TEF-Terra Merger / Reports
Telefonica SA
15 April 2005
RAMIRO SANCHEZ DE LERIN
General Vice Secretary
and Vice Secretary to the Board of Directors
TELEFONICA, S.A.
Telefonica, S.A., as provided in article 82 of the Spanish Stock Market Act (Ley
del Mercado de Valores), hereby submits the following
NOTICE
In accordance with the information disclosed by Telefonica, S.A. on March 14th,
2005 under RNS Nos. 6920J and 6954J, Telefonica S.A., in its capacity as
acquiring company, has filed on April 14th with the Securities and Exchange
Commission (SEC), the regulatory body for the United States securities exchange,
an amendment to the F-4 form filed by the Company this past March 7th ,
2005 in order to complete and update the information contained in that original
document.
This amendment to the F-4 form includes the following documents as
appendices: (i) the Report of the Directors of Telefonica, S.A., approved by its
Board of Directors at the Board meeting held on April 13th , 2005; (ii) Report
of the Directors of Terra Networks, S.A., approved by its Board of Directors at
the Board meeting held on April 12th, 2005; and (iii) the report issued on April
12th, 2005 by the independent expert 'KPMG Auditores, S.L.', named by the
Companies Registry of Madrid on March 3rd, 2005.
In view of the above, both companies consider it appropriate to hereby submit
those documents with this notice to the securities markets.
--------------------------------------------------------------------------------
REPORT OF THE DIRECTORS OF TELEFONICA, S.A.
ON THE PLAN FOR THE MERGER BY ABSORPTION
OF TERRA NETWORKS, S.A. INTO TELEFONICA,S.A.
Madrid, April 13, 2005
REPORT OF THE DIRECTORS OF TELEFONICA, S.A.
ON THE PLAN FOR THE MERGER BY ABSORPTION
OF TERRA NETWORKS, S.A. INTO TELEFONICA,S.A.
______________
1. INTRODUCTION
At meetings held on February 23, 2005, the Boards of Directors of
TELEFONICA, S.A. (hereinafter, 'Telefonica') and TERRA NETWORKS, S.A.
(hereinafter, 'Terra'), approved the Merger Plan of Telefonica and Terra,
which has been prepared and signed by the directors of each company (with
the abstentions and absences indicated in the Merger Plan itself), pursuant
to the provisions of Section 234 et. seq. of the Spanish Corporations Act,
and has been deposited with the Commercial Registries of Madrid and
Barcelona on March 2, 2005 and March 3, 2005, respectively.
In compliance with the provisions of Section 237 of the Corporations Act,
the directors of Telefonica prepare and approve, upon the terms set forth
below, the detailed report of the directors regarding the Merger Plan
(hereinafter, the 'Report'), which, in accordance with the provisions of
such Section, provides a detailed explanation and rationale of the legal and
financial aspects of such Plan.
The Report has been divided into three parts. The first part contains the
strategic reasons for the transaction (see Section 2 below). The second part
contains a review of the legal aspects of the transaction; basically the
procedure for the merger (see Section 3 below). The third and final part
covers financial aspects, paying particular attention to the calculation of
the exchange ratio and particular valuation difficulties (see Section 4
below).
2. STRATEGIC REASONS FOR THE TRANSACTION
2.1 Recent Changes in the Telephony and Internet Businesses.
Like many other Internet companies, Terra has evolved within the context of
a strategic model based on a separation between the Telephony business and
the Internet service provider (ISP) business. Notwithstanding other prior
circumstances, it has recently (more specifically, during the last twelve
months) become manifestly obvious, in a clear and distinct manner, that an
irreversible crisis is affecting the traditional model of the pure Internet
services provider, and that, in parallel, a new model based on the
operational integration of the Telephony and Internet businesses has
appeared in the telecommunications market.
The root of these changes lies in the emergence, development, and blossoming
of broadband technology applied to Internet access, which has led to the
blurring - especially in the last year, during which its penetration and
growth have accelerated exponentially - of the traditional line of
separation between the above-mentioned Telephony and Internet
businesses.
In fact, the following phenomena have recently become evident:
a. The explosion of broadband technology has fostered a new dynamic in
the supply market, with which synchronization can only be obtained
based on a complete interweaving of network functions and the
provision of services or, put another way, the integrated managed of
the connectivity, access and service layers. In this scenario,
Internet access providers need to become communications operations
in order to compete in the market. For such reason, they must either
invest in network infrastructure (which would compromise their
viability, given the time required for the maturation of the
investment and the high capital cost of addressing it) or else
become fully integrated with the network operators, who already have
the necessary infrastructure and technical and human resources.
b. Moreover, on the demand side, today's customer is not content with
Internet access alone. Users' preferences are becoming increasingly
oriented towards integrated offerings (voice, images, Internet
access, etc.), for which it is necessary to hold a position as
operators who can offer all of the services that the market demands,
and thereby compete with other entities that are able to provide all
of these services to the end customer.
c. In addition, the technological evolution of the services - the rapid
increase in connection speeds, the technical complexity needed to
provide high-quality audiovisual content, the required
interoperability of the various elements of the offering (e-
mail, messaging, voice mail, content consumption, etc.) - demands
increasingly greater capabilities, scale, and resources in order to
stay competitive in a market that is growing in size but whose
offerings are constantly changing.
All of this explains the activities of competing groups aimed at making
bandwidth the center or core of their strategy, and, consequently, at
reintegrating the Telephony and Internet businesses. The most recent
examples are the mergers of France Telecom and its Internet subsidiary
Wanadoo, and of Deutsche Telekom and T-Online. The proposed merger
of Telefonica and Terra contained in the Merger Plan obeys the same logic.
2.2 Reasons for and Objectives of the Merger.
As explained in the Merger Plan, the Boards of Directors of Telefonica and
Terra believe that it is absolutely necessary to take the path of
integrating their Telephony and Internet businesses in order to have any
guarantee of success in dealing with the challenges posed by the development
of the industry, technological change and customers' new needs. It is thus
intended to create a customer-oriented business segment able to
offer customers integrated solutions in the telecommunications market that
consolidates access, voice and video over ADSL.
The Boards of Directors of Telefonica and Terra see the merger as a
strategic imperative of this highest order, and as an outstanding
opportunity for mutual advantage. The shareholders of both Terra and
Telefonica will benefit from it.
Although the merger will depend in part on the ability of the directors of
the acquiring company to obtain the expected business opportunities and
synergies, it can be affirmed that the integration of the businesses of
Telefonica and Terra resulting from the merger will make it possible:
a. To strengthen the competitive positioning of Terra and Telefonica in
the above-referenced markets, which will translate into an
increase in customers and an expanded share of the market. This is
the case because of (i) the greater capacity of the unified firm to
respond to the integrated offerings of competitors; (ii) the
improved position for creating new services that optimize the use of
the Telefonica's network capabilities (which is critical for
services with a need for greater bandwidth, greater security, etc.)
and that integrate them fully into the service provided to the end
customer; (iii) the strengthening of the offering made to the
market, combining the positive attributes of the Telefonica and
Terra brand names, which in turn will make it possible to strengthen
the leadership of the combined company; (iv) the greater scale of
operations, which will make it possible to undertake innovative
projects that would now be more difficult to undertake; and (v) the
greater leveraging of the commercial resources of the two companies,
e.g., proprietary channels, third-party channels, joint
advertising, etc. In particular, the integration of Terra and
Telefonica will allow for improved positioning of the acquiring
company as a leader in the Internet portal market, given that it
will be able to extend the use of the portal to Telefonica's
customer base, will facilitate the establishment of alliances with
leading content providers, and will allow for the provision of
highly integrated network services.
b. To make better use of current customer bases, through (i) the ability
to define and implement a global strategy based on customer
segments, beyond the current product-based vision; (ii)
increased penetration; (iii) an increase in the loyalty of existing
customers, by reducing churn rates through the packaged sale of
services; (iv) increased cross-sales of services; and (v)
the resulting increase in per-customer earnings.
c. To minimize costs and optimize investments, through (i) the
integrated management of networks and platforms (provision of
services, billing, CRM/customer service, etc.), with the additional
benefit of greater quality for the end customer, through end
- to-end management; (ii) the rationalization of
investments that are particularly relevant, given the growing needs
for an ability to manage new services that are broadband intensive;
(iii) the total elimination of duplication in the development of new
services; (iv) the streamlining of corporate structures, eliminating
duplications and thereby improving management and increasing
efficiency; and (v) an increased ability to achieve synergies in the
purchases of contents and services. In particular, the integration
of Terra and Telefonica will allow for strengthening access to the
Internet business, given that, by participating in the Telephony
operating business, there will be a reduction in financial risk as
well as the risk of acquisition of technical and marketing
capabilities associated with the open loop leasing system, and a
significantly higher value will be captured as compared to the re
-sale of access on a wholesale basis.
d. To facilitate the exploitation of the opportunities for growth in new
markets, using broadband Internet access as an offering that is more
attractive and competitive than fixed-base
telecommunications (a factor that is particularly relevant in terms
of the expansion of the Brazilian market).
e. To develop a single strategy and to promote and create businesses in
the e-commerce field and general gateways for access to
information and advertising, as a result of the major growth of
broadband Internet access in all markets.
3. LEGAL ASPECTS OF THE MERGER PLAN
3.1 Legal Structure of the Merger Transaction
The legal structure selected for the integration of the businesses of
Telefonica and Terra is the merger by absorption of Terra (the acquired
company) by Telefonica (the acquiring company), with the dissolution without
liquidation of Terra and the en bloc transfer of all of its assets and
liabilities to Telefonica which will acquire, by universal succession, all
of the rights and obligations of Terra.
Such en bloc transfer entails the acquisition by Telefonica in a single act
of all of the elements comprising the assets and liabilities of Terra.
Therefore, there will be a transfer all of Terra's rights and obligations
and, in general, all of its legal relationships, which shall continue in
force even though the holder thereof will change, except in those events in
which a change in the holder of the legal relationship entails the
termination thereof.
At the same time, the merger entails the shareholders of Terra (other than
Telefonica) becoming shareholders of Telefonica through the allocation to
them of shares representing a portion of the capital stock of Telefonica in
proportion to their respective interest in the capital stock of Terra
pursuant to the terms set forth in the Plan.
