The South American continent emerged as one of the hottest markets in the past two decades as

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The South American continent emerged as one of the hottest markets in the past two decades as a result of economic policy changes and the region’s growth prospects. Privatization, deregulation, and regional economic integration unshackled the imaginations and energies of the continent’s entrepreneurs and attracted the attention of foreign investors, while surging commodities exports boosted the economies of such countries as Brazil (iron ore), Chile (copper), Bolivia (tin), and Venezuela (oil). One industry directly impacted by these policy changes is telecommunications. Once the sleepy preserve of inefficient and overstaffed state-owned enterprises, the industry has become a magnet for new firms and new technologies. The most aggressive entrant is Telefónica SA. Telefónica’s managers knew all too well the problems of state-owned telecommunications monopolists because Telefónica was just such a firm in its former guise as government-run Telefónica de España. Telefónica de España first obtained its monopoly concession on telephone services in Spain in 1924. Originally privately owned, the company was nationalized in 1945, with the government owning outright 41 percent of the company’s shares. For four decades the company enjoyed the easy life of a monopolist. The seeds of change were planted in 1986, however, when Spain joined the European Union (EU). Telefónica de España was ill-equipped to handle the explosive growth in telephone service or the chorus of complaints about poor service that followed. Moreover, as part of its single market initiative, the EU announced that state-sponsored telephone monopolies would be abolished by 1998. Any European telecommunications firm would then be able to provide service anywhere within the EU. Faced with the threat of new entry from European rivals that promised increased competition, lower prices, and smaller profit margins, Telefónica’s managers realized they had to transform the company. A leaner and more competitive company emerged as managers trimmed fat, shed unprofitable operations, and invested in new technologies and facilities. With the EU-directed ending of state telephone monopolies, Telefónica’s managers confronted a new strategic problem: Should they change the scope of their operations? Should they erect a fortress in Spain and keep out EU rivals, expand into other EU markets, or do something else? In analyzing their strategic choices, Telefónica’s managers recognized they had a strong position in Spain, and that domestic demand for telephone services would continue to grow in the relatively underserved Spanish market. Thus, they continued to invest in new equipment and technologies there. This approach has worked: Telefónica has 12 million local fixed-line subscribers and 24 million cellular customers in its home market. Despite the EU’s competition directive, at the end of 2012 Telefónica retained 69 percent of Spain’s fixed-line business and about 41 percent of its mobile phone market. In assessing their international prospects, Telefónica’s managers decided that the company lacked a competitive advantage against European rivals like British Telecom and Deutsche Telekom, who had equal if not better access to the latest technology and managerial talent. That ruled out attacking other EU markets, at least initially. However, they noted that many South American countries were about to privatize their own state-owned telephone monopolies, and that investing in these companies made strategic sense. Telefónica did have a competitive advantage vis-à-vis local entrepreneurs in accessing technology, capital, and managerial talent. Moreover, because of linguistic and cultural ties between Spain and South America, Telefónica believed it had a competitive advantage over any of its European rivals who might wish to enter the South American market. Telefónica de España launched its invasion of the South American market in 1990, when it acquired a minority interest in Compania de Telefonos de Chile and a contract to manage the southern half of Argentina’s telephone system. In 1995, it purchased a majority interest in Telefónica del Peru, that country’s state-owned monopoly provider of telephone services. A year later it acquired 35 percent of a regional Brazilian telephone company at a state-sponsored auction. Telefónica also acquired interests in Argentina’s largest cable company and a digital satellite TV provider. The Spanish government then sold off the last of its ownership position, making Telefónica de España wholly privately owned. In 1998, the company changed its name—to Telefónica SA—and paid $4.9 billion at auction to acquire control of the fixed-line and cellular operations of Telebras, Brazil’s former state-owned telephone giant. In 2000, Motorola sold its Mexican cellular service operations to Telefónica for $2.6 billion, and in 2006 Telefónica purchased 50 percent (plus one share) of state-owned Colombia Telecommunicaciones, making it the largest landline operator in that country as well. In 2010 it acquired full ownership of Brazilcel, a Brazilian mobile phone joint venture, by buying out its Portuguese partner for €7.5 billion. All told, Telefónica has invested more than $64 billion in South America. It is the largest telecommunications company on that continent and now has more landline customers there—24 million—than in Spain.

