THE SPANISH OPERATOR.

Telef[acute{o}]nica swaps geographic borders for business lines to build a global communications titan.

THE LATEST PLAN AT SPAIN'S TELEF[acute{O}]NICA CALLS FOR AN end to geographic divisions between its headquarters in Madrid and its far-flung national phone companies across the Atlantic. From Puerto Rico to Buenos Aires, corporate boundaries will fall along business lines such as Internet services, cellular phones and media operations. The big payoff? Stock offerings from each of the new multinational subsidiaries.

"We're restructuring the company," says Miguel Angel Garz[acute{o}]n, the head of international corporate communications for Telef[acute{o}]nica.

"The spinning off of assets like this is a high-growth business," says Oliver Mizne, director of Latin America telecom research at Credit Suisse First Boston.

It had better be. If the combined worth of these different business lines fails to substantially boost the overall market value of Telef[acute{o}]nica, then the company will remain the prey of big global operators and Juan Villalonga, the executive who engineered the plan, risks paying the price. From June 1996 to the end of last year, the controversial 47-year-old executive had increased the Spanish phone company's return on investment almost fivefold. But his latest push would secure Telef[acute{o}]nica's spot as a global player in the shrinking world of telecommunications.

Not that Telef[acute{o}]ncia is a small company, it posted an almost 32% increase in sales to near US$14 billion last year. The company reported a first-quarter profit of about $363 million, almost a third better than during the first quarter of a year ago.

Surging demand for its communications services, especially in Latin America, fueled the growth. The company's Latin American companies added about $97 million to the Telef[acute{o}]nica International earnings total for the first quarter, an increase of about 153%.

In fact, telecom companies represent 17.2% of the total 1999 sales of the companies composing the LATIN TRADE 100. "And by far, the strongest company in the sector in the region is Telef[acute{o}]nica," says Geoffrey Dennis, equity strategist at Salomon Smith Barney.

The Spanish company, with its total market capitalization of about $85 billion in 1999, looms large in Latin America. But the firm casts a pretty short shadow in Europe, where big challengers like Deutsche Telekom are buying up companies to gain control of the increasingly competitive market.

That's why Villalonga was courting European partners like Dutch telecom Royal KPN as allies in early May. But, according to analysts, his personal style killed the merger plan that would have transformed Telef[acute{o}]nica into one of Europe's largest communications companies. Observers say that powerful stockholders and Spanish government officials nixed the deal because Villalonga had started to make bold, expensive business moves to secure more power for himself and his company without the support, and sometimes over the objections, of the very people who had put him in power, such as Spanish Prime Minister Jos[acute{e}] Maria Aznar.

Telef[acute{o}]nica executives shrug off the setback. "We're in conversations with a bunch of companies all the time about partnerships," Garz[acute{o}]n said, just days after the botched deal. "And nobody is questioning who is going to be the CEO."

And so it was that less than a week later, Telef[acute{o}]nica's Internet arm, Terra Networks, snatched up leading U.S. Internet portal Lycos in a stock-swap deal worth about $12.5 billion, combining operations throughout Europe, Asia and the Americas. "It will be a truly global company," Villalonga said in a press conference to announce the deal.

The new combined corporate powerhouse, Terra Lycos, will be a mixture of offices and corporate officers from both companies. But Terra is in control and Villalonga remains as chairman of the Internet company.

Villalonga made it clear that Terra Lycos is just beginning to spin its web. "From today on," he said at the press conference, "AOL has a competitor."

Terra Lycos is better situated than AOL and other competitors, according to Villalonga, because the new company has better operations in Europe, Asia and Latin America, where the Internet is growing more quickly than the AOL stronghold, the United States.

