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From Distrito
Telefónica

Letter to Shareholders_

César Alierta Izuel

Chairman & CEO


Dear shareholder,

It is my pleasure to offer you a brief summary of Telefónica’s business results for 2012 and share my vision of our industry’s and especially our company’s future. 

2012 was characterised by an uneven world economic growth and an intensification of the differences between developed and emerging countries. The markets where Telefónica operates exhibited divergent behaviour, with 3per cent growth in Latin America compared to just 0.2 % in Europe.

The euro zone, in particular, made substantial institutional progress, denoting a firm commitment not only to the continuity of European integration, but also to a reformist agenda able to lay the grounds for sound growth in the near future.


In Spain specifically, significant headway was made in 2012, in which the commitments undertaken pursued two objectives: the sustainability of the national debt and the implementation of an ambitious programme of reforms to elasticise the economy and thereby contribute to a medium-term rise in growth potential.

In this context, 2012 was a key year in Telefónica’s transformation, a year in which the decisions adopted and implemented already began to bear fruit: decisions regarding the transformation of our commercial model, simplification across the board, optimisation of our investment management model and recovery of financial flexibility.
2012, key year for the transformation of Telefónica’s business model

In 2012 we reached very significant milestones in Telefónica’s transformation, in our commitment to become a Digital Telco and return to a pathway of growth and commercial leadership. 

In this year we have implemented a number of initiatives designed to attain sustainable and differential top-line growth, based primarily on fixed and mobile broadband connectivity as well as new digital services. 

We have also placed our stakes on capturing growth in high potential markets such as Latin America, which was the Company’s major source of revenues for the first time in 2012. 



By focusing sharply on high value customers in Latin America, we are growing profitably in the region, where Brazil is the benchmark market. In Europe, we have regained strong commercial momentum in the major markets and laid the foundations for future growth.  


"In this context, 2012 was a key year in Telefónica’s transformation, a year in which the decisions adopted and implemented already began to bear fruit"
Despite unfavourable economic, competitive and regulatory conditions in some markets, in 2012 our yearly revenues climbed to 62.4 billion euros, only 0.8% less than in 2011. 

In parallel, in 2012 we undertook a profound transformation of our commercial model, changing our offering from a subsidy-focused model to a more sustainable approach based on distinctive quality and offerings that enhance customer loyalty. 

More specifically, in Spain we adopted bold decisions such as the elimination of subsidies for handsets and the launch of “Movistar Fusión”, an integrated communications offering that shatters industry paradigms and constitutes an inflection point in the course of Telefónica’s business in Spain. Similar offerings are being successfully launched in other countries,  
such as the “On&On” smartphone rates in the United Kingdom and “O2 Blue” integrated mobile data rates in Germany.

As a result of the significant impetus given to contract and fixed and mobile broadband accesses, our customer database grew by 3 % year-on-year to nearly 316 million.

At the same time, we made significant efforts to streamline processes and simplify our product base, a measure that is already generating sizeable savings and raising efficiency levels. Suffice to say that in Latin America alone we reduced our product and service catalogue by over 7,000 items during the year. Telefónica Global Resources has been instrumental in this process, with the consolidation of its operating model during this period and its consistent contribution to Telefónica’s progress toward maximising the benefits of its scale. 
As a result of the foregoing, the Company’s operating income before depreciation and amortisation (OIBDA) came to 21.2 billion euros in 2012, for a year-on-year rise of 5.1%. Of particular note is the recovery of the OIBDA margin, an indication of the success of the efficiency enhancement measures implemented throughout the year.  

Lastly, we optimised our investment management model, reallocating resources to the highest growth activities. From that perspective, in 2012 we decided to share networks and co-invest in some countries. Such decisions enabled us to offer our customers an optimal network experience, raise service quality and customer satisfaction, and strengthen our networks by acquiring spectrum. Furthermore, over 80% of the year’s total investment was allocated for growth and transformation projects, one of the priorities being the expansion of our high speed, fixed and mobile broadband services.

