The column was originally published on RealMoney on June 9 at 9:59 a.m. EDT.
I have rather simple reasons for shorting Spain's
at current levels. First, in the past three months, credit spreads have widened compared to U.S. Treasuries. I think this trend has only just begun, and that rising credit spreads will make foreign stock markets falter.
We are beginning to see the effects of this now, as emerging markets are under a great deal of pressure. This is especially true in the Latin American markets of Brazil, Argentina, Bolivia and Venezuela -- and also Telefonica's home country of Spain.
Moreover, given France's "no" votes to the European constitution referendums, this is subjecting the euro to a great deal of stress. Central banks that once considered putting their enormous dollar reserves into euros are now reconsidering, and those that have done so are considering their actions perhaps a bit premature. In any case, a lower euro is expected over the intermediate term. This, combined with the volatility in Latin American currency markets, provides an added level of macro risk that hurt Telefonica shares in 2001-02.
I am willing to risk a move through $52.50 to profit from a trade toward the August 2004 lows at $40.75. Telefonica closed Wednesday at $49.83. I've put on the first 40% of my position now, and I'll add additional 20% increments on $1.50 moves lower.
Here are the potential catalysts outside of my evolving macro story.
First is Telefonica's acquisition strategy. The company has been very aggressive on this front, spending roughly $8 billion in 2004. This is an enormous sum to be sure, but at least all the major acquisitions were in Spanish-speaking or Portuguese-speaking countries.
But April's purchase of the Czech Republic's
is the first deal outside of this purview, and I find this change in strategy rather troubling because it signifies a move outside Telefonica's core competencies. The final purchase cost of Cesky will be more than $6 billion. Telefonica is also rumored to be in the hunt for the Turkish government's 55% stake in
, adding another $3 billion-plus to its 2005 acquisition total.
Now, I don't disagree that it must expand outside of the Latin American markets at some point, but I would rather have it focus on integrating its other acquisitions before doing so. This simply spreads Telefonica very thin.
The other big concern is balance-sheet leverage. Although Telefonica has a pristine balance sheet, the international incumbent telecom market is rather fully valued now. Any premiums paid by Telefonica increase its balance-sheet leverage. This commensurately increases the risk to future earnings and, more importantly, cash flow will be less than expected. I don't think this is priced into the company's shares at this juncture.
Thus, when taking both the macroeconomic and company-specific fundamentals into account, I see risk to share prices. I'm willing to put my capital to work on this trade, and the risk-reward parameters laid out previously are in my favor.
At the time of publication, Rhodes was short Telefonica, although holdings can change at any time.
Richard G. Rhodes, Jr., is president of Rhodes Capital Management and editor and publisher of the Rhodes Report. He specializes in recommendations with emphasis on world macroeconomic fundamental and technical analyses. While he cannot provide investment advice or recommendations, he appreciates your feedback;
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