The basic commercial regulation of merger transactions is contained in
Sections 233 et. seq. of the Corporations Act and Sections 226 to 234 of the
Regulations of the Commercial Registry.
3.2 Analysis of Legal Aspects of the Merger Plan
The absorption Merger Plan has been prepared following the rules of Sections
234 and 235 of the Corporations Act.
In addition to the minimum disclosures required by the Corporations Act, the
Merger Plan includes and expands upon other aspects, the inclusion of which
has been deemed appropriate by the directors of Telefonica and Terra.
3.2.1 Identification of the Entities Participating in the Merger
Pursuant to the provisions of Section 235(a) of the Corporations Act,
Section 2 of the Plan identifies the companies participating in the merger,
with each of their corporate names, their respective domiciles, and
information identifying their registration with the Commercial Registry and
their Tax ID Number.
The choice of Telefonica as the acquiring company is due not only to its
larger size and market capitalization or the fact that Terra is a 75%
-owned subsidiary of Telefonica, but also to the strategic reason
for the transaction, which is to integrate the Telephony business with the
Internet business.
3.2.2 Merger Exchange Ratio
Pursuant to Section 235(b) of the Corporations Act, Section 3 of the Plan
contains the merger exchange ratio. The exchange ratio has been determined
on the basis of the actual value of the assets of the entities participating
in the merger, and is two (2) shares of Telefonica, each having a par value
of one Euro, for every nine (9) shares of Terra, each having a par value of
two Euros. The shares of Telefonica that are delivered in exchange shall
have the same characteristics and rights as Telefonica's other outstanding
shares. No additional cash compensation is planned.
Section 4 of this report contains a financial analysis of the merger
exchange ratio.
3.2.3 Merger Balance Sheets
Section 4 of the Merger Plan specifies that for the purposes set forth in
Article 239.1 of the Corporations Act, the balance sheets for the merger
shall be deemed to be the balance sheets of TELEFONICA and TERRA as of
December 31, 2004, which have been verified by their respective auditors and
which will be submitted for the approval of the shareholders at their
respective General Shareholders' Meetings prior to the adoption of the
merger resolution.
Although the reference to the merger balance sheets is not explicitly
required by Section 235 of the Corporations Act, it has been deemed that it
is supplemental to the information that has been deemed appropriate to
mention in the Plan.
3.2.4 Procedure for the Exchange of Shares
Section 5 of the Plan complies with the requirement set forth in Section 235
(c) of the Corporations Act that mention be made of the procedure for
exchanging the shares of companies that are to be cancelled.
Section 6 of the Plan provides that, if necessary, Telefonica may increase
its share capital by the amount necessary and issue the exact number of
shares needed to make the exchange for Terra shares in accordance with the
exchange ratio established in the Plan, in application of the provisions of
Section 249 of the Corporations Act. This section also provides that the
increase in capital may be reduced by the delivery to Terra shareholders of
old shares held in Telefonica's treasury. In this sense, the Telefonica's
Board of Directors has ultimately chosen to satisfy the entire exchange by
means of the delivery of old Telefonica shares that are in the company's
treasury, and will therefore propose at the General Shareholders' Meeting
that Telefonica fully satisfy the exchange by means of the delivery of
Telefonica's own shares. Therefore, there will be no proposal at the General
Shareholders' Meeting for Telefonica to increase its capital in order to
satisfy the exchange of shares arising from the merger.
Therefore, once the merger has been approved by the shareholders acting at
the General Shareholders' Meetings of Telefonica and Terra and the merger
has been recorded with the Commercial Registry, Telefonica will deliver to
Terra shareholders the shares that Telefonica holds in treasury, in
accordance with the exchange ratio described above. As referred to above,
such exchange shall take place upon the recording of the merger instrument
with the Commercial Registry of Madrid, and will be effected by the relevant
financial entity and during the period indicated in the announcements to be
published in the Official Gazette (Boletin Oficial) of the Commercial
Registry and in two widely-circulated newspapers in Madrid and
Barcelona.
Pursuant to the prohibition established in Section 249 of the Corporations
Act, there will be no exchange of Terra shares that it holds in treasury or
that are held by Telefonica or by any person acting in their own name but on
behalf of Terra or Telefonica. Taking into account that Terra does not
expect to reduce its direct holdings of treasury shares, currently 7,000,000
shares of Terra's own stock, and that Telefonica, in order to allow for the
total number of Terra shares that are to participate in the exchange to be a
multiple of the exchange ratio, plans to acquire seven additional Terra
shares prior to the call of Terra's General Shareholders' Meeting, the
exchange of Terra shares will require that Telefonica deliver a maximum of
29,274,686 of its own shares, which will be frozen as of the date of
adoption of the merger resolution. All of the shares of Terra will be
cancelled as a result of the merger.
The exchange of Terra shares for Telefonica shares shall be made through the
entities participating in the Sociedad de Gestion de los Sistemas de
Registro, Compensacion y Liquidacion de Valores, S.A. (Securities
Registration, Clearing, and Liquidation Systems Management Company, Inc.)
(Iberclear) that are depositories thereof.
Pursuant to the provisions of paragraph (d) of Section 5 of the Merger
Plan, those shareholders of Terra who hold shares representing a fraction of
the number of Terra shares designated as the exchange ratio may purchase or
transfer shares in order to exchange them in accordance with such exchange
ratio. Each shareholder must individually make timely decisions for such
purpose to either purchase or sell Terra shares in the market in order to
reach the number of Terra shares that are a multiple of nine.
Without prejudice to the foregoing, and pursuant to the provisions of
Section 5 of the Plan, the Boards of Directors of Telefonica and Terra,
after due conversations, will submit for approval at their respective
General Shareholder Meetings a mechanism designed to facilitate the exchange
with those Terra shareholders who are holders of a number of shares that is
not a multiple of nine (9). The basic terms and conditions of such mechanism
are as follows:
a. Taking into account that the exchange ratio for the merger is
equivalent, in singular terms, to the delivery of one Telefonica
share for every 4.5 shares of Terra, at the close of the last
session for trading in Terra stock on the Spanish stock exchanges
(hereinafter, the 'Reference Date'), each shareholder of Terra who,
by application of such singular exchange ratio of one Telefonica
share for each 4.5 Terra shares, is entitled to receive a whole
number of Telefonica shares, and who has an odd-lot residue
of less than 4.5 Terra shares, may transfer such residue to the odd
-lot agent appointed for such purpose (hereinafter, the 'Odd
-Lot Agent'), all with the understanding that for the
calculation of the odd-lot corresponding to each shareholder
position, all of the Terra shares forming such position will be
calculated.
Likewise, a Terra shareholder who is the owner of less than 4.5
Terra shares will be able to transfer such shares to the Odd
-Lot Agent. It shall be deemed that each shareholder of
Terra accepts the odd-lot acquisition system, without having
to remit instructions to the relevant entity participating in
Iberclear, which shall inform the shareholder of the results of the
transaction once it has been concluded.
b. Given the agreed exchange ratio, and regardless of the number of
shares comprising each shareholder's position, the only
circumstances under which the acquisition of odd-lots may
take place are the following:
Number of Terra shares Corresponding Telefonica shares Odd-lot shares of Terra
by virtue of the exchange subject to the odd-lot
acquisition system
1 0 1
2 0 2
3 0 3
4 0 4
5 1 0.5
6 1 1.5
7 1 2.5
8 1 3.5
9 2 0
Therefore, in any shareholder position, an odd-lot will
range between a minimum of 0.5 Terra shares and a maximum of 4 Terra
shares.
c. The acquisition price of the odd-lots will be determined
based on the arithmetic mean of the average weighted prices of Terra
shares on the Automated Quotation System (Sistema de Interconexion
Bursatil) (continuous market) for the last three trading sessions
for Terra stock on the Spanish stock exchanges. If the odd-
lot in question is other than one share, its acquisition price shall
be calculated based on the same criterion set forth herein, but in a
proportion corresponding to the specific amount of the odd-
lot.
d. The entity appointed as the Odd-Lot Agent, acting on its own
behalf, will acquire the odd-lot shares remaining in the
positions existing at the close of the trading session corresponding
to the Reference Date. The shares or fractions of shares of Terra
acquired by the Odd-Lot Agent shall be exchanged for the
number of Telefonica shares set forth in the Merger Plan.
3.2.5 Date from which the Shares Delivered in Exchange will Carry the Right
to Participate in Corporate Earnings and Date of the Merger for Accounting
Purposes
In compliance with the provisions of the second sub-section of
Section 235(c) of the Corporations Act, Section 7 of the Plan sets January
1, 2005 as the date from which the shares delivered by Telefonica in
exchange will give their holders the right to participate in Telefonica's
corporate earnings under the same terms as the other shares currently in
circulation. After the registration of the merger instrument with the
Commercial Registry, the holders of Telefonica shares delivered in exchange
for Terra shares will participate in distributions paid by Telefonica with
rights equal to the holders of all other Telefonica shares. This means that
the shares delivered in exchange will participate in the corporate earnings
of Telefonica for the fiscal year beginning January 1, 2005.
In addition, and pursuant to the provisions of paragraph d) of Section 235
of the Corporations Act, Section 9 of the Plan sets January 1 2005 as the
date from which the Terra transactions are deemed for accounting purposes to
have taken place on behalf of Telefonica.
3.2.6 Special Rights and Benefits Extended to Directors and Independent
Experts
Pursuant to the provisions of Section 235(e) of the Corporations Act,
Section 10 of the Plan provides that the shares to be delivered by
Telefonica shall not give special rights to the holders thereof.
Likewise, such section states that there are no special Terra shares or
owners of special rights in Telefonica other than the shares, except for
those belonging to the beneficiaries (employees, officers and directors of
companies in the Terra group) of stock option plans described in the last
paragraph of Section 5 of the Plan. Following the registration of the merger
with the Commercial Registry, Telefonica will succeed Terra as the entity
bound by such plans, which will be amended in accordance with the exchange
ratio established in the Plan. Thus, Terra stock option rights shall be
automatically converted into Telefonica stock option rights, upon the terms
resulting from the exchange ratio established in the Merger Plan. All
references to Terra or, as applicable to Lycos Inc. or to Lycos Virginia in
such option plans shall be deemed to be made to Telefonica starting on the
date of registration of the merger.
