Telefonica - a Telecommunications Company

II. Telefonica Overview

Telefonica is a telecommunications company currently providing services to over 218 million customers worldwide. Previous to its incorporation in 1924, Telefonica was supported by a small group of individuals and small French and Spanish companies run by the government. During this time, Telefonica suffered inefficiency under strict governmental regulations, and their manual systems proved to be incompatible throughout Spain. The ineffective phone service situation in Spain was clearly failing, so the Spanish government decided to grant one single body the responsibility to service all of Spain; Telefonica was this chosen body.

Since this decision in 1924, Telefonica has grown and succeeded tremendously. The couple decades following 1965, and the technological advancement of satellites and data transmission, aided in Telefonica’s growth as the company’s telephone installments increased to 3.5 million. In the 1990’s, the company expanded their global presence past Europe into Latin America; there they are the telecommunications leader, providing service to 126 million users.

The new millennium presented many numerous business opportunities that allowed the company to further its global growth. In 2005, they acquired English company O2, whose operations are represented in Telefonica’s consolidated financial statements as of February 2006. They also acquired Cesky TelecomвЂ"a leading provider in Czech RepublicвЂ"and in 2006 merged with Colombia de Tellecommunicaciones in Latin America.

Starting in 2004, in two short years Telefonica doubled its size in customers, employees, market share and assets. Now in 2007, it currently boasts presence in 23 countries. It has three distinct business units (Telefonica Spain, Telefonica O2 Europe, and Telefonica Latin America) and maintains historical trends that suggest effective strategy. Financial analysis further supports Telefonica’s success and growth potential.

III. Financial Statement Analysis

i) Grade under Statements prepared in accordance

with International Financial Reporting Standards

Balance Sheet

The financial analysis of the balance sheet produces fairly positive results for the company. Almost every account in the statement has shown an overall growth rate of over fifty percent between 2004 and 2006. This statistic demonstrates the high growth levels the company has experienced in the past few years. Telefonica’s total assets have increased 80.9 percent overall and 46.5 percent between 2005 and 2006 alone. The firm also shows specific strength in its inventory asset. The inventory account values only 0.9 percent of its total assets in 2006, but represents only 21 days in inventory and shows a quick turnover of 17 times вЂ" more than once a month.

In contrast, Telefonica shows some weakness in its liquidity, as 84.6 of its assets in 2006 are non-current. This imbalance can create a higher level of risk for the company, especially as the company’s current assets cover barely half of its current liabilities. On the other hand, less liquidity can also point towards greater investment in non-current assets such as capital and capacity which can be used to maintain the firm’s growth.

On the other side of the balance sheet, the firm’s liabilities have been increasing faster than its assets at 93.9 percent and €51.4 billion overall. Telefonica’s equity accounts, on the other hand, have been increasing much more slowly, showing 43.3 percent and €7.1 billion overall. These findings are further supported by the increase in Telefonica’s debt to equity ratio from 1.98 to 2.95 between 2005 and 2006, respectively. The company is choosing to finance more of its growth with debt, which can allow the company to acquire the financing needed to grow without diluting its shares. On the other hand, debt financing can prove more risky due to the increased costs associated with interest and the repayment of the principal amount.

Another significant increase in Telefonica’s liabilities is that of the company’s payables, which showed growth of 2087.3 percent and €11.4 billion between 2004 and 2005 alone. The increase in accounts payable is attributed to the company’s overall growth. In fact, payables have valued consistently around 14 percent of total assets in 2005 and 2006. The health of this account is further supported by the firm’s 261 days in payables outstanding and accounts payable turnover of less than twice a year. Telefonica is able to sell its inventory remarkably faster than it pays its bills.

Income Statement

Telefonica has achieved strong growth in both revenue and earnings over the past three years, 2004 to 2006 respectively. Revenues have increased by close to 80 percent during this period, and earnings have improved by 150 percent. Telefonica’s profit margin has also slightly improved from nine percent in 2004 to 12 percent in 2006.Various factors, such as a strong Spanish economy, weak mobile competition in Spain, and a strong uptake in Latin America, have contributed to this accelerated growth.

However, as expected, costs have also significantly increased over this period. The cost of revenue and operating expenses has grown by approximately 85 percent causing margins to fall slightly. Telefonica’s gross profit margin fell from 75 percent in 2004 to 69 percent in 2006 and its operating profit margin fell by three percent over the same period. Despite significant acquisition activity, Telefonica has managed to keep its selling and administrative expenses, as well as other associated expenses, in check. Its selling and administrative expense as a percentage of sales has decreased by two percent from 2004 and other expenses as a percentage of sales have remained constant at 12 percent. Most impressively, the company has been able to reduce the percentage of sales devoted to income tax expense from 3.4 percent to 2.7 percent. This was a driver that led to bottom line growth from €4.1B in 2005 to €6.3B in 2006.

Finally, Telefonica has improved both its return on assets and return on equity ratios. Over the past year, its return

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