316 million customers

reflect Company
growth in 2012

Revenues up to
62.4 billion euros

0.8% less than in 2011

OIBDA reached
21.2 billion euros

a year-on-year increase of 5.1%
The Company also made a substantial investment effort which, including spectrum acquisition, amounted to 9.5 billion euros, bringing the CapEx to sales ratio to 14.2 %, a value comparable to the 2011 figure.

Outstanding performance in financial flexibility
Financially speaking, 2012 was the year we recovered our financial flexibility, reducing debt significantly by upward of 5.0 billion euros. I can assure you that very few companies are in a position to lower their debt so drastically in a single year. In fact, in 2012 Telefónica scaled down its debt more than any other telecoms operator worldwide.

That extraordinary achievement was possible thanks to determined short-term measures,
such as: proactive portfolio management; an active refinancing policy; and, as an exceptional, one-off measure, cancellation of the dividend for fiscal year 2012. A trying but necessary decision adopted by the Board of Directors in July 2012, it was the key to recovering financial flexibility. That favourable outcome was also the result of robust cash flows: in 2012 the Company generated a free cash flow of nearly 7.0 billion euros. 

These measures led to a sizeable decline in financial leverage, stabilisation of our credit rating and a significant improvement in the Company’s liquidity. 
After the year’s stringent adjustments, the Company is now in a position to resume shareholder remuneration in 2013, with a cash dividend of 0.75 euros per share. The intention is to split this dividend into two payments: the first, at 0.35 euros per share, in November 2013 and the second for the remaining 0.40 euros per share in the second quarter of 2014. This proposal confirms our commitment to continue to reward our shareholders and translates into the ongoing payment of dividends year after year. In May 2012, for instance, Telefónica paid its shareholders a 2.8 billion-euro dividend on its 2011 earnings. 

 At the current share price (10.8 euros on 10 April 2013), the remuneration announced for 2013 constitutes a 6.9per cent return. That is a higher dividend yield forecast for 2013 than offered by any of the other top 25 Information and Communication Technology companies by market capitalisation.

Over 5 billion euros
debt reduction

9.5 billion euros
invested

during 2012

Over 80%

of investment in growth and
transformation projects
Quartely improvement in Earnings per Share
comparable terms (euros/share)

0,29
0,34
0,36
0,46
1,44
1Q 2012
2Q 2012
3Q 2012
4Q 2012
2012
Net debt evolution Billion euros
56.304
51.259
Net debt / OIBDA
2,46x
2,36x
Dec. 2011
Dec. 2012
Becoming a genuine Digital Telco

Now I would like to share my vision with you on the situation prevailing on our market today, the period of fastest change ever in the history of our industry. Suffice to say by way of example that in 2012 mobile penetration reached 90 % worldwide, while the number of smartphone users grew by 42 %. That only 17 % of mobile customers have smartphones despite such a significant rise is an indication of the enormous growth potential to which we can look forward. 

We are indisputably in the midst of a Digital Revolution that is driving profound change in our everyday lives, while the availability of increasingly smarter devices and the development of new digital solutions have become the key drivers of our industry’s growth. 

At Telefónica we are decidedly focusing on the digital world to capitalize on the opportunities already afforded by the digitisation of the economy.


Telefónica Digital is playing an essential role in this process, furthering innovation to offer our customers optimal digital solutions. Some of its key initiatives include the development, in conjunction with Mozilla, of the HTML5-based Firefox open mobile operating system; the empowerment of machine to machine (M2M) solutions in different industries; the development of mobile payment options; the unconditional commitment to e-Health through the acquisition of Axismed in Brazil; and the active participation in innovation areas such as Big Data, Cybersecurity or Voice Recognition. 