Its wireless subsidiary, using the brand name Movistar, has 177 million customers in Latin America. It has followed the same pattern in each country it has entered: Trim excess payrolls ruthlessly and expand capacity aggressively. For example, it laid off half of the 22,000 workers in its Argentine subsidiary while doubling its network there to 4 million lines. Telefónica’s actions in South America have not lacked criticism, however. Telefónica’s tactics have been denounced by local skeptics as “conquistador capitalism.” After winning the Telebras auction, it moved quickly to expand service in Brazil’s commercial center, São Paulo, while laying off thousands of workers. This strategy of doing more with less backfired, as chaotic disruptions in service led to numerous complaints. Minority shareholders also complained that Telefónica charges its South American subsidiaries exorbitant management fees that reduce the value of their interests. For example, its Argentine subsidiary pays 4.6 percent of its revenues to Telefónica for management services provided by the parent corporation. Minority shareholders have also protested Telefónica’s practice of transferring product lines with high growth potential from the subsidiaries to the parent. For example, Telefónica created Terra Networks SA to consolidate all of its South American Internet operations. It then sold to the public 30 percent of Terra Networks, retained the other 70 percent, and listed it on stock exchanges in Madrid and the United States.

As part of this deal, Telefónica transferred the Internet operations of its Chilean subsidiary to Terra Networks for $40 million; minority owners believed that the price should have been double that figure. Minority shareholders in other subsidiaries have made similar complaints. Similarly, Telefónica has been transferring the telemarketing operations of its South American subsidiaries to an umbrella company in Madrid, arguing that they would benefit from the economies of scale that a consolidated operation would offer. Telefónica also faces some operational challenges. Some are of its own doing: It was forced to pay $8 million in refunds in 1999 to São Paulo customers because of poor service. Others are not: It was forced to take a $300 million write-off for currency losses after Brazil devalued its currency in 1998 and a €1.8 billion markdown of its Venezuelan assets in 2010 after the bolivar was devalued. Moreover, changes in government policies have increased competitive pressures. For example, Argentina and Peru began to deregulate their telecommunications industries in 2000, ending their reliance on monopoly provision of telephone service. And Telefónica’s success has attracted new competitors. In 1999, for instance, BellSouth signed up 1 million cellular phone subscribers in São Paulo, capturing nearly 50 percent of that market in only 10 months of operations. But BellSouth executives were unhappy with the venture’s profitability, and in 2004 Telefónica purchased BellSouth’s Latin American subsidiary for $5.9 billion, thereby eliminating a well-funded, technologically sophisticated competitor. Having built strong bases in Spain and Latin America, in 2005 Telefónica turned its attentions back to Europe.

It purchased Çesky Telecom, the leading provider of landline and mobile telecommunications services in the Czech Republic. In 2006, it acquired O2, the largest provider of mobile phone service in the United Kingdom. O2 is a major player in the German and Irish markets as well. In 2007, it purchased a minority position in Telecom Italia. In 2009, it paid €913 million for HanseNet, a German provider of telecommunications services. Telefónica now serves some 50 million European customers outside its Spanish home market. It also purchased 5 percent of China Netcom in 2005, the second-largest provider of landline service in China. In 2008, it agreed to buy an additional 2.2 percent of that company for €309 million. After China Unicom acquired China Netcom, Telefónica entered into a strategic alliance with China Unicom and increased its ownership of that company to 9.7 percent. Overall, this strategy seems to be working. In 2012, Telefónica earned €5.9 billion on revenues of €62.4 billion. Under the direction of César Alierta, the firm’s CEO since 2000, the company has become Europe’s second-largest telecommunications company.

Almost half its revenues—and more than half its operating profits—are generated by its Latin American operations. Its grip on the Spanish market remains firm, and Telefónica has made significant inroads in the British, Irish, Czech, Slovakian, and German mobile phone markets. Telefónica now operates in 25 countries, serving 40 million landline customers and 247 million mobile phone customers. Telefónica does, however, face one significant financial challenge: it has to trim its excessive debt burden, the result of its rapid expansion through acquisitions. In 2012, the company liquidated a portion of its China Unicom position and some of its Colombian operations to reduce its debt burden. Telefónica also sold off 23 percent of its stake in its German subsidiary through a public offering, raising €1.4 billion through the sale. In 2013, the company raised $1.25 billion by selling treasury stock; the sales proceeds were used to pay off some of its remaining €51 billion in debt.

11-30. Why did Telefónica initially choose to enter the Czech market, rather than the larger French or German markets?

11-31. Considering Telefónica’s large and persistent share of the Spanish telecommunications market, how successful has the EU’s directive been in promoting competition within the European telecommunication industry?

11-32. Minority investors in Telefónica’s South American subsidiaries are unhappy with the parent corporation. Suppose you are a senior manager at the parent corporation. How would you handle the problem of minority investors? What would you recommend to the CEO should be done about the minority investors?