In addition, as set forth in Section 5 of the Plan, in order not to
prejudice the interests of the beneficiaries of such plans, Telefonica will
establish, if necessary, mechanisms to ensure that due attention will be
given to the commitments assumed by Terra in connection with such stock
option plans. In this regard, no specific mechanism is expected to be
established in order to meet the commitments assumed by Terra with respect
to the stock option plans outside of the provisions above, given that there
is no obligation in such plans to establish specific mechanisms, nor is it
considered necessary under the current market situation.
For its part, Section 11 of the Merger Plan, in compliance with the
provisions of Section 235(f) of the Corporations Act, provides that no
benefits in Telefonica of any type shall be extended to the directors of any
of the entities participating in the merger, or to KPMG Auditores S.L., the
independent expert appointed by the Commercial Registry to prepare the
mandatory report regarding the Plan.
3.2.7 Other Mentions of the Merger Plan
The Merger Plan contemplates other matters, the mention of which, like some
of the content already commented on, is not expressly required by applicable
legislation. As in the cases already analyzed, these are matters whose
importance has caused the directors of the companies participating in the
merger to believe that the inclusion thereof would be appropriate. Such
matters are summarized below:
a. Dividends. - Section 8 of the Plan describes the distributions
and dividend payments that Telefonica and Terra expect to make and
that have been taken into consideration for the preparation of the
Merger Plan and the determination of the exchange ratio.
Telefonica plans to make the following distributions:
i. Payment of a dividend based on the earnings for the fiscal year
ending December 31, 2004, which will be paid on May 13, 2005.
This dividend was announced by the Board of Directors at its
meeting held on January 26, 2005. On February 23, 2005, the
Board of Directors resolved to set the amount of such dividend
at 0.23 Euros per share. As indicated in Section 7 of the Plan,
Terra shareholders who become Telefonica shareholders as a
result of the merger will not benefit from such dividend. This
has therefore been taken into account for the formulation of the
exchange ratio.
ii. A portion of the reserve for additional paid-in capital
will be distributed by means of the delivery of Telefonica's
treasury stock, at the ratio of one share of treasury stock for
each twenty-five shares owned by the shareholder,
charged against the reserve for additional paid-in
capital. The proposal for such distribution plan was approved by
the Board of Directors at its meeting held on November 24, 2004.
The effectiveness of the distribution is subject to the
corresponding approval by the shareholders at the Ordinary
General Shareholders' Meeting of Telefonica. The payment is
expected to be made during the days following the meeting and,
in any event, before the merger of Telefonica and Terra is
recorded with the Commercial Registry. Terra shareholders who
become Telefonica shareholders as a result of the merger will
not benefit from such distribution. This has therefore been
taken into account for the formulation of the exchange ratio
iii. The payment of a dividend with a charge against the reserve for
additional paid-in capital, which should be paid on
November 11, 2005. This proposal for this dividend was announced
by the Board of Directors at its meeting held on November 24,
2004. The effectiveness of the distribution is subject to the
corresponding approval by shareholders at the Ordinary General
Shareholders' Meeting of Telefonica. The exact amount of such
dividend is expected to be 0.27 Euros per share. Unlike the
provisions for dividends described above in subsections (i) and
(ii), this dividend will be received by both the Telefonica
shareholders and the Terra shareholders who become Telefonica
shareholders as a result of the merger. This has therefore not
been taken into account for the formulation of the exchange
ratio
Terra expects to pay a dividend in the amount of 0.60 Euros per
share, with a charge against the 'Reserve for Additional Paid
-In Capital' account. The proposal for such distribution was
approved by the Board of Directors at its meeting held on February
23, 2005. The effectiveness of the distribution is subject to the
corresponding approval by the shareholders at the Ordinary General
Shareholders' Meeting of Terra. Payment is expected to be made
during the days following the meeting and, in any event, before the
merger of Telefonica and Terra is recorded with the Commercial
Registry. Only the shareholders of Terra will benefit from such
distribution. This has therefore been taken into account for the
formulation of the exchange ratio
b. Tax Regulations.- Section 12 of the Plan provides that the
merger transaction will be governed by the special tax regime set
forth in Chapter VIII of Title VII of the Restated Text of the
Corporate Income Tax Law, for which purpose the merger transaction
will be reported to the Government Inspection Office of the Ministry
of Finance in accordance with the terms of Section 96 of such
Consolidated Text and related provisions.
c. Bylaw/Charter Amendments.- Section 13 of the Plan provides
that in the context of the merger transaction, the Boards of
Directors of Telefonica and Terra may submit for the approval of the
shareholders at their respective General Shareholders' Meeting the
bylaw/charter amendments of Telefonica that pertain to the Plan
itself, and such others that are mutually decided upon.
In this regard, it is expressly stated that the Boards of Directors
of Telefonica and Terra have not agreed to submit for approval at
their respective General Shareholders' Meetings any amendment to
Telefonica's charter/bylaws with respect to the merger. It is noted,
however, that Telefonica plans to reduce its capital stock in order
to retire shares pursuant to the TIES Program.
d. Appointment of Independent Expert.- Section 14 of the Plan
provides that the directors of Telefonica and Terra have asked the
Commercial Registry of Madrid to appoint a single independent expert
for the preparation of the report on the Merger Plan referred to in
Section 236 of the Corporations Act.
The Commercial Registry of Madrid appointed KPMG Auditores, S.L. as
independent expert, and such expert accepted the appointment on
March 3, 2005.
e. Administrative Authorizations.- Finally, Section 15 of the
Project refers to the notices, authorizations and registrations upon
which the effectiveness of the merger between Telefonica and Terra
is conditioned.
It is not expected that authorizations or registrations in Spain or
the other jurisdictions in which both companies are present need be
effected or obtained in order for the merger to become effective,
other than with respect to the registration of the 'Form F-
4' that has been submitted to the United States Securities and
Exchange Commission. The National Securities Market Commission has
been notified of the submission of this form, as well as the
contents thereof, by means of a Communication of Relevant Facts.
3.3 Implementation of the Legal Process for Merger by Absorption
Below is a brief reference to the principle milestones marking the
implementation of the merger process, with special mention of the relevant
rules of the Corporations Act.
3.3.1 Approval and Signing of the Merger Plan
In order to carry out the merger, Section 234.1 of the Corporations Act
requires the directors of the companies participating in the merger to
prepare a merger plan.
The Merger Plan, which contains the basis and rules for implementing the
merger transaction, was approved and signed by the directors of Telefonica
and Terra at meetings held on February 23, 2005 (with the abstentions and
absences indicated in the Merger Plan itself). Two signed specimens of such
Merger Plan have been deposited with the Commercial Registries of Madrid and
Barcelona, respectively, prior to the call of the General Shareholders'
Meetings of Telefonica and Terra, the fact of the deposit in Madrid having
been published in the Official Gazette of the Commercial Registry on March
14, 2005 and the fact of the deposit in Barcelona having been published in
the Official Gazette of the Commercial Registry on March 29, 2005.
3.3.2 Report of the Independent Expert Regarding the Merger Plan
In addition, pursuant to the provisions of Section 236.2 of the Corporations
Act, on February 24, 2005, the Commercial Registry of Madrid was jointly
requested by Telefonica and Terra to appoint a single independent expert to
prepare a single report regarding the Merger Plan and regarding the assets
to be received by Telefonica from Terra as a result of the merger.
On March 3, 2005, the Commercial Registry of Madrid appointed KPMG
Auditores, S.L. as the independent expert, and such expert accepted the
appointment on the same date. On March 29, 2005, KPMG Auditores, S.L., asked
the Commercial Registry of Madrid for an extension of the period for issuing
its report, with an extension through May 3, 2005 being granted on March 30,
2005. Within such period, the expert has issued the corresponding report
regarding the Merger Plan, in which it stated the following conclusion:
In accordance with the work performed, for the sole purpose of complying
with the provisions of Article 236 of the Restated Text of the Corporations
Act, and taking into account the stated in foregoing paragraph 4, we believe
that:
• The valuation methodologies used to determine the actual value of
the Companies are proper within the context and circumstances of the
transaction in question, and the exchange rate provided in the
Merger Plan is justified.
• The assets reported by the acquired company are at least equal to
the acquired company's capital increase as set forth in the Merger
Plan.
3.3.3 Report of the Directors Regarding the Merger Plan
In accordance with Section 237 of the Corporations Act, the directors of
Telefonica have approved this report on the date hereof, which report gives
a rational for and detailed explanation of the legal and financial aspects
of the Merger Plan, with special reference to the exchange ratio.
Likewise, in accordance with Section 237 of the Corporations Act, on April
12, 2005, the directors of Terra approved a report that contains their
respective rationale for and explanation of the Merger Plan, and that is
divided into two sections, one relating to 'legal aspects of the merger' and
another relating to 'financial aspects.'
3.3.4 Notice of the General Shareholders' Meetings
On April 20, 2005, the Boards of Directors of Telefonica and Terra are
expected to approve the giving of notice of the respective General
Shareholders' Meetings to be held in Madrid and Barcelona, respectively. It
is expected that the General Shareholders' Meeting of Telefonica will be
called for May 24, 2005, on first call, and on May 25, 2005, on second call,
and the General Shareholders' Meeting will be called for May 31, 2005, on
the first and only call.
Among the items comprising the Agenda of such General Meetings will be
debate on and approval, if granted, of the merger between Telefonica and
Terra, upon the terms set forth in the Merger Plan.
Pursuant to the provisions of Section 238.1 of the Corporations Act, upon
publication of the notice of the respective General Meetings, the documents
listed in Section 238.1 and set forth below will be made available to the
shareholders, debtholders, and owners of special rights other than shares,
as well as labor representatives, for examination thereof at the respective
corporate headquarters of Telefonica and Terra.
In addition, from the date of publication of the notices of the respective
General Meetings, the shareholders, debtholders and holders of special
rights other than shares of Telefonica and Terra may request the free
delivery or shipment of such documents, pursuant to the provisions of
Section 240.2 of the Corporations Act.
3.3.5 Merger Resolutions and Publication of Announcements
Section 240 of the Corporations Act provides that the merger resolution must
be adopted by the shareholders at the General Shareholders' Meetings of each
of the companies participating in the merger process, in accordance with the
provisions of the Merger Plan.
