Downgrading Telefonica's Moat Rating to None, Lowering FVE; Asset Sales and Deleveraging Key

We are downgrading Telefonica’s moat rating to none from narrow, as we believe the company’s advantaged position in Spain and the United Kingdom as a result of effcient scale is not enough to offset its weaker position in Germany, Brazil, or Latin America. Although Telefonica is doing a good job of reshaping its portfolio by divesting no-moat divisions and crystallizing value through asset sales, the company’s returns on invested capital are close or just slightly above its cost of capital, leaving little margin for error, which reduces our certainty that the company will more likely than not be able to generate excess ROICs over the next 10 years. Our moat rating downgrade together with more moderate revenue growth and margin assumptions is the main explanation for our fair value estimate cut to EUR 4.90 from EUR 8.70 (our new fair value implies a 6.0 times terminal enterprise value/EBITDA multiple).