A Shockingly Tough Quarter for Telefonica

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Telefonica (NYS: TEF) , the European telecommunications giant, posted a loss in its third-quarter results, the first in almost nine years. The company has been bogged down by competition and costs related to a charge for layoffs that would extend into 2013. Let's take a closer, Foolish look to see what happened to Telefonica.

That sinking feeling
Telefonica saw its revenues increase by 3.7% to $21.5 billion. While Spanish revenues fell by 8.8%, Latin American operations, which form more than 50% of revenues, saw a 17.5% increase.

The company posted a third-quarter net loss equivalent to $584 million, a huge contrast to its profit of $6.96 billion in the previous year. The figure was worse than the $290 million loss analysts had in mind.

The main reason for the plunge was employee costs that more than doubled on account of a $3.6 billion charge as layoff expenses. An estimated 20% of Telefonica's staff (6,500 people) will get a pink slip by 2013. Telefonica never expected to pay such a large sum. However, after being criticized by the government for its plan for a mass layoff, it was forced to shell out a higher amount. This comes at a time when Spain is seeing unemployment levels at a whopping 20%.

As a consequence of this charge, the company's operating income tumbled 69% to $4 billion.

For Telefonica, the layoffs might be just what the doctor ordered, as it has recently faced turbulent times with low fixed-line traffic and intense competition that have resulted in lower prices. This problem has been magnified by Spain's worst-ever economic crisis in decades.

Competition abound
The company witnessed a slight dip in its Spanish mobile phone market share in September, down 18 basis points to 40.47%, while companies such as TeliaSonera and France Telecom (NYS: FTE) have seen their market shares rise. Even Jazztel, a rival to Telefonica's fixed-line operations, saw its net income double from the year-ago period.  

Italy's largest telecommunications service provider, Telecom Italia (NYS: TI) , also witnessed a 33% jump in third-quarter profits, while revenues saw a 13% rise. Given the competition Telefonica faces, analysts have said that the company might continue to see lower revenues in Spain.

Not willing to bow down
Even in the aftermath of its red quarter, the company refused to concede defeat and made it clear that it will meet its targets for the year. It also said that it would continue to pay a handsome dividend to shareholders with a target dividend of approximately $2.40 per share, which would be paid next year. However, analysts have been skeptical about the sustainability of the dividend as the company has $75.2 billion in net debt and a debt-to-equity ratio of 2.6, which could force the management to rethink the dividend policy.

The Foolish bottom line
Analysts say Spain has shown signs of further deterioration from past quarters, and ongoing weakness can be expected as further austerity measures deal a severe blow to consumption. However, on the bright side, the company can benefit from Latin America's economic growth. Telefonica will also experience the benefits of its cost cutting-measures in the quarters to come. But, to stay on the safe side, I'm not putting any of my money into Telefonica for now. You can also stay up to speed with Telefonica's progress by adding it to your very own watchlist. It's free, and it keeps you up to date on the latest news and analysis for your preferred companies.

At the time this article was published Keki Fatakia does not hold shares in any of the companies mentioned in this article. The Motley Fool owns shares of Telefonica. Motley Fool newsletter services have recommended buying shares of France Telecom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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