TEF: Potential Vodafone Spain Deal And Modest Margin Gains Will Guide Next Steps

Key Takeaways

• Accelerated fiber and 5G rollout, plus digital B2B service expansion, drive premium offerings, operational efficiency, and greater top-line and margin growth.
  
• Core market focus, non-core asset sales, and network modernization strengthen free cash flow, minimize risk, and enable sustained profitability improvement.
  
• High debt, stagnant growth in core markets, competitive pressures, and exposure to Latin American volatility all challenge Telefónica's profitability and future expansion opportunities.

Catalysts

Provides telecommunications services in Europe and Latin America.

• The ongoing acceleration in fiber network and 5G deployment (e.g. fiber-to-the-home rollout, expanded premises passed, copper network shutdown in Spain, strengthening of Vivo's fiber leadership in Brazil) positions Telefónica to capture greater customer lifetime value, expand premium service offerings, and improve operational efficiency-supporting both revenue and margin expansion.
  
• The company's pivot to adjacent B2B digital services-including double-digit growth in IT sales, cloud, IoT, big data, and cybersecurity-is gaining traction, especially with enterprise customers. Initiatives like sizable IT sales in Spain, 42% growth in Brazil's cloud revenues, and strategic partnerships (e.g., Siemens in Germany) are expected to accelerate top-line growth and improve mix towards higher-margin services.
  
• The completion of large-scale portfolio optimization and monetization of non-core assets (sale of Argentina, Peru, Colombia, Uruguay, Ecuador, etc.) is reducing geographic risk and freeing up significant capital (€3 billion+). The strategy to focus on core markets (Spain, Brazil, Germany, UK) enables redeployment of resources to higher-return areas, improving free cash flow and ROCE.
  
• Margin enhancements are being delivered from network modernization and automation, notably through the shutdown of legacy copper infrastructure (with 1 percentage point margin gain in Spain this year and another 0.5 points targeted over 3 years), process simplification, and cost efficiencies-leading to sustained EBITDA growth and improved cash conversion.
  
• Anticipated regulatory and political support (e.g., EU funding for digital inclusion, increased European cyber defense and AI investment, and government-backed strategic autonomy in tech) may provide new revenue streams and subsidized infrastructure investment, supporting growth in high-value digital and infrastructure services and potentially de-risking future capital spending.

Telefónica Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Telefónica's revenue will decrease by 2.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from -1.9% today to 5.7% in 3 years time.
• Analysts expect earnings to reach €2.2 billion (and earnings per share of €0.4) by about September 2028, up from €-797.0 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting €3.0 billion in earnings, and the most bearish expecting €1.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.7x on those 2028 earnings, up from -31.9x today. This future PE is lower than the current PE for the GB Telecom industry at 51.5x.
• Analysts expect the number of shares outstanding to grow by 0.07% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.49%, as per the Simply Wall St company report.

Telefónica Future Earnings Per Share Growth

Risks

• Persistent high leverage remains a long-term risk for Telefónica, as leverage is currently above the company's own guidance target, and although management expects improvement, high debt levels limit investment flexibility, constrain M&A activity, and can weigh on net margins and future earnings.
  
• Stagnation in mature core markets, especially Spain and Germany, where revenue and EBITDA growth remain low relative to peers, indicating ongoing difficulty in accelerating organic topline growth-risking long-term revenue expansion if secular demand for connectivity plateaus.
  
• Intensifying competition and pricing pressure, particularly in the UK and Germany, where aggressive promotions by alternative operators and a "more for less" consumer mindset are forcing price competition and leading to declining ARPU and EBITDA-threatening revenue and profit margins.
  
• Continued exposure to Latin American currency and political volatility, as evidenced by the impact of foreign exchange on reported results and the need to divest multiple markets for €3 billion, creates ongoing risks to earnings stability and reliable cash flow.
  
• Execution risk in digital transformation and adjacent tech markets, with management acknowledging historical skepticism about telco digital innovation, and the need for calculated risks in new ventures (such as cybersecurity and AI/data businesses); failure to succeed relative to tech-first competitors could limit future revenue and margin growth.

Valuation

• The analysts have a consensus price target of €4.405 for Telefónica based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €5.4, and the most bearish reporting a price target of just €3.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be €38.3 billion, earnings will come to €2.2 billion, and it would be trading on a PE ratio of 14.7x, assuming you use a discount rate of 8.5%.
• Given the current share price of €4.51, the analyst price target of €4.41 is 2.3% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.