Why it matters

The Spanish telecommunications market has recently gone through important structural and ownership changes that could affect its competitive landscape. In this report, we outline our main expectations for our ratings on its four main operators.

Our Ratings Outlook On Spanish Telecoms Operators Is Stable To Positive

Our long-term issuer credit ratings on Spanish telecoms operators range between 'BB-' and 'BBB-'.  Our generally stable ratings outlook on Spanish telecoms operators reflects our expectation that they will benefit from mild revenue growth, cost reduction programs, and declining capex needs, which will translate into earnings growth and sound improvements in free cash flow generation. Our ratings outlook also reflects generally transparent leverage targets, which support our forecast (see table 1 and chart 1).

Table 1

Chart 1

Table 2 provides on overview of our relative ranking of Spanish telecoms operators' business risk profiles.

Table 2

Three Large Players Dominate The Spanish Telecoms Market

The telecoms market in Spain was subject to transformational events that will affect its structure over the medium term.  These events included the merger between Orange Spain (Orange) and MasMovil--the former second- and third-largest players--and the change in ownership of Vodafone Spain, the previously fourth-largest player (see chart 2). Incumbent operator Telefonica S.A. (BBB-/Stable), Lorca Telecom Bidco S.A.U. (MasOrange, BB/Stable), and Zegona Communications PLC (Zegona, BB/Positive) now account for close to 90% of the Spanish retail market, with Digi Communications N.V. (Digi, BB-/Stable), virtual operators, and independent operators accounting for the remaining share.

Chart 2

Over the medium term, the merger between Orange and MasMovil could reduce competitive pressure on telecoms companies that operate in mid-pricing segments.  Competition between Orange and MasMovil spurred churn rates, which could decrease after the merger. We believe MasOrange, the joint entity, will not target subscriber growth aggressively, which stands in stark contrast to MasMovil's recent track record of doubling its mobile customer base over 2018-2023 via organic growth and, to a lesser extent, acquisitions. Rather, we expect MasOrange will focus on increasing convergence and releasing cost and capex savings from the merger.

We anticipate that the value segment will remain competitive, with many players competing for low-margin customers.  MasMovil (including Yoigo, Pepephone, and Lycamobile) and Digi expanded quickly in this segment over recent years, while premium providers--such as Telefonica, Orange, and Vodafone--experienced customer losses. In line with its approach over recent years, Digi will continue to pursue organic growth through competitive offers. The group will focus on the mobile services segment after receiving the mid- and high-band spectrum remedies following the creation of MasOrange, and the signing of a radio access network-sharing agreement with Telefonica. Due to its lack of a low-band spectrum, however, it will remain dependent on its roaming agreement with Telefonica to maintain coverage across its areas of operation. The recent agreement for the sale of most of its FTTH network to Onivia also exacerbates its dependence on wholesale agreements to expand operations. In our view, this will reduce the likelihood of aggressive price cuts.

Under its new ownership, Vodafone Spain will aim to increase its presence in the value segment by expanding the Lowi brand.  Due to the added risk of premium customers potentially trading down to value offerings, the group will also focus on reducing net customer losses in its Vodafone brand through improving customer care, refreshing its product offering, and increasing its focus on content bundles. We also expect the group will target operating efficiency improvements instead of aggressive price-driven offers to attract customers.

We think the premium end of the market will remain largely dominated by Telefonica.  The group benefits from superior infrastructure ownership, TV content, and ancillary consumer services, such as home insurance, alarms, and device leasing. We therefore expect Telefonica's retail operations will remain largely unaffected by market consolidation.

We anticipate that MasOrange and Zegona will attempt to increase their share in business-to-business (B2B) communications and wholesale activities, which will potentially challenge Telefonica's leadership position.  That said, underlying tailwinds in non-communications-related revenue streams--for example IT, cloud services, digital solutions, and internet of things, which, combined, are growing at 8%-9% annually--present healthy market dynamics for all B2B players (see table 3). We also consider that Telefonica's well entrenched position in the B2B market and sound capabilities through its Telefonica Tech division mean that it is unlikely that MasOrange or Vodafone will hold a meaningful market share over the near term.

Table 3

Topline Growth Will Be Modest

The Spanish telecoms market is too mature to present high-growth opportunities.  The penetration of next-generation technologies is high--with an FTTH coverage of 95% and a 5G network coverage of 92%--while prices and market-wide subscriber growth are low. We expect Telefonica, MasOrange, Zegona, and Digi will resume to grow slowly over 2025-2027, although their performance will differ. We anticipate that the market will expand by 1%-2% over the same period, reflecting modest subscriber growth in the mobile and FBB segments, as well as modest inflation-induced ARPU growth. Our macroeconomic forecast foresees consumer price inflation growth of about 2% over 2025-2026.