And Villalonga is building still more business in Latin America. His fiercest bid for corporate power so far has been for full control over Telef[acute{o}]nica's Latin American affiliates. The $22 billion stock-swap plan announced in mid-January would take four phone companies completely private, including regional heavyweights Telecomunicac[tilde{o}]es de S[tilde{a}]o Paulo, Telef[acute{o}]nica de Argentina and Telef[acute{o}]nica del Per[acute{u}]. The massive exchange would remove the local telecoms from the list of the LATIN TRADE 100 companies, promising to reshape the region's corporate investment landscape.

"These are the biggest operations that we've ever done," Garz[acute{o}]n says. "This is very important for the future of the company."

Stocking up. But there's more. Once Telef[acute{o}]nica has gained full control of each affiliate, it plans to tear them apart and package the former national businesses together into international companies with one business line. Telef[acute{o}]nica M[acute{o}]viles (cellular phones), for example, brings the company's wireless-phone users in Spain and Latin America into one unit with 10 million customers, creating the world's sixth-largest mobile-phone company. Telef[acute{o}]nica Media does the same for media assets, as does Telef[acute{o}]nica DataCorp for data transmission services. Each company will issue stock to fund its acquisitions and boost Tel[acute{e}]fonica's overall market value.

"We are doing two things with this operation: continuing with the segregation of our business lines and growing in size," Villalonga said when he announced his strategy at the beginning of the year.

"We don't believe any of this is too risky," Garz[acute{o}]n says. "All of the experts and analysts are saying it's the right thing." And, he adds, the company will follow the business plan no matter who's the CEO.

The market loved the Telef[acute{o}]nica idea. Right after the plan was announced, Telef[acute{o}]nica shares rose as much as 15% in Madrid, the maximum permitted during a single day's trading.

It's no wonder. Terra Lycos, the first to issue stock in a pan-regional package, turned a pretty penny. "We were the first to have the vision and see where the market was going," Villalonga said.

The Spanish telephone company bought the money-losing Internet businesses of its Chilean and Peruvian telephone subsidiaries for about $700 per subscriber, petty cash compared with the resale price implied in its initial stock offering: some $4,200 per customer. While not all of the company's 1.4 million subscribers were flipped for such a pan-regional profit, the share sale in November 1999 did fetch an impressive $344 million.

Minority shareholders of Telef[acute{o}]nica's Compa[tilde{n}][acute{i}]a de Telecomunicaciones de Chile fiercely questioned the terms of the Internet deal.

In its initial public offering, Terra Networks said that the Chilean shareholders could try to annul the deal there, or seek damages by arguing, for example, that separating out of the Internet company hurt the Chilean company's overall bottom line.

Who's the boss? Villalonga's bold bid to buy out minority shareholders in the region would remove any potential opposition to his proposed repackaging of Spanish company's international businesses. Full ownership would also provide the Telef[acute{o}]nica chief executive with a clear line of power.

"It will simplify the whole situation," says Garz[acute{o}]n, adding that the company learned its lessons about eliminating potential problems involving minority stockholders in forming Terra.

"Although Telef[acute{o}]nica will attempt to balance the interests of all Telef[acute{o}]nica Group members in a fair manner, it is possible that we may disagree with the outcome of a particular decision," according to the prospectus issued by Terra. "Therefore, because Telef[acute{o}]nica will continue to control us after the global offering, we may be unable to carry out all of our strategic initiatives if they are contrary to the balance that Telef[acute{o}]nica creates among its group members."

When the Terra Lycos deal was announced, Villalonga made it clear that Telef[acute{o}]nica would have a very close relationship with the new company, especially when it came to wireless Internet service. "Telef[acute{o}]nica will be more than a shareholder," he said. "I built Terra from scratch," he added calling the company his "baby," Even though Lycos brought more than 60% of the sales to the joint company--and the only positive earnings--it was still Villalonga's Terra shareholders who gained the greater control, and 11 of 14 directors descended from Terra.

Many analysts believe Terra's former CEO Juan Perea and ex-General Director Jos[acute{e}] Antonio s[acute{a}]nchez left their jobs in March because the two executives were too independent for Villalonga's liking.

