At Telefonica''s upcoming CMD on 8th Nov, its first in over a decade, management had intended to lay out a path for sustainable FCF growth. But the recent loss of the 1and1 MVNO contract in Germany, increasing FTTH overbuild, and uncertainty around Spanish consolidation mean that target looks challenging. Whilst company-defined FCF will hit EUR4bn this year, we see this falling to EUR3.6bn on a lfl basis by 2026e and just EUR2.2bn on an underlying basis. Downgrade to U/P, EUR3.2 TP.
Spain remains the focus, but we see pressure from multiple angles
TEF certainly has some positives to highlight, and completing the FTTH rollout will unlock cost savings and drive lower capex. But continued FTTH overbuild is an ongoing headwind to wholesale revenues. On the retail side, competition is increasing again and TEF''s backbook price increases have already been eroded by customer down-spinning. We also still see downside risk from EC''s decision on Spanish consolidation - particularly if structural remedies go to Digi (Be careful what you wish for...). Our 2023e/24e/25e OpFCF forecasts are -1%/-4%/-7% for Telefonica Spain vs. VA cons.
TEF DE (-) wholesale losses still underappreciated, VMEDO2 dividend appears unsustainable
We estimate the loss of 1and1''s MVNO business to VOD (see Checkmate) implies a EUR400m FCF hit to TEF DE. Consensus likely only models in half of this, but assumptions that new MVNO contracts can plug the gap are overly optimistic in our view. Continued altnet growth in the UK presents a challenge to VMEDO2, but also the opportunity to use cash for small-scale MandA. Either way we believe that the uncovered dividend being upstreamed to TEF is likely to be reduced.
Real cash conversion likely to disappoint, leverage issues and FX risk warrant a discount
We expect TEF to deliver EUR4.2bn of FCF this year, pre spectrum. But multiple headwinds and the VMEDO2 divi cut mean that we see this declining to EUR3.6bn by 2026e (-8.5% below VA cons...