We think market consolidation is unlikely to have a material effect on ARPUs.  This is because consolidation took place largely in the competitive mid-range and value segments, and because of our expectation of sustained price competition from Digi. Subscriber growth will also be largely unaffected by the market structure as it is more strongly correlated to demographic trends. We anticipate that Telefonica's and MasOrange's consumer segments will expand, in line with the average market growth over the next two to three years and spurred by modest ARPU gains. MasOrange could also benefit from improved convergence over the near term as the contracts of about 13 million lines (40% of the base in 2023) were FBB- and mobile-only (including prepaid).

We expect Zegona's revenues will stabilize gradually over the next two years, after several years of declines.  We believe Vodafone Spain's consumer segment could resume growth in 2026 due to the expansion in value brands (Lowi, Finetwork) and a moderation in customer losses in the Vodafone brand.

We forecast that Digi's growth will be strong but more moderate after years of rapid expansion.  After revenues increased threefold over 2019-2023, annual growth across mobile and FBB segments will decline toward 15% by 2025-2026, from an estimated 30% in 2023. We note, however, that Digi is significantly smaller than the top three players.

Consolidation Could Spur Margin Expansion Over the Long Term

Market consolidation tends to reduce customer churn, which enables telecoms operators to decrease their subscriber acquisition and retention costs.  However, based on previous consolidations in Europe--especially the Netherlands and Germany--benefits from "market repair" tend to materialize gradually rather than immediately. As such, we do not expect a material, sustained drop in Spanish telecoms operators' customer churn over the near term.

We expect telecoms operators will focus heavily on profitability over the near term.  MasOrange is well positioned to realize over €350 million in cost synergies from the recent merger, largely driven by network rationalization. Zegona is targeting significant cost savings through the renegotiation of wholesale contracts and a layoff program that will decrease headcount by 28%. Telefonica also launched a resizing of its headcount in fourth-quarter 2023, reduced the staff in Spain by close to 20%, and achieved about €285 million in cost savings (€200 million of which will flow through in 2024).

We expect Spanish telecoms operators' profitability margins will stabilize or improve over the next two to three years:

• Telefonica Spain's margins will remain broadly flat;
• MasOrange's S&P Global Ratings-adjusted EBITDA margins will improve to 40%-42% by 2026, from our expectation of 38% in 2024; and
• Zegona's adjusted EBITDA margins will increase to 40%, from our expectation of 37% in 2024.

The Spanish telecom regulatory landscape is largely unaffected by the MasOrange merger but shows potential for deregulation.  We think market consolidation is unlikely to become a driver of material deregulation as current regulations largely correspond to Telefonica's superior infrastructure and mostly apply to areas where Telefonica is a dominant player (with over 50% retail market share and less than three competing next-generation networks with at least 20% coverage). These non-competitive areas covered about 30% of the population at the latest regulatory update in late 2021, and we do not expect that they would change meaningfully after the merger of MasMovil (largely asset-light) and Orange. Similarly, we think it is unlikely that transactions via FiberCos would occur in non-competitive areas, given the heightened regulatory scrutiny they would entail and the loss of Telefonica's competitive edge in these areas.

That said, we understand that the Spanish competition authority (CNMC) has recently taken steps to reduce regulation in the telecoms market, and that it has recently launched a consultation that could lead to deregulation in the fiber access market as early as 2025.

Decline In Capex Intensity Will Improve Free Cash Flows

Spain has one of the largest FTTH networks in Europe.  The number of accesses (including overbuilds) amounted to 79 million in first-quarter 2024, with more than 95% of Spanish homes covered by a FTTH network. In this regard, Spain's FTTH infrastructure is significantly more advanced than the European average--just under 70% of homes in Europe had access to FTTH networks in 2023, according to the FTTH Council Europe. Take-up and penetration metrics reflect similar trends. 87% of Spanish homes with FBB access were connected to FTTH networks in first-quarter 2024 and an implied 82% of Spanish households were connected to FTTH networks (see charts 3 and 4).

Chart 3

Chart 4

The extent of Spanish telecoms operators' FTTH coverage differs. 