However, even wearing Villalonga's "short leash," Terra has proven to be a terror. Before the Lycos buyout, the Internet division spent more than $500 million to acquire Internet service providers across the region and more recently sought to acquire content such as its $68 million deal with leading Brazilian newspaper O Estado de S. Paulo and its purchase of 30% of auction Web site Dermate.com. The world's top Spanish-language portal recently even penned a deal with pizza powerhouse Telepizza to provide speedy deliveries of snacks, CDs, books and other consumer items primarily in Spain, Portugal, Mexico and Chile.

But all of that paled compared to the Terra Lycos deal. Villalonga estimates the new company to be worth $30 billion to $35 billion the largest-ever combination of telecom provider with a Web portal in the short lifetime of the Internet. And, even more disconcerting for the competition, the company would have a piggy bank of about $3 billion once all of the stock swapping and other financial business is done. "We're going to have a cash reserve that any other company would kill for," said Bob Davis, former Lycos and current Terra Lycos CEO.

German media conglomerate Bertelsmann signed a $1 billion dollar contract for content with the new company.

The deal certainly puts more pressure on companies like Deutsche Telekom and France Telecom, to find ways to connect with customers beyond their own national borders. But, despite Villalonga's bluster, AOL--with its $148 billion deal to acquire Time Warner--is unlikely to seek cover anytime soon.

Terra's been on the ropes lately The company recently slipped to the third spot in Brazil, behind service providers iG and UOL, mostly because of the competition in that market caused by the free Internet provider service being offered there. Terra's revenue per customer dropped by about 65% to $16 during the first quarter of this year, compared to last year's first four months.

Some analysts fear, too, that the two companies may have some problems blending, at least for a while. Terra gets about 80% of its revenue from Spain, Brazil and Mexico and there's some concern that there will be some hiccups marrying the Lycos English-language content with the predominantly Spanish- and Portuguese- Terra operations.

There's also concern about the price Terra paid--almost twice Lycos' $6.77 billion market capitalization the day before the deal was announced. Analysts immediately downgraded Terra stock and it dropped as much as 6.9% May 16, the day the deal was announced.

But while the deal appeared to be bad--initially--for the stock, all the major analysts predicted it would be good for the new Terra Lycos and Telef[acute{o}]nica in the long stretch. This was not the first time that Villalonga had been accused of spending too much, and his companies' performance in both the markets and in business operations had proved his hunches right time and again.

"The markets only reward the winners," he said. "And the winners take it all."

And Villalonga intends to be a winner. If the other Telef[acute{o}]nica spin-offs prove to be as aggressive as the parent company and Terra, the communications world could see a series of high-profile takeovers. Telef[acute{o}]nica Media, which serves 2.3 million pay-TV customers, has already launched a $5.3 billion deal for Holland's Endemol Entertainment Holding and a $4 billion merger between Telef[acute{e}]nica's Argentine operations and local media holding company CEI. Jos[acute{e}] Antonio Rios, Telef[acute{o}]nica Media CEO, has also indicated interest in numerous properties, including Spanish-language TV network Univision. He's a former executive for Venezuela's powerful Cisneros Group, which holds a 25% interest in the network.

The big Spanish spending presupposes that Latin America and the financial market for high-tech stocks, the twin pillars of Telef[acute{o}]nica strategy, will remain stable. However, both are shaky supports.

Consider what happened in Brazil. Telef[acute{o}]nica paid about $4.9 billion for the S[tilde{a}]o Paulo phone company Telesp in July 1998 and the Brazilian real devalued by about 65% only six months later in January 1999. Last year, Telef[acute{o}]nica International posted a whopping 56% drop in equity income largely due to the Brazilian currency crunch.

High-tech turbulence. But straight through the crisis, Telef[acute{e}]nica still made money, thanks in no small measure to the pricey fees it charges Latin affiliates for administrative services. Perhaps more importantly the Latin American market continued to expand despite the economic slump, with Telef[acute{o}]nica lines under management rising 15% to 18 million and mobile-phone users more than doubling to roughly 10 million.