Once the merger plan, if any, is adopted, the relevant announcement will be
published three times in the Official Gazette of the Commercial Registry and
in two widely-circulated newspapers in Madrid and Barcelona,
respectively, all in compliance with the requirements of Section 242 of the
Corporations Act. Upon publication of these announcements, which shall set
forth the right of the shareholders and creditors of Telefonica and Terra to
obtain the full text of the merger resolutions and the merger balance
sheets, a period of one month will commence for the creditors of the merging
companies to challenge the merger until claims which have not expired as of
the date of publication are guaranteed, in accordance with Section 243 of
the Corporations Act.
3.3.6 Execution and Registration of the Merger Instrument
Once the relevant merger resolutions have been adopted, the announcements
have been published, and the legal period has passed without any creditor
having exercised its right of challenge or, if applicable, the claims
thereof, if enforced, have been duly satisfied or guaranteed, the
corresponding merger instrument will be executed.
Prior to the registration of the merger instrument, a notation will be
placed on the instrument by the Commercial Registrar of Barcelona stating
that there are not impediments to registration of the intended merger.
Thereafter, such instrument will be submitted for registration with the
Commercial Registry of Madrid, and the Commercial Registry of Barcelona will
be requested to cancel the registration entries for Terra.
3.3.7 Performance of the Exchange
Upon the passage of the merger resolutions at the General Shareholders'
Meetings of Telefonica and Terra, and the registration of the merger
instrument with the Commercial Registry of Madrid, the shares of Telefonica
will be exchanged for the shares of Terra upon the terms set forth in the
Plan.
3.4 Information Regarding the Planned Merger Transaction
Pursuant to the provisions of Section 238 of the Corporations Act, as from
the publication of the call notice of the corresponding General Meeting, the
following documents will be made available to the shareholders, debtholders,
and holders of special rights other than shares, as well as the labor
representatives, for examination thereof at the corporate headquarters of
each of the companies participating in the merger:
a. The Merger Plan.
b. The report of the independent expert, KPMG Auditores, S.L., on the
Merger Plan.
c. This report of the directors of Telefonica on the Merger Plan, and
the corresponding report of the directors of Terra.
d. The annual financial statements and management's discussion and
analysis for the last three fiscal years of the companies
participating in the merger, together with the corresponding
auditors' reports.
e. The merger balance sheet of each of the companies participating in
the merger, accompanied by the corresponding verification report
issued by the auditors.
f. The charter/bylaws of each of the companies participating in the
merger.
g. The list of names, surnames, and age, nationality and address of the
directors of the companies participating in the merger, as well as
the date on which they took office and, if applicable, an indication
of those who will be proposed as directors of Telefonica as a result
of the merger.
Pursuant to the provisions of Section 240.2 of the Corporations Act, the
shareholders, debtholders and holders of special rights other than shares
may obtain the free delivery or shipment of the full text of the documents
set forth above.
The documents referred to in the preceding paragraphs will be available for
consultation on the website of Telefonica (http://www.telefonica.es) and
Terra (http://www.terranetworks.es) beginning on the date of the notice of
meeting.
4. FINANCIAL ASPECTS OF THE MERGER PLAN
4.1 Merger Balance Sheets and Changes
Section 4 of the Merger Plan specifies that the balance sheets of Telefonica
and Terra ended as of December 31, 2004, and which have been verified by the
respective auditors of these companies, shall be considered the merger
balance sheets for purposes of Section 239.1 of the Corporations Act, and
will be submitted for approval at the respective General Shareholders'
Meetings prior to the adoption of the merger resolution.
It is hereby noted that, with respect to the possibility given by such legal
rule to change certain valuations in order to insert alterations that might
not appear in the accounting entries, the use of such possibility has not
been required with respect to the merger balance sheets of Telefonica and
Terra. Therefore, such merger balance sheets do not contain any changes
regarding the respective balance sheets ended as of December 31, 2004.
Likewise, it is hereby noted that no significant changes in the assets of
Telefonica or Terra have occurred between the date of the Merger Plan and
the date of this report.
4.2 Exchange Ratio
Section 3 of the Merger Plan provides that the exchange ratio established
for the merger is two (2) shares of Telefonica, each having a par value of
one Euro, for each nine (9) shares of Terra, each having a par value of two
Euros (with no supplemental cash compensation).
As provided in the Merger Plan, the directors of Telefonica and Terra have
not resolved for the shareholders of Terra to receive any supplemental cash
compensation.
4.3 Determination of the Exchange Rate
As is also set forth in Section 3 of the Merger Plan, the merger exchange
ratio has been determined based on the actual value of the assets of
Telefonica and Terra.
In order to determine the actual values of the corporate assets of
Telefonica and Terra and to calculate the exchange ratio, Telefonica's
directors have used the valuation methods described in Sections 4.3.1 and
4.3.2 below, which are justified and contrasted with other methods in
Section 4.3.3 below. In determining the exchange ratio, the directors of
Telefonica have also taken into account the forecasts for the payment of
dividends by both companies that are described in Section 3.2.7(a) of this
Report.
Morgan Stanley & Co. Limited (hereinafter, 'Morgan Stanley'), as
Telefonica's financial advisor for the merger transaction, has expressed to
the company's Board of Directors in its fairness opinion that the agreed
-upon exchange ratio is equitable for Telefonica's shareholders. For
their part, Lehman Brothers International (Europe), Spain Branch, and
Citigroup Global Markets Limited, as Terra's financial advisors for this
transaction, have expressed to the latter company's Board of Directors in
their fairness opinion that the agreed-upon exchange ratio is
equitable for Terra's shareholders other than its majority shareholder,
Telefonica.
4.3.1 Actual Net Worth of Telefonica
In the case of Telefonica, the valuation has been based on the listing price
of the Company's shares. In the opinion of Telefonica's directors and
financial advisors, this valuation method is justified due to the high
liquidity of Telefonica's shares and the fact that the shares to be
delivered by Telefonica to Terra's shareholders as a result of the merger
represent less than one day's volume of listings on the ordinary market, for
which reason there will not be a negative impact on the price for those
shareholders who decide to sell their securities on the stock market. In any
event Telefonica and its financial advisers have used several valuation
methods which, by way of comparison, allow reaching the conclussion that the
market quotation value reflects an appropriate valuation of the Company.
On such basis, Telefonica's has been assigned an actual value of euro
66,361 million, which has been used to set the exchange ratio. As has been
stated, such amount has been calculated based on the listed price of
Telefonica's shares at the close of the trading session on February 21, 2005
(euro14.19 per share), discounting a total of euro0.80 per share
corresponding to the dividends that Telefonica expects to distribute prior
to the registration of the merger, which implies a value of euro13.39 per
share. The above amount (euro66,361 million) results from multiplying the
share price by the total number of Telefonica shares, 4,956 million.
4.3.2 Actual Net Worth of Terra
For its part, as regards Terra, the directors of Telefonica and its
financial advisors believe that the different methods applied represent
different focuses for valuation and are complementary. Among these methods,
notable are those based on (i) discounted cash flow, (ii) multiples of the
listing prices of comparable companies, (iii) multiples paid in comparable
transactions, and (iv) market listings. Although it might be estimated that
the discounted cash flow method best reflects the intrinsic value of Terra,
the limited access that Telefonica's financial advisors have had to Terra's
management team has prevented basing conclusions exclusively on this
methodology. In any event, as it could not be otherwise, the directors
valued Terra in its current condition, without taking into account
historical periods when the share prices were much higher.
The actual value of Terra used to determine the exchange ratio is euro
1,690 million. This actual value has been chosen from within certain ranges
in order to match the exchange ratio of two Telefonica shares for nine Terra
shares. The ranges which were used have been calculated using the different
valuation methodologies set forth above (a summary thereof is set forth in
Section 4.3.3 below), and the dividend of euro0.60 that Terra expects to
distribute prior to the registration of the merger has been discounted. All
of the foregoing results in a unitary value of euro2.98 for each share of
Terra.
4.3.3 Valuation Methodology and Procedure
Telefonica retained Morgan Stanley to provide it with financial advisory
services regarding the merger transaction, the valuation process of the
companies participating therein, and the determination of and rationale for
the exchange ratio proposed for the merger. As already stated, on February
23, 2005, Morgan Stanley rendered a fairness opinion with respect to the
transaction addressed to Telefonica's Board of Directors in which it
concluded that, based upon and subject to what is provided in such document,
the merger exchange ratio and the extraordinary dividend of 0.60 Euros per
share expected to be distributed by Terra to its shareholders pursuant to
the Merger Plan, are fair for Telefonica from a financial point of view.
With the advice of Morgan Stanley, Telefonica carried out the corresponding
work of evaluating the companies participating in the merger, and based
thereon and after arms-length negotiations with Terra, decided upon
the financial terms of the merger that are reflected in the Plan.
In performing its financial advisory work for Telefonica, Morgan Stanley
carried out various analyses of company valuations in regards to the
preparation of its fairness opinion. Set forth below is a summary of such
analyses, which are based on prices for the shares of Telefonica and Terra
as of February 21, 2005, adjusted for the following dividends that both
companies expect to distribute:
• Telefonica:
Telefonica's price is adjusted for a total of euro0.80 per share in
dividends declared by Telefonica (and which will not be payable to
Terra's shareholders with respect to the Telefonica shares they would
receive in the merger, pursuant to the Merger Plan), as follows: (i) a &
euro;0.23 per share dividend based on earnings for the fiscal year
ending December 31, 2004, payable to Telefonica's current shareholders
on May 13, 2005; and (ii) The distribution of Telefonica's treasury
stock, at the ratio of one share of treasury stock for each twenty
-five shares owned by the shareholder, from the additional paid
-in capital reserve, which is expected to occur following the
Ordinary General Shareholders' Meeting (estimated at euro0.57 per
share at Telefonica's closing share price as of February 21, 2005).
• Terra:
Terra's price is adjusted for the euro0.60 extraordinary dividend
approved by Terra's board of directors on February 23, 2005, which will
be distributed to Terra's shareholders prior to the registration of the
merger with the Commercial Registry.