I can assure you that at Telefónica we are working actively to position the Company as a major player in the digital world and turn it into a genuine “Digital Telco”. I am of the conviction that digital telcos such as Telefónica will continue to be the lead actors in the next stage ahead, whose foundations are being built over the investment effort made to deploy the latest generation networks. 
Our social commitment

To conclude, I would like to devote a few words to our commitment to the comprehensive development of the societies where we operate, which materialises in three lines of work. First is our commitment to social and cultural action, channelled through Fundación Telefónica, to foster learning and pluralise knowledge by connecting people and institutions. Secondly, we are committed to entrepreneurship, innovation and support for youth through programmes such as Telefónica ‘Think Big’, ‘Wayra’, Amérigo, ‘Campus Party’ and ‘Talentum’, initiatives designed to back young entrepreneurs and identify ideas with high growth potential in the Information and Communication Technologies industry. Lastly, we are committed to corporate sustainability to ensure efficient social, economic and environmental risk management and pursue value creation in partnership with society.


I realise that 2012 was a difficult year, but together we are building a better future for the Company. I am confident that in 2013 we shall continue to harvest the fruit of the profound change undertaken, a venture that has enabled us to attain a position of privilege and leadership in the new wave of growth driven by the digitisation of the economy. Telefónica’s present and especially Telefónica’s future depend on its role as a Digital Telco leader.

Lastly, I wish to thank all of our shareholders for your support and for confiding in our company year after year. Both personally and on behalf of the Board of Directors, I can promise that we are going to continue to put all our enthusiasm and dedication into making Telefónica a leader in the new digital world.
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Telefónica
in the world

Telefónica in the world_

And_
Telefónica reinforces its global scale with alliances and collaboration agreements. Through our strategic alliances with China Unicom and Telecom Italia, we reach 871 million customers.
Ireland
UK
Argentina
Uruguay
Chile
Peru
Colombia
Ecuador
Mexico
Nicaragua
Czech Rep.
Spain
Guatemala
Panama
Germany
Slovakia
Brazil
Venezuela
Costa Rica
El Salvador
Revenues
Investment
Staff
Accesses
62,356 M€

joint revenues
9,458 M€

total investment
315.7 million

accesses
1st European

operator by revenue
133.263 employees

95% of all contracts are








permanent
7th operator in the world

by market capitalization
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Telefónica
in numbers

Telefónica in numbers (2012)_


Net profit
-27.3%
Million euros
5,403
3,928
2011
2012
The behavior of net profit in 2012 compared to that of 2011 (-27.3%) was affected by various extraordinary impacts, which reduced this quantity by 2,536 million in the last year.

These include the value adjustment in the participation in Telecom Italia and Telefónica Ireland, and the effect of the devaluation of the Venezuelan bolívar. Without these effects, the consolidated net profit was 6,465 million euros.
Cash flow
-25%
Million euros
9,270
6,951
2011
2012
The free cash flow was 25.0% less than 2011, fundamentally as a result of lower generation of working capital and higher interest payments. 

Nevertheless the financial flexibility has been increased and there is ample provision for the dividends promised for 2013.
Revenue
-0.8%
Million euros
62,837
62,356
2011
2012
Revenue fell by 0.6% year-on-year (rise of 0.7% excluding the impact of regulation).

Noteworthy is the solid growth in mobile data revenue (+12.8% year-on-year) and the evolution of this in Latin America (+5.5%), which accelerated in the fourth quarter to grow by 7.5% organically. 
OIBDA
+5.1%
Million euros
20,210
21,231
2011
2012
The consolidated OIBDA of Telefónica grew by 5.1% in reported terms to 21,231 million euros, which situated the OIBDA margin at 34% (+1.9pp).
Investment
-7.5%
Million euros
10,224
9,458
2011
2012
During the year, Telefónica allocated 14.2% of its revenue to investment (excluding investments made in spectrum). Of this, 81% was assigned to projects of growth and transformation.
Suppliers
+2.4%
Million euros
27,295
27,958
2011
2012
In 2012, Telefónica had about 20,000 contracted suppliers from 68 countries, of whom 85.6% are contracted at a local level. The purchasing volume was close to 28,000 million euros, which is 2.4% greater than the previous year.
Accesses
+3%
Million euros
306,607.7
315,742.1
2011
2012
67.3% Latin America
32.7% Europe
Telefónica closed the year with a customer base that grew 3% to reach 316 million accesses and with recovery in the commercial impetus in Europe. 