There's more than regional risk involved, however. The U.S.-based high-tech stock market, Nasdaq, took world markets on a roller-coaster ride in April, "And the volatility related to Nasdaq is not over yet," says James Upton, the Latin American equities strategist for Credit Suisse First Boston.

While the ups and downs may slow the stock offerings of Telef[acute{o}]nica's business units, the dips may also represent buying opportunities for the Spanish company and its affiliates. After all, Terra's share price may suffer with the Nasdaq nosedive, but Telef[acute{o}]nica's Internet arm managed to pull off it's $12.5 billion acquisition of Lycos.

Indeed, Telef[acute{o}]nica may be writing the book on merging and re-issuing stock. Other companies are now joining the trend. America Online has registered its Latin American operations for a stock offering. BellSouth, an Atlanta-based telecom company, has also filed with the Securities and Exchange Commission for an initial public offering of its Latin American operations, which is expected to raise around $1 billion.

The industry is moving toward consolidation. "The mergers haven't even started in Latin America," says Mizne of Credit Suisse First Boston. "Soon there are going to be only three or four large telecoms in Latin America."

Telef[acute{o}]nica plans to be one of them.

Testing Telesp

MICHAEL FABEY

Brazilian telecom tries to improve service and plans for expansion.

WHEN YOU HAVE A TELEPHONE MONOPOLY IN ONE OF THE WORLD'S LARGEST cities, you can afford to tick off millions of customers by putting them on hold for more than a year. But those days are over for Telecomunicac[tilde{o}]es de S[tilde{a}]o Paulo or Telesp.

"Yes, we know we have competition now," says Telesp Chief Financial Officer Juan Revilla. "But it won't be easy for them, just coming into the market. And we are working on improving our quality and quantity of service.

Since Telef[acute{o}]nica bought the S[tilde{a}]o Paulo phone company from the government in July 1998, the Spanish telecom giant has wasted no time in overhauling the sluggish formerly state-owned monopoly. Almost immediately, it flew in about 100 new executives to replace the old management team.

The new bosses had their work cut out for them operationally. Telesp had contracted for more than 700,000 lines shortly before Telef[acute{o}]nica bought the Brazilian company. "We had to install all of those lines and the plant was not ready to handle all of that," Revilla says.

Crossed signals. The company met many of its goals for installing more lines, but it failed to meet concession goals for things like connected calls, complaint responses and other service standards--mostly because the system was overloaded.

The problems became so bad that the company agreed to provide for free about US$13 million worth of services to appease the Brazilian consumer watchdog agency, Procon, and paid a $2.5 million fine to the country's telecom regulator, Anatel.

Revilla says service is getting much better now that the company has improved its network to handle the extra installations. Telesp, however, still ranks as one of the leaders for Procon service complaints, according to Pyramid Research.

Complaints or not, the company continues to hook up new customers as fast as it can. It reported about 9.5 million installed lines by the end of 1999, a 38.8% increase compared to 1998. More installations mean more than just more customers. "There's a prize," says Oliver Mizne, director of Latin America telecom research for Credit Suisse First Boston in S[tilde{a}]o Paulo. Crossing state lines, That prize is the ability to compete in other states in Brazil. According to Brazilian government telecom regulations, telephone companies that meet installation requirements may expand service into other parts of the country. So, Telesp is hustling to make the grade. "We will be surpassing our goals," says Revilla. "What we are supposed to reach at end of 2002, we will get in 2001. We want to be in every other state, not only our neighbors, everywhere."

But even as Telesp sets its sights beyond S[tilde{a}]0 Paulo, competitors are invading its home turf. New national operator V[acute{e}]sper, a company run by Bell Canada International and VeloCom Inc, is competing directly with the former monopoly for fixed line service in Brazil's largest city.