(i) Trading Range Analysis
Morgan Stanley has reviewed the range of closing prices for the shares of
Telefonica and Terra for various periods ending on February 21, 2005. Morgan
Stanley has observed the following:
Period ending Telefonica Terra
February 21, 2005
Last 90 Days euro12.18 - euro13.76 euro2.20 - euro2.70
Last Six Months euro10.66 - euro13.76 euro2.17 - euro2.70
Last Twelve Months euro10.40 - euro13.76 euro2.17 - euro2.70
Morgan Stanley has calculated that the exchange ratio of 2 Telefonica shares
for every 9 Terra shares pursuant to the Merger Plan represents a 15%
premium over the unaffected price of Terra shares as of February 11, 2005,
and a 14% premium to the 30 trading days average of Terra shares prior to
February 21, 2005.
(ii) Comparable Companies Analysis
Morgan Stanley has compared certain financial information of Telefonica and
Terra to financial estimates published in financial analysts' reports for
certain companies with business models similar to those of Telefonica and
Terra, respectively. The companies used in this analysis are the following:
a. With respect to Telefonica: Belgacom, British Telecom, Deutsche Telekom,
France Telecom, KPN, Hellenic Telecommunications (OTE), Portugal
Telecom, Swisscom, Tele Danmark (TDC), Telecom Italia, TeliaSonera,
Telekom Austria y Telenor; and
b. With respect to Terra: using as a reference the unaffected closing share
price of T-Online as of October 8, 2004 (prior to Deutsche
Telekom's announcement of a minority buy-out tender offer
followed by a merger with T-Online).
For the purposes of this analysis, Morgan Stanley has used the ratio of
aggregate business value (defined as market capitalization plus total debt
less cash and cash equivalents, plus other adjustments) to estimated 2005
earnings before interest, taxes, depreciation and amortization for
Telefonica and to estimated 2006 earnings before interest, taxes,
depreciation and amortization for Terra. Morgan Stanley has applied these
multiples to Telefonica's 2005 and Terra's 2006 earnings, utilizing as
information sources for Telefonica, financial forecasts published in
financial analysts' reports, and for Terra, financial forecasts prepared by
such company's management team.
Based on the number of Telefonica's and Terra's shares, Morgan Stanley has
estimated the implied value per share of Telefonica and Terra, respectively,
as of February 21, 2005, as follows:
Financial Statistic Financial Multiple Based on Implied Value
Statistic Amount Analysis of per Share
Comparable
Companies
Telefonica's business value to 2005 earnings euro14,301 MM 5.6x - 6.6x euro10.89-
before interest, taxes, depreciation and euro13.77
amortization
Terra's business value to 2006 earnings euro60 MM 12.6x euro2.67
before interest, taxes, depreciation and
amortization
No company utilized in the comparable companies analysis is identical to
Telefonica or Terra. In evaluating comparable companies, Morgan Stanley has
made judgments and assumptions with regard to industry performance, general
business, economic, market and financial conditions and other matters, many
of which are beyond the control of Telefonica or Terra, such as the impact
of competition on the businesses of Telefonica or Terra and the industry
generally, industry growth and the absence of any significant changes in the
financial condition and prospects of Telefonica or Terra or the industry or
in the financial markets in general. Mathematical analysis (such as
calculating the average or median) is not in itself a representative method
of using comparable company data.
(iii) Discounted Cash Flow Analysis
Morgan Stanley has calculated the range of equity values per share for each
of Telefonica and Terra based on a discounted cash flow analysis. With
respect to Telefonica, Morgan Stanley has relied on financial forecasts
published in financial analysts' reports for 2005 through 2010 and
extrapolations from such protections for 2011 through 2014. In arriving at a
range of equity values per share of Telefonica, Morgan Stanley has
calculated the residual value by applying a range of perpetual growth rates
ranging from 1.0% to 1.5%. The unleveraged free cash flows from 2005 through
2014 and the residual value were then discounted using a range of average
weighted capital cost rates from 8.0% to 9.0%. With respect to Terra, Morgan
Stanley has relied on financial projections for Terra provided by
Telefonica's management team (as received by them from Terra), for 2005
through 2008 and extrapolations from such projections for 2009 to 2014. With
respect to those financial projections and other information and data
relating to Terra, including information as to Terra's tax situation, Morgan
Stanley has been advised by Telefonica's management team that such financial
forecasts and other information and data were prepared based on bases
reflecting the best current estimates and judgments of Telefonica's
management team as to the future financial performance of Terra and the
judgment of Telefonica's management team regarding the financial performance
and tax situation of Terra. In order to determine the equity value per share
of Terra, Morgan Stanley has calculated the residual value by applying a
range of perpetual growth rates from 3.0% to 4.0%. The unleveraged free cash
flows from 2005 through 2014 and the residual value have been discounted
using a range of average weighted capital cost rates of 11.5% 12.5%. The
unleveraged free cash flows include the benefits to Telefonica resulting
from the business or tax or other savings as well as payments to be received
by Terra arising from its strategic alliance with Telefonica.
The following table summarizes the results of Morgan Stanley's analysis:
Key Assumptions Implied Market Value Implied Market Value per
(euroMM) Share
Telefonica: 1.0% - 1.5% perpetual euro69,928 - euro88,215 euro14.11 - euro17.80
growth rate; 8.0% - 9.0% discount rate
Terra: 3.0% - 4.0% perpetual growth euro 1,448 - euro1,522 euro2.55 - euro2.68
rate; 11.5% - 12.5% discount rate
(iv) Financial Analysts' Price Targets
Morgan Stanley has reviewed and analyzed future public market trading price
targets for Telefonica and Terra published by financial analysts. These
targets reflect estimates of future public market trading prices for the
shares of Telefonica and Terra. The range of target prices for Telefonica
and Terra is euro13.70 - euro15.70 and euro2.30 - euro2.65, respectively.
The public market trading price targets published by financial analysts do
not necessarily reflect current market trading prices for Telefonica or
Terra. Such estimates are subject to uncertainties, including the future
financial performance of Telefonica and Terra and future market conditions.
(v) Analysis of Precedent Transactions
Morgan Stanley has analyzed the tender offer by Deutsche Telekom for the 26%
of T-Online it didn't already own, and the subsequent merger between
Deutsche Telecom and T-Online announced on October 9, 2004.
For the purposes of this analysis, Morgan Stanley has used the ratio of
aggregate value (defined as market capitalization plus total debt less cash
and cash equivalents plus other adjustments) to estimated 2005 earnings
before interest, taxes, depreciation, and amortization, and has applied this
multiple to Terra's 2005 earnings before interest, taxes, depreciation and
amortization, based on financial forecasts prepared by Terra's management.
Based on the number of shares, Morgan Stanley has estimated the implied
value per share as of February 21, 2005 as follows:
Financial Statistic Financial Statistic Multiple Applied Implied Value per
Amount Based on Precedent Share
Transactions
Terra's aggregate business value to euro52 MM 17.7x euro2.96
2005 earnings before interest, taxes,
depreciation and amortization
No company or transaction utilized in the precedent transaction analyses is
identical to Terra or the merger. In evaluating the comparable companies,
Morgan Stanley has made judgments and assumptions with regards to industry
performance and business, economic, market and financial conditions and
other matters, many of which are beyond the control of Terra, such as the
impact of competition on the business of Terra networks or the industry
generally, industry growth and the absence of any adverse material change in
the financial condition or forecasts for Terra or the industry of the
financial markets in general, which could affect public trading values or
the aggregate value of the transactions to which the merger in question is
being compared.
(vi) Exchange Ratio Analysis
Morgan Stanley has analyzed the ratio of the closing prices of Terra's stock
divided by the corresponding closing prices of Telefonica's stock over
various periods ending February 21, 2005. Morgan Stanley has examined the
premiums arising from a comparison of the announced exchange ratio of
0.2222, as set forth in the Merger Plan, and the benchmarks set forth in the
following table, observing the following:
Telefonica Terra Implied Exchange Implied Premium
(euro/share) (euro/share) Ratio (1)
Last 90 Days Avg. euro12.18- euro2.20- 0.181- 23% -
euro13.76 euro2.70 0.196 13%
Last Six Months Avg. euro10.66- euro2.17- 0.196-
euro13.76 euro2.70 0.204 9% - 13%
Last Twelve Months Avg. euro10.40- euro2.17- 0.196-
euro13.76 euro2.70 0.209 6% - 13%
(1) Implied premium defined as announced exchange ratio of 0.2222
divided by the resulting exchange ratio for each trading average
(vii) Comparison with Criteria for De-Listing Offers
Telefonica's directors, being advised by Morgan Stanley, have determined
that that the value of Terra used to calculate the exchange ratio meets the
requirements set forth in Section 7(3) of Royal Decree 1197/1991 for the
determination of the de-listing offering price. The amounts that
they arrived at, adjusted for the euro0.60 per share dividend that Terra
is to pay to its shareholders prior to registration of the merger, are as
follows:
a. Book value: euro2.28 per share.
b. Last 6 months average listing price (prior to 02/21/05): euro2.31
per share.
c. Last twelve months tender offer price: although it would not be
applicable because no offer has been made during the last year, it
is appropriate to indicate that the offer for Telefonica in May 2003
was made at a price of euro2.65 per share (discounting the euro2
extraordinary dividend distributed in 2004 and the euro0.60
extraordinary dividend pending distribution prior to the merger).
d. Liquidation value: Although the specific calculations have not been
made, Telefonica's directors and financial advisors believe that the
liquidation value would never be more than the above-
mentioned book value (euro2.28 per share).
All of the foregoing leads to the deduction that the valuation of Terra
taken into account in formulating the exchange ratio (euro2.98) is
considerably greater than the highest of the indicated criteria.
(viii) Reference to Tax Credit arising from the sale of Lycos Inc.
during fiscal year 2004.
As set forth in Terra's report corresponding to its annual financial
statements for fiscal year 2004, Terra has recognized a tax credit in the
amount of euro272 million, which is the result of multiplying the
applicable tax rate by the difference between the sale price of Lycos Inc.
shares and the value with which the capital increase used to acquire this
company was accounted for, less corrections that were already deductible for
tax purposes prior to the sale.
