MADRID/PARIS Telefonica's (TEF.MC) decision to scrap its dividend for the first time since the Spanish Civil War in the 1930s reflects wider concern across companies that Spain's deepening economic crisis may render heavy company debt unsustainable.
Telefonica, a corporate stronghold both in Spain and abroad, shocked investors late on Wednesday with the surprise move intended to slash its debt pile and protect its prized investment-grade rating, now under threat from two agencies.
As well as cutting the dividend for 2012, Telefonica cancelled its share buyback programme and trimmed top management's salaries, though remuneration remains above industry standards.
The plan will help Telefonica confront its 57 billion euros of debt, and was welcomed by analysts and rating agencies. The company's shares closed up 3 percent at 8.9 euros, having initially fallen more than 8 percent at the market open.
The firm has taken action ahead of heavy debt redemptions early next year, with a 1.5 billion euro bond maturing on February 14 and a 1.2 billion euro bond repayment due on June 12.
The cost of insuring against Telefonica's five-year debt using credit default swaps (CDS) has jumped around 170 percent in the last year to over 550 basis points.
The firm's CDS has increased 11 percent since the beginning of the month, while Spain has struggled to avoid taking a full-scale sovereign rescue.
"I see the risks at present for this and other Spanish companies - especially those with consistent refinancing needs - are around liquidity and making sure they can fund themselves internally at least through 2013 and potentially beyond," said Stuart Reid, senior director at Fitch, which rates Telefonica two notches above junk with a negative outlook.
"Telefonica have recognised and responded to this, although there is still more to be done."
The telecoms giant, alongside other Spanish bluechips like oil firm Repsol (REP.MC) and bank Santander (SAN.MC), long boasted that a global footprint spared them from domestic woes in an economy reeling since a property bubble burst in 2008.
But as Spain has become the new frontline in the euro zone debt crisis, its companies have been struggling to access funding on international markets and now are racing to cut massive debts accumulated during a decade-long boom.
Spain's total corporate debt, including real estate and construction companies, is 1.2 trillion euros, or 120 percent of its Gross Domestic Product.
The country's borrowing costs, to which top companies are closely tied, eased on Thursday after euro zone policymakers hinted at a solution to Spain's funding woes. They remain at a level seen unsustainable in the medium term, however.
FEELING THE HEAT
Other Spanish firms are feeling the heat - Repsol vowed "to do whatever it takes" to save its investment grade rating on Thursday, pushing ahead with plans to raise up to 2.5 billion euros with disposals such as liquefied natural gas assets or the redemption of preference shares.
Santander reported a halving of first-half profit after it wrote down losses on bad property investments in Spain dating from a housing and construction boom that crashed in 2008.
For Telefonica, the key question is whether the dividend cut and an ongoing programme of asset sales will be enough to allow it to keep its credit rating.
Standard & Poor's downgraded its debt to BBB in May and Moody's put it on review for downgrade.
The company, which needs to raise 7-8 billion euros a year through 2015 to cope with debt maturities, said preliminary talks with ratings agencies showed they welcomed the move.
If it lost its investment grade rating, raising such massive sums would be harder and cost more. Many bond funds buy only investment grade debt, so the pool of buyers for Telefonica's debt would be sharply reduced if its debt was cut to junk.
"The risk is you purchase the new bond issue and then they become a sub-investment grade issuer," said Louis Gargour, chief investment officer at London-based hedge fund manager LNG Capital, which is neutral on Telefonica.
Telefonica has already paid out around 2.8 billion euros in dividends this year, and should save around 4.2 billion euros compared with 2011 by scrapping remaining payments.
Analysts welcomed Telefonica's plan as prudent but also underlined the company had little choice, given the severity of its situation.
"They've done what shareholders, the markets in general and credit rating agencies were asking them to do," said Ivan San Felix, an analyst at Renta4 in Madrid.
They also said the company had bought itself more time to sell assets and list its German business on the stock market before facing a cash crunch later this year.
Telefonica said in an analyst presentation it would list O2 Germany in the last quarter of 2012 and remained committed to asset sales. It hopes to raise up to 1.5 billion euros from the sale of call centre business Atento and other units.
But liquidity pressures beyond next year mean the company could still have to do more.
"At best, these will further reduce cash payments to shareholders, at worst they could require further asset disposals," said Ian Kelly, fund manager on the Schroder ISF European Dividend Maximiser, which does not currently hold stock in Telefonica.
Telefonica's 0.75 euro per share payout in 2013, halved from the previously announced 1.5 euro per share, will still give a dividend yield of 8.6 percent, higher than the sector average of 8.1 percent, according to Deutsche Bank.
Telefonica, which made its dividend announcement along with the surprise early release of its first-half results on Wednesday, also said it would slash salaries by 20 percent for board members and around 30 percent for top management.
The move is emblematic of the widespread belt-tightening at the company, whose shares have lost 37 percent since the start of the year.
Telefonica Chairman Cesar Alierta's total salary should fall to around 4.8 million euros this year, still significantly higher than the 1.52 million in gross compensation paid to France Telecom FTE.PA boss Stephane Richard in 2011.
($1 = 0.8248 euros)
(Additional reporting by Tracy Rucinski and Jose Rodriguez in Madrid, Sinead Cruise, Laurence Fletcher, Isla Binnie, Josie Cox and Alasdair Reilly in London and Blaise Robinson in Paris; Editing by Julien Toyer and Peter Graff)