Spanish Phone Company Boosted By Latin America

Among Europe's former state-run phone company giants, Spain's Telefonica has emerged as the best positioned, several analysts say.

Key acquisitions, especially in Latin America, have sparked Telefonica's (NYSE: - ) sales and profit growth in highly competitive markets. The acquisition spree also has sparked some concern among investors. But for now, solid execution has earned the company a good outlook.

"Among Europe's big incumbents, Telefonica offers the best growth profile," said Chris Alliott, an analyst at ABN Amro.

Europe's big phone companies include Deutsche Telekom (NYSE: - ), France Telecom (NYSE: - ) and Telecom Italia (NYSE: - ). Like Telefonica, their fixed-line phone businesses have come under attack from wireless and Internet calling services.

Telefonica, though, has performed better than expected against rivals in Spain. And its wireless unit in Latin America continues to notch strong growth.

"Telefonica has executed well in its domestic market, both in mobile and fixed-line," Alliott said. "Its Latin American business, which generates a very meaningful amount of growth, has been performing in-line or ahead of expectations."

Telefonica's American depositary receipts have shot up 42% over the past year, including 15% in 2007.

Shares in France Telecom and Deutsche Telekom posted solid gains in 2006, but their stocks have cooled. Telecom Italia's U.S. stock has fallen 14% since April.

Telefonica's second-quarter profit, excluding a one-time capital gain, rose 11% from the year-ago quarter to $1.72 billion. Its revenue rose 6.5% to $19.2 billion.

Telefonica upped 2007 targets. It now expects 2007 revenue to rise 8% to 10%. Its earlier target was 6% to 9%. Telefonica raised guidance for operating income growth before depreciation and amortization to 10% to 13% from 8% to 11%.

While the new guidance boosted Telefonica's stock, analysts say that its acquisition strategy still concerns investors. Acquisitions have hiked its debt to around $72 billion. In May 2006, Telefonica promised investors it would not increase debt by more than $2 billion over the next 18 months. But that pledge expires in December.

"A criticism of the company has been that it's been too acquisitive," said Mike Meloan, a Goldman Sachs analyst. "The message they're trying to send to the market now is about continuing to deliver and maintain their credit rating. They don't want to go below that (current rating of BBB), into the junk (bond) category."

Telefonica's big-spending ways go back to Juan Villalonga's six-year reign as chief executive, which ended in 2000. Telefonica's Terra unit bought U.S. Internet firm Lycos for $12.5billion in stock in 2000. Telefonica purchased Dutch media company Endomol for $5.4 billion the same year.

Cesar Alierta Izuel took over as Telefonica's CEO in mid-2000. Under him, Telefonica acquired the Latin American assets of BellSouth for $5.9 billion in 2004 and Cesky Telecom in the Czech Republic for $3.5 billion in 2005.

Telefonica acquired U.K.-based wireless firm O2 for $31.5 billion in 2006. Telefonica's stock took a big hit after it announced the deal.

Telefonica recently sold off Airwave, O2's emergency services radio network in the U.K., for $1.8billion to raise cash.

As part of a consortium, Telefonica this year agreed to buy a stake in Olimpia, which controls Telecom Italia. Telefonica also wants to buy out Portugal Telecom's 50% stake in Vivo, a wireless joint venture in Brazil.

Meloan says the Olimpia deal and a Vivo takeover make sense for Telefonica. He says Telefonica blocked rival America Movil's (NYSE: - ) move into Europe by buying a 7.5% indirect stake in Telecom Italia.

"Vivo has been badly run as a joint venture. That's an asset Telefonica wants to control, and the market is happy with that," Meloan said.

More deals might be coming in Asia. Analysts say Telefonica is interested in upping its stake in China Netcom from 5% to 10%.

Telefonica's expansion into Latin America's wireless market, which began in the mid-1990s, has paid dividends, analysts say. The Latin American unit's second-quarter revenue jumped 13% to $6.7 billion.

Telefonica has upped the Latin American unit's 2007 revenue growth target to 13% to 16% from 11% to 14%.

"Growth at Telefonica is far superior to that at European peers," said Jonathan Dann, a Bear Stearns analyst. "And Latin American assets are the key driver of growth."

In the U.K. and Germany, where O2 also sells mobile services, Telefonica faces tough competition, analysts say. In Germany, revenue fell 2% in the second quarter.