Such report also notes that the possibility of showing a greater negative
tax basis for fiscal year 2004, in the amount of up to 7.418 billion Euros,
as a result of applying the tax acquisition value resulting from taking the
market value of Lycos shares that were received, instead of the book value
with which they were recorded in application of the provisions of Section
159 of the Corporations Act. Notwithstanding the foregoing, given the
contrary position stated by the Spanish Revenue Service in response to tax
questions in similar cases, and current uncertainties regarding the final
decision that it might adopt, as of the date of preparation of the annual
financial statements, no accounting effect whatsoever was taken into account
with respect thereto for purposes of the valuation. Despite the fact that
the above-mentioned legal difficulties put the effectiveness of such
tax credits into question, and that in the best of cases under the current
situation, there will probably be a long time before recovery thereof, a
value of approximately euro230 million has been attributed thereto, which
equals euro0.40 per share of Terra.
4.4 Net Book Value of Terra's Assets to be Received by Telefonica
Pursuant to the individual balance sheets of Terra as of December 31, 2004,
the value of Terra's equity that will be received by Telefonica on such date
is the amount of 1,633,964 thousand Euros.
4.5 Total Number of Telefonica Shares Needed to Satisfy the Exchange
Given the type of exchange established in the Merger Plan, taking into
account the prohibition on participating in the exchange set forth in
Section 249 of the Corporations Act, and assuming, as is envisaged:
a. that Terra's capital stock, currently represented by 574,941,513
shares, with a par value of 2 Euros each, will not change through
the registration of the merger with the Commercial Registry;
b. that Telefonica will not change its shareholdings in Terra
(436,205,419 shares, representing 75.87% of the capital stock) as of
the date of the Plan, except for the acquisition on the Stock
Exchange of 7 additional shares of Terra (with Telefonica becoming
the holder of 436,205,426 Terra shares); and
c. that on the date of the exchange, Terra will not have more than the
7,000,000 of its own shares mentioned in Section 5 of the Merger
Plan held in treasury, and such treasury stock will not change
through the date of registration of the merger with the Commercial
Registry;
the maximum number of Terra shares that would participate in the exchange
would be 131,736,087, for which reason the maximum number of Telefonica
shares to deliver to the shareholders of Terra in the exchange would be
29,274,686
As noted in Section 3.2.4 above, Telefonica has a sufficient number of
shares in treasury to satisfy the merger exchange with old shares. The Board
of Directors of Telefonica therefore expects to fully perform the exchange
with old Telefonica shares, which will simplify the procedure.
4.6 Report of Terra's Directors
Sections 2.4 and 2.5 of the report recently issued by Terra's directors on
the Merger Plan contain a detailed description of the criteria used by its
financial advisors (Citigroup Global Markets Limited and Lehman Brothers
Europe Limited) in order to value Terra and Telefonica and to assist Terra
in the determination of and rationale for the exchange ratio proposed for
the merger. The report of Terra's directors concludes by stating that the
exchange ratio is considered to be fair for Terra's shareholders other than
Telefonica.
Terra retained the financial advisory services of Citigroup Global Markets
Limited and Lehman Brothers Europe Limited with respect to the merger and
the process of valuation of Terra and Telefonica, as well as the
determination of and rationale for the exchange ratio proposed for the
merger. As already indicated, on February 23, 2005, both entities issued
fairness opinions to Terra's Board of Directors regarding the merger
transaction in which, based on and subject to the provisions of such
documents, the merger exchange rate and the extraordinary dividend of 0.60
Euros per share (initially not contemplated in Telefonica's merger plan)
that Terra is to distribute to its shareholders in accordance with the
Merger Plan, are fair from a financial point of view for Terra's
shareholders other than Telefonica. The report of Terra's directors on the
Merger Plan (which, as already indicated, can be viewed on the websites of
Telefonica and Terra as from the date of call to the respective Ordinary
General Shareholders' Meetings) contains a summary of the various valuation
analyses of the companies performed by Citigroup Global Markets Limited and
Lehman Brothers Europe Limited with respect to the preparation of their
fairness opinion.
5. CONCLUSION
For the foregoing reasons, the director's of Telefonica state their
conviction that:
a. the Merger Plan which is the subject of this Report is highly
appropriate for both entities and the shareholders thereof, given
that the merger will allow for the integration of the Telephony and
Internet businesses and thereby ensure success in facing the
challenges raised by the development of the industry, technological
change and new customer needs; and
b. the exchange ratio proposed in the Plan is justified, and is fair for
the shareholders of both entities, as confirmed by the reports of
the financial advisors and the independent expert appointed by the
Commercial Registry.
* * * * *
This report has been prepared and approved in Madrid, on April 13, 2005, by the
directors of Telefonica, who sign below. It is hereby noted that the Directors
Antonio Viana-Baptista and Enrique Used Aznar have abstained from
participating in the drafting and signing of this Report, as they understand
that they are affected by a potential conflict of interest. For this reason,
their signatures do not appear in this document. Likewise, it is stated that the
signature of the Director Mr. Jose Fonollosa Garcia is missing, since he did not
attend the meeting of the Board of Directors held on the aforesaid date.
BOARD OF DIRECTORS OF TELEFONICA
/s/ Cesar Alierta Izuel /s/ Isidro Faine Casas
Cesar Alierta Izuel Isidro Faine Casas
/s/ Fernando de Almansa Moreno-Barreda /s/ Jesus Maria Cadenato Matia
Fernando de Almansa Moreno-Barreda Jesus Maria Cadenato Matia
/s/ Maximino Carpio Garcia /s/ Carlos Colomer Casellas
Maximino Carpio Garcia Carlos Colomer Casellas
/s/ Alfonso Ferrari Herrero /s/ Gonzalo Hinojosa Fernandez de Angulo
Alfonso Ferrari Herreo Gonzalo Hinojosa Fernandez de Angulo
/s/ Miguel Horta e Costa /s/ Luis Lada Diaz
Miguel Horta e Costa Luis Lada Diaz
/s/ Antonio Massanell Lavilla /s/ Mario E. Vazquez
Antonio Massanell Lavilla Mario E. Vazquez
/s/ Antonio Alonso Ureba /s/ Pablo Isla Alvarez de Tejera
Antonio Alonso Ureba Pablo Isla Alvarez de Tejera
/s/ Gregorio Villalabeitia Galarraga /s/ J. Antonio Fernandez Rivero
Gregorio Villalabeitia Galarraga J. Antonio Fernandez Rivero
/s/ Jesus Maria Cadenato Matia
Jose Fonollosa Garcia
--------------------------------------------------------------------------------
REPORT OF THE DIRECTORS OF
TERRA NETWORKS, S.A.
ON THE PLAN FOR THE MERGER BY ABSORPTION OF TERRA NETWORKS, S.A. INTO
TELEFONICA, S.A.
Madrid, April 12, 2005
TABLE OF CONTENTS
1. legal aspects of the merger
1.1 General characteristics
1.2 Applicable legislation
1.3 Selection of Telefonica as absorbing company
1.4 Legal procedure for the merger
1.4.1 Merger Plan and exchange ratio
1.4.2 Deposit of the Merger Plan
1.4.3 Report of an Independent expert
1.4.4 Report of the directors
1.4.5 Call of Shareholders' Meetings to deliberate and, if
appropriate, approve the merger
1.4.6 Publication of the merger resolutions and opposition
period for creditors
1.4.7 Deed of merger
1.4.8 Making the exchange
1.5 Procedure for exchanging the shares
1.6 Terra stock option plans
1.7 Bylaw amendments at the absorbing company
1.8 Administrative issues
1.9 Applicable tax regime
2. ECONOMIC Aspects
2.1 Strategic support for the merger
2.2 Merger balance sheets
2.3 Exchange ratio
2.4 Actual net worth of Terra and Telefonica
2.4.1 Actual net worth of Telefonica
2.4.2 Actual net worth of Terra
2.5 Valuation methods
2.5.1 Citigroup
2.5.2 Lehman Brothers
2.5.3 Reference to Tax Credit arising from the sale of Lycos
Inc. during fiscal year 2004
2.6 Comparison with the methods foreseen for de-listing
offers
2.7 Conclusions
This report was prepared by the Directors of Terra Networks, S.A. pursuant to
Article 237 of the Revised Spanish Corporations Law approved by Legislative
Royal Decree 1564/1989, of December 22 (the 'Corporations Law'), with a view to
explaining and supporting in detail, in compliance with the legislation in
force, the merger plan (the 'Plan' or the 'Merger Plan') of Terra Networks, S.A.
(the absorbed company, hereinafter 'Terra') and Telefonica, S.A. (the absorbing
company, hereinafter 'Telefonica'), deposited at the Madrid and Barcelona
Mercantile Registries on March 2 and 3, 2005, respectively.
1 LEGAL ASPECTS OF THE MERGER
1.1 General characteristics
In accordance with the provisions of the Plan, the terms of which are
deemed to be reproduced here as necessary, the projected merger will
consist of the absorption of Terra into Telefonica with the
extinguishment of the former, by dissolution without liquidation, and
the transfer en bloc of its assets and liabilities to the absorbing
company, which acquires, by universal succession, the right and
obligations of the absorbed company.
This universal transfer means that all the assets and liabilities making
up the absorbed company's net worth are acquired in a single act.
Accordingly, all the assets, right and obligations and, in general, all
the legal relationships of the absorbed company are transferred, which
relationships will remain in force despite the change in party, save in
those cases in which, at the wish of the parties or by statutory
provision, a change in party under the specific legal relationship gives
rise to the termination of such relationship.
The merger also means that the shareholders of the absorbed company are
simultaneously incorporated into the absorbing company through the
allotment to those shareholders of shares representing a part of the
absorbing company's capital stock in proportion to their respective
holdings in the capital stock of the absorbed company.
1.2 Applicable legislation
The basic corporate legislation on mergers is found in Articles 233
through 251 of the Corporations Law and in Articles 226 through 234 of
the Mercantile Registry Regulations.
1.3 Selection of Telefonica as absorbing company
Telefonica was selected as absorbing company due to its larger size and
stock market capitalization, its greater presence on the
telecommunications market and the fact that Telefonica owns 75.87% of
the capital stock of Terra.
1.4 Legal procedure for the merger
1.4.1 Merger Plan and exchange ratio
For a merger to be carried out, the Corporations Law requires the
Directors of the merging companies to prepare a merger plan.
In this connection, on February 23, 2005, all the Directors of Terra
and Telefonica (with the exceptions recorded in the Merger Plan
itself) approved and signed the Merger Plan.
