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Telefonica moves ahead with O2 Germany IPO

By Clare Kane and Alexander Hübner

MADRID/FRANKFURT (Reuters) - Telefonica started the sale of up to 20 percent of its O2-branded German subsidiary on Wednesday, with the company set to raise up to 1.5 billion euros ($2 billion) from the initial public share offer which is now expected to go ahead later this month to help cut the Spanish group's huge debts.

Announcing the intention to list its shares by the end of the year, Telefonica Deutschland told potential investors that it aims to pay a dividend next year of 500 million euros ($647 million) on its 2012 profits.

The flotation is part of Telefonica's efforts to reduce its 57 billion-euro debt pile and keep its prized investment-grade credit rating, under threat from the troubles in Spain.

The company must raise 7-8 billion euros a year through 2015 to cover debt repayments and risks rising refinancing costs if credit ratings were cut.

Telefonica did not say on Wednesday how much of Telefonica Deutschland it planned to float. The final size of the offer will depend on now gauging investor demand and price, said two financial sources, with marketing to potential buyers set to begin immediately.

One of the sources had said previously Telefonica aimed to list between 10 and 20 percent of Germany's smallest mobile operator, which it has valued at 10 billion euros.

The liquidity of the newly listed entity will likely prove a key issue for investors, who tend to shy away from small partial listings, especially when they are under the control of a powerful majority shareholder such as Telefonica.

A listing of 10 percent of Telefonica Deutschland would therefore be too small to attract investors, said the sources.

One said the IPO should raise above 1 billion euros for Telefonica but is unlikely to top 1.5 billion euros, with Telefonica Deutschland roughly valued at around 8 billion to 9 billion euros and only existing shares to be sold.

The company's executives will begin a roadshow of presentations to potential investors in around two weeks time.

In Germany, Telefonica's 02 brand is the smallest mobile operator with roughly 16.4 percent of subscribers, trailing KPN's E-Plus , Deutsche Telekom and Vodafone .

However, analysts and bankers say room for growth makes Telefonica Deutschland an attractive prospect for investors, along with the promised dividend payment, which Telefonica said will increase in the coming years.

"We are operating in one of Europe's strongest economies and one of the biggest telecoms markets on the continent," Rene Schuster, Chief Executive of Telefonica DeutsGermany said.

Telefonica Deutschland's net debt stood at 1.1 billion euros at end-September.

PAYOUT RATIO

The unit's 500 million-euro dividend payout next year could make the dividend yield as high as 9 percent depending on the final valuation of Telefonica Deutschland, though 6-7 percent is more likely, according to the sources.

Will Draper, an analyst at Espirito Santo bank, questioned whether the dividend would be enough to attract investors given concerns over the liquidity of such minority stakes.

"It's a reasonable dividend, but it's not going to attract yield investors," said Draper. "Nobody likes being a minority in this kind of situation, especially if you are a 10 percent minority, and especially if you are a minority to Telefonica."

"There's a lot of risk there - you could be bought out by Telefonica in the future on an unfair basis."

The promise of a dividend payout in Germany comes after Telefonica cancelled its own dividend for 2012, the first time it has passed on a dividend since the Spanish Civil War in the 1930s.

Other telecom operators in Europe such as France Telecom, KPN, and Telekom Austria have also sliced dividends this year. On Tuesday credit rating agency Standard & Poor's said Telefonica had the weakest credit profile of all of Europe's seven former state telecom operators.

The German listing will not make a huge difference to the company's huge debts but analysts say it will provide ready cash for Telefonica at a time when it is hampered by high borrowing rates.

($1=0.7731 euros)

(Reporting by Sonya Dowsett and Robert Hetz in Madrid, Harro Ten Wolde in Frankfurt, and Chris Vellacott in London; Writing by Leila Abboud; Editing by Greg Mahlich)

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