V[acute{e}]sper has signed up about 100,000 customers--mainly in S[tilde{a}]o Paulo--during its first couple of months of operation, while Telesp customers still number in the millions. V[acute{e}]sper's initial installation fees were four times those charged by Telesp.

"V[acute{e}]sper holds the advantages over delivery time and better customer service, but they have simply overpriced their basic service product," says Andy Castonguay, a telecom analyst for Pyramid Research in S[tilde{a}]o Paulo. "When V[acute{e}]sper brings down its prices, then you'll see things take off."

V[acute{e}]sper recently did just that, offering a price comparable to that of Telesp's, about $50 a line.

And V[acute{e}]sper may just be the beginning of increased competition. Long-distance fixed-line companies Empresa Brasileira de Telecomunicacoes, or Embratel controlled by MCI WorldCom, Teleming--which is backed by Sprint--and Telemar are expected to launch campaigns into Brazil's big city in the next couple of years. Cell phone companies are also gunning for a portion of the fixed-line business.

Revilla says Telesp will have its service act in order before it has to take on Embratel and the cell phone companies. For the first time, the S[tilde{a}]o Paulo company will have no choice.

Bye-Bye Bolsas?

THE MAJOR LATIN AMERICAN STOCK MARKETS ARE LOSING THEIR HIGHEST volume stocks. Brazil's Bovespa has lost former telecom holding Telebr[acute{a}]s shares, and, if Telef[acute{o}]nica's bold stock purchase plans go through, Brazil, Argentina and Peru will lose the highly traded shares of the Spanish company's subsidiaries.

"You certainly have to be aware of the delisting in the markets," says Geoffrey Dennis, Latin American Equity Strategist at Salomon Smith Barney, referring to this trend of taking stocks off a market. "Many of these companies simply would rather list in New York."

Indeed, until the recent tanking of the high-tech markets, many Latin American Internet start-ups hoped to go straight to Nasdaq, bypassing any local listings. And it's no big secret why: easy access for global investors, protection for minority shareholders, dollar denominated trading and high volumes mean increased share prices.

The delisting drive in Latin America is not entirely due to New York's hostile takeover of Latin stocks. In many cases, international buyers simply want full ownership of their targets, which often means taking them off the market.

But, certainly, poor protection of minority shareholder rights has helped fuel the exodus. In the Brazilian state of Minas Gerais, for example, Gov. Itamar Franco recently ousted the management team of U.S. energy company AES Corp. from the board of Cemig, an energy company jointly run by the state government and AES. The U.S. company's protests fell largely on deaf ears.

The Latin stock markets or bolsas are feeling the heat of increased competition for high profile stocks. Bovespa, the S[tilde{a}]o Paulo stock exchange, recently absorbed the much smaller Rio de Janeiro exchange. Brazilian authorities are also now taking belated actions to make the market more investor friendly and beef up minority shareholder rights--long a concern for market investors. Analysts say those changes could make quite a difference in keeping companies in the bolsas and attracting other businesses there.

The Central Bank has agreed to permit pension funds to invest up to 10% of their stock portfolio in foreign companies trading in Brazil. The funds control about US$64.3 billion, half of which they can invest in equities. "There's been a growing amount of pension fund assets being funneled into the market," Dennis says, adding this could prompt companies to list shares or to remain on the market.

Marcia Tarter, a Latin American analyst for Warburg Dillon Read, adds, "People have more money to put to work. There are some start-ups making their first forays in the market."

There were expected to be even more forays in June, when the Brazilian government was slated to change investing laws to better protect minority shareholders by giving investors more power to influence company management and protect their interests in cases of mergers and acquisitions. Among other things, the proposal would force companies to sell voting and non-voting stock in the same proportion, increasing the quantity of common shares in the market and diluting the power of the majority holders.

The Central Bank has also been considering cutting trader fees, making business dealings and ownership more transparent and easing regulations for investment funds.

Michael Fabey