The Merger Plan sets an exchange ratio, without any additional cash
payment, of two (2) Telefonica shares, each with a par value of one
euro (euro1), for every nine (9) Terra shares, each with a par
value of two euros (euro2).
1.4.2 Deposit of the Merger Plan
Pursuant to Article 226 of the Mercantile Registry Regulations, a
copy of the said Merger Plan was deposited at the Madrid and
Barcelona Mercantile Registries on March 2 and 3, 2005,
respectively.
The fact that the Merger Plan was deposited at the Madrid Mercantile
Registry was published in the Official Mercantile Registry Gazette
on March 14, 2005 and at the Barcelona Mercantile Registry in the
Official Mercantile Registry Gazette on March 29, 2005.
1.4.3 Report of an Independent expert
Likewise, pursuant to Article 236 of the Corporations Law, on
February 24, 2005 the Directors of each merging company asked the
Registrar of the Madrid Mercantile Registry, as the Registrar of the
registered office of the absorbing company, to appoint a single
independent expert on behalf of both companies to issue a report on
the Merger Plan.
On March 3, 2005, the Madrid Mercantile Registry appointed KPMG
Auditores, S.L. as independent expert to issue a single report on
the Merger Plan and the net worh contributed by the company which is
to be extinguished.
The aforesaid independent expert issued its report by the statutory
deadline, with the following conclusion:
'In accordance with the work performed, for the sole purpose of
complying with the provisions of Article 236 of the Revised
Corporations Law and having regard to section 4 above, we deem that:
• The valuation methods used by the Boards of Directors to
calculate the actual value of the Companies are suitable given
the context and the circumstances of the projected transaction,
and the exchange ratio stipulated in the Merger Plan is
justified.
• The net worth contributed by the absorbed company is at least
equal to the maximum amount of the capital increase at the
absorbing company provided for in the Merger Plan'.
1.4.4 Report of the directors
The Directors of Terra also approved and signed this Report on the
date hereof, with a view to explaining and supporting the legal and
economic aspects of Merger Plan in detail, with special reference to
the exchange ratio, all in compliance with Article 237 of the
Corporations Law.
1.4.5 Call of Shareholders' Meetings to deliberate and, if appropriate,
approve the merger
Once the foregoing requirements have been met, the management bodies
of the two companies will resolve to call their respective
Shareholders' Meetings with a view to deliberating and, should be
the case, approving the projected merger. It is foreseen that the
Shareholders' Meeting of Terra will be held on May 31, 2005, on
first and only call, and that the Shareholders' Meeting of
Telefonica, will be held on May 24, 2005, on first call, and on May
25, 2005, on second call.
Pursuant to Article 238 of the Corporations Law, when the call
notice for the Shareholders' Meeting is published, the following
documents will be made available to shareholders, debenture holders
and holders of special rights other than shares, as well as to
employee representatives, for inspection at the registered office:
a. Merger Plan;
b. Report of the independent expert on the Merger Plan;
c. Report of the Directors of Terra and of Telefonica on the
Merger Plan;
d. Annual accounts and management reports for the last three
fiscal years of Terra and Telefonica, with the related
auditors' report;
e. Merger balance sheets of Terra and of Telefonica, which
correspond to the last annual balance sheet of each company,
with the related auditors' report;
f. Current bylaws of Terra and at Telefonica;
g. List of first names, last names and ages, in the case of
individuals, or corporate name, in the case of legal
entities, and, in either case, the nationalities and
addresses of the Directors of Terra and of Telefonica, as
well as the date since which they have held office and, if
appropriate, the same details for those who are to be
proposed as Directors as a result of the merger.
Pursuant to Article 240.2 of the Corporations Law, shareholders,
debenture holders and holders of special rights other than shares
may, as from the date of publication of the call notice to the
respective Shareholders' Meetings, ask to have the foregoing
documents delivered or sent at no charge.
All of the foregoing documents will be accessible telematically as
from the date of the call notice, on the Terra website
(www.terranetworks.com).
1.4.6 Publication of the merger resolutions and opposition period for
creditors
Pursuant to Article 242 of the Corporations Law, the merger
resolution must be published three times in the Official Mercantile
Registry Gazette and once in two large circulation newspapers in
Madrid and Barcelona, respectively.
Following publication of these notices, which must state for the
record the right of shareholders and creditors of Telefonica and
Terra to obtain the full text of the merger resolutions and the
merger balance sheets, a one-month period will commence in
which the creditors of the merging companies may oppose the merger
until they obtain sufficient guarantee for their financial claims
not yet due at the time of publication, pursuant to Article 234 of
the Corporations Law.
1.4.7 Deed of merger
Following adoption of the relevant merger resolutions, publication
of the notices and lapsing of the statutory period without any
creditor having exercised his right to oppose the merger or, if
appropriate, after the financial claims of creditors who did
exercise their right have been satisfied or duly guaranteed, the
relevant deed of merger will be executed.
Prior to registration of the deed of merger, the Barcelona
Mercantile Registrar will record an entry in the deed stating that,
from the standpoint of the registry, there are no obstacles to
registration at the Madrid Mercantile Registry. Afterwards, said
deed of merger will be filed with the Madrid Mercantile Registry for
its registration, and the Barcelona Mercantile Registry will be
asked to cancel all the entries of Terra.
1.4.8 Making the exchange
After the deed of merger has been registered at the Madrid
Mercantile Registry, the shares of Terra will be exchanged for
shares of Telefonica on the terms stipulated in the Merger Plan and
described in the following section.
1.5 Procedure for exchanging the shares
The procedure for exchanging Terra shares for Telefonica shares is
described in section 5 of the Merger Plan.
Section 6 of the Merger Plan provides that, if necessary, Telefonica may
increase its capital stock by the necessary amount and issue the needed
number of shares to cover the exchange of Terra shares, according to the
exchange ratio stipulated in the Plan and with application of Article
249 of the Corporations Law. Section 6 also provides that the amount by
which capital is to be increased may be reduced by the delivery of
Telefonica treasury stock to the shareholders of Terra.
In accordance with the provisions of the Merger Plan, it is foreseen
that Telefonica will use only treasury stock to make the exchange of
shares under the merger and, accordingly, it will not be necessary for
Telefonica to issue new shares for the exchange.
In the light of the provisions of Article 249 of the Corporations Law
(the Terra treasury stock or Terra shares owned by Telefonica will not
be exchanged for Telefonica shares), in line with the exchange ratio
included in the Merger Plan (2 Telefonica shares for every 9 Terra
shares) and given that:
(i) the capital stock of Terra, currently represented by 574,941,513
shares, each with a par value of euro2, will not be modified until
the registration of the merger;
(ii) Telefonica currently owns 436,205,419 Terra shares
(representing 75.87% of its capital stock), and this holding will
not be modified, other than by the acquisition in the stock market
of 7 Terra shares, so that the number of Terra shares on the market
is a multiple of the exchange ratio, for the purpose of facilitating
the exchange; and
(iii) Terra has no more treasury stock than the 7,000,000 shares
referred to in section 5 of the Merger Plan and such treasury stock
will not be modified until the registration of the merger;
the maximum number of Terra shares exchanged will be 131,736,087 which
will require Telefonica to deliver up to a maximum of 29,274,686 shares
of treasury stock, which will be frozen as from the date of adoption of
the merger resolution.
Accordingly, after the merger has been resolved by the Annual
Shareholders' Meetings of Telefonica and Terra, and the merger
resolution has been registered at the Mercantile Registry, Telefonica
will make the exchange by delivering treasury stock to the shareholders
of Terra, according to the aforesaid exchange ratio. The exchange will
take place, as mentioned, after the deed of merger has been registered
at the Madrid Mercantile Registry and will be made by the financial
institution and during the period indicated in the notices to be
published in the Official Mercantile Registry Gazette and in two of the
large circulation newspapers in Madrid and Barcelona.
Terra shares will be exchanged for Telefonica shares through the
entities participating in Sociedad de Gestion de los Sistemas de
Registro, Compensacion y Liquidacion de Valores, S.A. (Securities
Registration, Clearing, and Settlement Systems Management Company, Inc.)
(IBERCLEAR) which are the custodians of the shares.
In accordance with section 5 (d) of the Merger Plan, shareholders of
Terra who own shares representing a fraction of the number of Terra
shares set in the exchange ratio may acquire or transfer shares with a
view to exchanging them pursuant to the exchange ratio. The relevant
decisions either to purchase or to sell Terra shares on the market in
order to attain a number of Terra shares that is a multiple of nine must
be made by each shareholder on an individual basis.
Notwithstanding the foregoing and under section 5 of the Merger Plan,
the Boards of Directors of Terra and Telefonica deemed it appropriate,
following the relevant conversations, to submit to the approval of their
respective Shareholders' Meetings a mechanism aimed at facilitating the
exchange in the case of shareholders of Terra who own a number of shares
that is not a multiple of nine (9). The terms and conditions of this
mechanism are as follows:
(i) Bearing in mind that the exchange ratio is equivalent, in
singular terms, to the delivery of one share of Telefonica for every
4.5 shares of Terra, at the close of the last stock market session
of Terra, each shareholder of Terra who, pursuant to said exchange
ratio, expressed in singular terms, of one share of Telefonica for
every 4.5 shares of Terra, is entitled to receive a whole number of
shares of Telefonica and has an excess fraction or a residue of
shares of Terra of less than 4.5, may transfer such fraction or
residue to such share fraction/residue acquirer as may be designated
for the purpose by Telefonica and Terra, all the foregoing on the
understanding that for the calculation of the fraction/residue
corresponding to each shareholder position it will be considered the
total number of shares of Terra forming such position.
Likewise, a shareholder of Terra who has a number of shares of Terra
that is less than 4.5 may transfer those shares to the share
fraction/residue acquirer.
It will be deemed that each shareholder of Terra accepts the share
fraction/residue acquisition system provided for herein, without
needing to send instructions to the relevant entity participating in
IBERCLEAR, which will inform the shareholder of the result of the
transaction after completion.