Mobile clients reached 247 million accesses at the end of 2012 (+4%), with a growth rate of +7% in the contract segment.

At the end of December, Telefónica had 52.8 million mobile broadband customers (+38%) and with 18.6 million end-user accesses of fixed broadband (+3%).
Employees
n.s.
Number of people
291,027
133,263
2011
2012
52.5% Latin America
47.4% Europe
The number of workers at 31 December 2012 is affected by thesale of Atento, which had over 150,000 employees. If we exclude this effect, the total workforce is 4.1% less than in 2011 due to the restructuring processes that the Company is carrying out in various operations to improve the fit of the workforce to the new business requirements.  Latin America still has the greatest percentage of the Telefónica Group workforce, with 52.5%, while 47.4% are based in Europe. Telefónica continues to opt for sustainable work policies, so that 95% of its workforce have permanent work contracts.
Debt
-5,045
Million euros
56,304
51,259
Net Debt / OIBDA
2.46x
2.36x
Dec. 2011
Dec. 2012
Between January and December, Telefónica reduced its net financial debt by more than 5,000 million euros to reach 51,259 million euros, which situates the ratio of net financial debt to OIBDA at 2.36 times.  Moreover, thanks to an active financing policy (15,000 million euros between January and December), the debt maturity profile of Telefónica is now provided for until beyond 2014. All this is compatible with the investments in areas of greatest growth and in acquisition of spectrum.
Remuneration of shareholders
2012 underlying EPS (euros/share)
0.29
0.34
0.36
0.46
1.44
1Q 2012
2Q 2012
3Q 2012
4Q 2012
2012
The evolution of the liquidity and the results throughout the year permit the renewal of the policy of remuneration of shareholders for 2013, with the distribution of a cash dividend of 0.75 euros per share.
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Telefónica in
terms of economic impact

Telefónica in terms of economic impact: motor of progress_


The Company has shown a significant improvement in its financial flexibility thanks to asset management and cash generation.

In 2012, the total amount distributed by Telefónica increased by 0.9% to reach 78,840 million euros. Regarding inflows, it should be emphasized that an important part of this amount comes from permanent financial divestments in China Unicom and Atento.

Both sales were commitments already announced by Telefónica to improve financial flexibility and ensure provision for the Company’s commitments to its stakeholders in 2013. It should also be said that these divestments compensate for the fall in net revenues that has taken place in the period, mainly impacted by the complex environment for operations in Europe, exchange rates and regulation.




This financial flexibility has manifested itself in an important increase in the liquidity position of the Company, which reached 5,803 million euros at 31 December 2012 and reduced the ratio of net debt over OIBDA from 2.46x to 2.36x. In addition, it has managed to reduce the outflow towards financial institutions by improved debt management, which has allowed the effective rate of interest of the Company to be reduced from 5.50% to 5.37%.

Just as in the preceding year, there were notable divestments in non-strategic mobile infrastructures. These make up a series of initiatives carried out to optimize the use of capital and improve the energy efficiency of services to Telefónica’s customers.
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Telefónica
milestones

4

Telefónica
milestones
in 2012

1
Transformation of the
commercial model
In 2012 we undertook a profound transformation of our commercial model, changing our offering from a subsidy-focused model to a more sustainable approach based on distinctive quality and offerings.
2
Simplification across
the board
We optimized our investment management model, reallocating resources to the highest growth activities. From that perspective, in 2012 we decided to share networks and co-invest in some countries.
3
Optimization of the investment management model
We optimized our investment management model, reallocating resources to the highest growth activities. From that perspective, in 2012 we decided to share networks and co-invest in some countries.
4
Recover
financial flexibility
We recovered our financial flexibility reducing debt significantly. Telefónica scaled down its debt more than any other telecoms operator worldwide.