jefferies.

Even before speculation about billionaire Paul Singer's fund, Pallete was trying to turn around investor sentiment. Telefonica's shares hit a two-decade low in September over concerns with its debt and growth prospects for the sector. That spurred him to bolster communications and burnish his image as a value-driven manager by taking a tougher stance on underperforming businesses.

Europe, with stocks that have lagged behind their U.S. counterparts, has become ripe for activists. Elliott's busy year on the continent includes moves at Telecom Italia, drugs-and-chemicals conglomerate Bayer AG and distiller Pernod Ricard SA.

Asset Sales

The obvious risk with an activist at Telefonica would be a call for swifter asset sales, which would undermine Pallete's careful messaging around disposals.

Pallete has long argued he's not forced into selling off pieces of the company and can reduce debt with cash generated internally. He's made progress: net borrowing has fallen to 42.6 billion euros ($49 billion), from 49.9 billion euros two years ago. Lately, Pallete has also pointed toward possibly selling out of regions that aren't delivering.

Addressing 900 managers at Telefonica's annual two-day confab at Madrid's La Caja Magica sports arena last month, Pallete reiterated his push into digital platforms, cloud services and artificial intelligence in search of growth.

What left a bigger impression was his message that if their businesses failed to achieve high enough returns, they could be sold, according to people who attended the meeting, who asked not to be identified as the discussions were private.

A spokeswoman for Telefonica declined to comment.

Latin America, a pillar of Telefonica's strategy for two decades, is among regions attracting management attention. The carrier has lately been positioning some of its units in Central America for possible sale to focus on a few large countries. It's also considering selling its data-center business, people familiar with the matter said last month.

Asset sales have been elusive for the company, however. The devaluation of the peso thwarted a planned Argentine initial public offering and the listing of its U.K. unit is on ice while the country tries to exit the European Union.

Javier Borrachero, head of telecom at Kepler Cheuvreux, said potential buyers know Telefonica has a debt problem that could make it a forced seller and that could be encouraging them to hold off in the hope of paying less later.

Telefonica management has rejected suggestions that its borrowing is unmanageable, pointing to commercial momentum in Spain and a competitive edge with premium clients afforded by soccer broadcast rights and Europe's biggest fiber-optic network.

But debt concerns have persistently dogged the company, tied with Royal KPN NV as the second-most leveraged among European carriers in a Bloomberg Intelligence ranking. With an era of low rates coming to an end, debt becomes a bigger issue, Borrachero said.

With a high-level ally now focused on messaging, Pallete has help in addressing questions about debt. This month, he recalled to Madrid the head of Telefonica's Brazilian arm, Eduardo Navarro, to take charge of group communications, advertising and public affairs. The appointment of the experienced financial and strategy executive is aimed at convincing investors that the business is solid, said a person familiar with Pallete's thinking.

Pallete is also getting a reprieve from a rotation by investors into beaten-down telecom names and analysts taking a more bullish stance on the industry. The carrier's shares have narrowed their year-to-date loss to 7.8 percent, since closing at 6.633 euros on Sept. 17 -- the lowest since 1997.

Still, Telefonica's current market value of about 39 billion euros is a far cry from the peak in 2007 of roughly 111 billion euros. That was during an era of empire-building among carriers that saw Telefonica inking deals to expand its interests into far-flung regions, including Latin America and China.

For Jefferies analyst Dellis, the idea of an activist at Telefonica is positive for the carrier's shareholders, who have watched rising interest from such funds among its peers, including at Telecom Italia, Vodafone Group Plc and BT Group Plc.

“If anything, it's probably a reason to own the shares,” Dellis said.

--With assistance from Thomas Seal, Daniele Lepido, Scott Deveau and Virginia Van Natta.

To contact the reporter on this story: Rodrigo Orihuela in Madrid at rorihuela@bloomberg.net

To contact the editors responsible for this story: Rebecca Penty at rpenty@bloomberg.net, Thomas Pfeiffer

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