• Incumbent Telefonica owns the most extensive FTTH network in the country. Close to 30 million premises are connected to its network, which covers most non-competitive regions in the country that only have one FTTH network. Almost 100% of Telefonica's customers have migrated from copper to FTTH.
• Next comes MasOrange, with an extensive (and in some cases overlapping) FTTH network that covers more than 15 million premises.
• Vodafone Spain's FTTH network covers 3.8 million premises. The group still largely relies on an outdated HFC network, which covers over 7 million premises and connects just under half of its FBB client base.
• Digi, as well as independent and local players' FTTH networks, cover about 20 million premises, according to data from Spain's National Authority for Markets and Competition. Digi's own network, covering about 10 million premises, focuses mainly on Spain's largest cities. That said, it recently agreed to dispose of a large portion of its network to independent provider Onivia. The latter, owned by a consortium of investors that is led by Macquarie Group, aims to become an important independent provider of wholesale FBB services through an FTTH network that is expected to reach 10 million premises by 2026.

Spain's mobile infrastructure is also advanced.  92% of the territory was covered by 5G (58% on the 3.5 gigahertz band) in 2023, with a 100% 5G coverage targeted for 2026. Since Spain was among the first countries in Europe to allocate the entire 5G spectrum, we do not anticipate any spectrum auctions over the near term.

Based on Spanish telecoms operators' already extensive FTTH and 5G coverage, we anticipate limited deployment capex by Spanish rated issuers.  Even though Digi will likely continue deploying FTTH accesses over the next one to two years, we expect it will materially reduce the pace of investments once it has met the commitments under its FTTH disposal agreement with Onivia. We do not expect material deployment capex from Telefonica, MasOrange, and Zegona, whose capex intensity is low and declining. Consequently, we anticipate a similar improvement in free operating cash flows across operators (see table 4).

Table 4

Telecoms operators' use of improved free cash flows will be a key ratings consideration.  Improved cash flows will support debt reduction for MasOrange and Zegona, which show a clear commitment to deleveraging after elevated leverage at the closing of their respective merger and takeover. In the case of Telefonica, we anticipate a degree of deleveraging toward the middle of its stated target of 2.2x-2.5x on a company-adjusted basis. Yet improved FOCF could also support higher shareholder distributions.

Potential Fiber Transactions Are Unlikely To Change Competitive Dynamics

Zegona has recently entered into agreements with rivals MasOrange and Telefonica for the creation of two joint ventures that would hold and operate FTTH infrastructure.  These FiberCos are expected to raise external funding through and operate largely as FTTH infrastructure providers to their respective partners, in exchange for an access fee. We believe these transactions are unlikely to disrupt the FBB segment materially--given that they are likely to be open only to their respective partners--and will most likely encompass assets in already competitive areas with at least one competing FTTH network. That said, they could provide a large portion of Vodafone Spain's fixed client base with direct access to FTTH infrastructure from day one. This means Vodafone Spain could avoid capex-intensive activities, such as FTTH deployment or upgrading HFC assets to FTTH technology.

These transactions could have material financial implications and might therefore affect ratings.  The key considerations are how telecoms operators will use the proceeds realized from the creation of such FiberCos--through the sale of minority equity stakes or by raising debt at the FiberCo level--and the terms of the agreements between FiberCos and operators. We typically classify minimum volume commitments or fixed payments as lease-like liabilities. To the extent that FiberCos were fully deconsolidated from the operators' financial statements, we could chose to re-consolidate them proportionately. This depends on the resulting ownership stake (the closer to a controlling stake, the higher the likelihood for a partial consolidation), our perception of their strategic importance to the operator, and the potential for future reconsolidation.

Other key ratings drivers that we will monitor include:

• The extent of ARPU recovery and the reduction in churn metrics (especially in the mid-range and value-end of the pricing spectrum) as both suggest differing degrees of "market repair."
• Competitive interference from independent infrastructure providers, such as Onivia, that could place further pressure on fixed wholesale prices and impair the largest network providers (Telefonica, MasOrange).
• Degree of aggressiveness in Digi's continued push to expand in Spain versus pursuing growth in other markets, such as Portugal and Belgium. Continued aggressive growth in Spain could harm Zegona's plans to expand through Lowi and Finetwork, and sustain high churn rates among MasOrange's value brands.

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• Telefonica Affirmed At 'BBB-/A-3' On New Financial Policy And Sound Credit Metrics; Outlook Stable, May 28, 2024
• Lorca Telecom Bidco (MasMovil) Upgraded To 'BB' On Close Of Joint Venture With Orange Spain; Outlook Stable, March 27, 2024