(ii) Having regard to the exchange ratio resolved, it is stated
for the record that, regardless of the number of shares making up
each shareholder position, the only situations in which a fraction/
residue can be acquired are as follows:
Number of Terra shares Corresponding number of Fraction/residue of Terra
shares of Telefonica by shares subject to fraction/
virtue of exchange residue acquisition system
1 0 1
2 0 2
3 0 3
4 0 4
5 1 0.5
6 1 1.5
7 1 2.5
8 1 3.5
9 2 0
Consequently, in any shareholder position, if there is a fraction/
residue, it will range from a minimum of 0.5 Terra shares to a
maximum of 4 Terra shares.
(iii) The fraction/residue acquisition price will be set pursuant to
the arithmetic mean of the average weighted prices of Terra shares
on the Spanish Unified Computerized Trading System (Continuous
Market) for Terra's last three stock market sessions.
If the fraction/residue in question is one share of Terra, its
purchase price will be the arithmetic mean of the average weighted
prices of Terra shares on the Spanish Unified Computerized Trading
System (Continuous Market) for the last three stock market sessions
of Terra; by analogy, if the fraction/residue is not one share, its
acquisition price will be calculated using the same criterion as
that resolved herein, but in due proportion to the specific amount
of the fraction/residue.
(iv) The entity designated as the share fraction/residue acquirer
will, acting in its own name and behalf, acquire any excess share
fraction or residue in the positions existing at the close of the
last stock market session of Terra. The shares or fractions of
shares of Terra acquired by the acquirer will be exchanged for the
appropriate number of shares of Telefonica pursuant to the exchange
ratio approved above.
1.6 Terra stock option plans
According to the provisions of the Merger plan, Telefonica will succeed
Terra as obligor under the Terra stock option plans. Those plans are:
(i) the Terra stock option plan approved at the General Shareholders'
Meeting of Terra held on October 1, 1999, as amended by resolutions
approved at the General Shareholders' Meetings held on June 8, 2000 and
on June 7, 2001 and as implemented by the Board of Directors of Terra,
and (ii) stock option plans resulting from the assumption by Terra of
the Lycos Inc. stock option plans approved at the General Shareholders'
Meeting of Terra held on June 8, 2000, amended by the General
Shareholders' Meeting held on June 7, 2001, and implemented by the Board
of Directors.
Therefore, following the registration of the merger, Telefonica will
succeed Terra as obligor under those plans. Terra stock option rights
will be automatically converted into Telefonica stock option rights, on
the terms resulting from the exchange ratio set in the Merger Plan. All
reference to Terra or, as the case may be, to Lycos Inc. or to Lycos
Virginia, in the stock option plans will be deemed made to Telefonica as
from the date of registration of the merger.
In order not to harm the interests of the beneficiaries of those plans,
Telefonica will, if necessary, establish mechanisms that ensure due
regard to the commitments given by Terra in relation to said stock
option plans.
1.7 Bylaw amendments at the absorbing company
No bylaw amendments will be made at the absorbing company as a result of
the merger.
It is placed on record that, nevertheless, Telefonica intends to reduce
its share capital to redeem treasury stock in accordance with Program
TIES.
1.8 Administrative issues
Lastly, section 15 of the Merger Plan indicates that the effectiveness
of the projected merger is subject to the service of the notices and to
the obtainment of the authorizations and registrations required in Spain
and in the other jurisdictions in which the two companies are present.
It is not expected to be any further need to apply for or obtain
authorizations or registrations in Spain, or in the other jurisdictions
in which the two companies are present, for the effectiveness of the
merger, except for the registration of a form named F-4 that has
been submitted by Telefonica to the Securities and Exchange Commission
of the United States of America. The submission of such form and its
content was reported to the Spanish Securities Market Commission by
means of a Relevant Fact.
1.9 Applicable tax regime
The conditions required by the Revised Corporate Income Tax Law,
approved by Legislative Royal Decree 4/2004 are met and, accordingly,
the projected merger qualifies for the special tax regime set forth in
Title VII, Chapter VIII and in additional provision two of the Revised
Corporate Income Tax Law.
In this connection, pursuant to the Merger Plan, a proposal will be
submitted to the Shareholders' Meeting to adopt a resolution to submit
the merger to the special tax regime indicated above.
2 ECONOMIC ASPECTS
2.1 Strategic support for the merger
As explained in the Merger Plan, the strategic support for the
transaction is based on the fact that Terra, like many other Internet
companies, has evolved within the context of a strategic model based on
a separation between the telecommunications business and the Internet
service provider (ISP) business. Notwithstanding other previous
circumstances, it has recently (more specifically, during the last
twelve months) become manifestly obvious, in a clear and distinct
manner, that an irreversible crisis is affecting the traditional model
of the pure Internet service provider, and that, at the same time, a new
model based on the operational integration of the telephone and Internet
businesses has appeared in the telecommunications market.
The root of these changes lies in the emergence, development, and
blossoming of broadband technology applied to Internet access, which has
led to the blurring - especially in the last year, during which its
penetration and growth have accelerated exponentially - of the
traditional boundary between the above-mentioned businesses.
• The explosion of broadband technology has, in fact, created a new
dynamic in the supply market, with which synchronization can only be
obtained based on a complete interweaving of the network functions
and the provision of services, or, put another way, the integrated
management of the connectivity, access, and service layers. In this
scenario, Internet access providers need to become communications
operations in order to compete in the market. Therefore, they must
either invest in network infrastructure (which could compromise
their viability, given the time required for the maturation of the
investment and the high capital cost of addressing it), or else
become fully integrated with network operators, who already have the
necessary infrastructure and technical and human resources.
• Moreover, on the demand side, today's customer is not content with
Internet access alone. Users' preferences are becoming increasingly
oriented toward integrated offerings (voice, images, Internet
access, etc.), for which it is necessary to hold a position as
operators who can offer all of the services that the market demands,
and thereby compete with other entities that are able to provide all
of these services to the end customer.
• In addition, the technological evolution of the services - the
rapid increase in connection speeds, the technical complexity needed
to provide high-quality audiovisual content, the required
interoperability of the various elements of the offering (e-
mail, messaging, voicemail, content consumption, etc.) - demands
increasingly greater capabilities, scale, and resources in order to
stay competitive in a market that is growing in size but whose
offerings are constantly changing.
All of this explains the activities of the competing groups aimed at
making bandwidth the center or core of their strategy, and,
consequently, at combining the telephone and Internet businesses. The
most recent examples are the mergers of France Telecom and its Internet
subsidiary Wanadoo, and of Deutsche Telekom and T-Online, the
latter of which is about to be completed.
The proposed merger of Telefonica and Terra set forth in the Merger Plan
obeys the same logic.
At this respect, the Boards of Directors of both companies have
considered, in fact, that this path must be taken in order to have any
guarantee of success in dealing with the challenges posed by the
development of the industry, technological change, and customers' new
needs. It is thus intended to create a customer-oriented
business segment able to offer customers integrated solutions within the
telecommunications market.
Therefore, the merger is viewed as a strategic imperative of the highest
order, and as an outstanding opportunity for mutual advantage. The
shareholders of both Terra and Telefonica will benefit from it.
Following the content of the Merger Plan, trying to summarize the most
essential aspects, it can be stated that the integration of the
businesses resulting from the merger will make it possible:
a. to strengthen the competitive positioning of Terra and Telefonica in
the above-referenced markets, which will translate into an
increase in customers and an expanded market share. This is the case
because of (i) the increased capacity of the unified firm to respond
to the integrated offerings of competitors; (ii) the improved
position for creating new services that optimize the use of
Telefonica's network capabilities (which is critical for services
with a need for greater bandwidth, greater security, etc.) and that
integrate them fully into the service provided to the end customer;
(iii) the strengthening of the offering made to the market,
combining the positive attributes of the Telefonica and Terra brand
names, which in turn will make it possible to strengthen the
leadership of the combined company; (iv) the greater scale of
operations, which will make it possible to undertake innovative
projects that would now be more difficult to undertake; and (v) the
greater leveraging of the commercial resources of the two companies,
e.g., proprietary channels, third-party channels, joint
advertising, etc.;
b. to make better use of current customer bases, through (i) the ability
to define and implement a global strategy based on customer
segments, beyond the current product-based vision; (ii)
increased penetration; (iii) an increase in the loyalty of existing
customers, by reducing churn rates through the packaged sale of
services; (iv) increased cross-sales of services; and (v)
the resulting increase in per-customer earnings;
c. to minimize costs and optimize investments, through (i) the
integrated management of networks and platforms (provision of
services, billing, CRM/customer service, etc.), with the additional
benefit of greater quality for the end customer, through end
-to-end management; (ii) the rationalization of
investments that are particularly relevant, given the growing needs
for an ability to manage new services that are broadband intensive;
(iii) the total elimination of duplication in the development of new
services; (iv) the streamlining of corporate structures, eliminating
duplications and thereby improving management and increasing
efficiency; and (v) an increased ability to achieve synergies in the
purchases of contents and services;
d. to facilitate the exploitation of the opportunities for growth in new
markets, using broadband Internet access as an offering that is more
attractive and competitive than fixed-base
telecommunications (a factor that is particularly relevant in terms
of the expansion of the Brazilian market);
e. to develop a single strategy of promoting and creating businesses in
the e-commerce field and general gateways for access to
information and advertising, as a result of the major growth of
broadband Internet access in all markets.
2.2 Merger balance sheets
Pursuant to Article 239.1 of the Corporations Law, the annual balance
sheets of Terra and Telefonica as of December 31 2004 will be used as
the merger balance sheets. Those balance sheets were verified by the
merging companies' auditors.
It is stated for the record that between the date of the Merger Plan and
the date of this Report, there have been no significant changes in the
net worth of Terra or in that of Telefonica.
2.3 Exchange ratio
The exchange ratio proposed in the Merger Plan, which was calculated on
the basis of the actual net worth of Telefonica and Terra, will be as
follows, without any additional cash payment: two (2) shares of
Telefonica, each with a par value of one euro (euro1), for every nine
(9) Terra shares, each with a par value of two euros (euro2).
The exchange ratio was calculated having regard to the following
dividends that Telefonica and Terra plan to distribute, as referred to
in section 8 of the Merger plan:
i. As a result of the negotiation with Telefonica of the terms of the
merger on market conditions, Terra will pay a dividend of euro0.60
per share with a charge to the 'Additional Paid-in Capital
Reserve' account. The proposed distribution was resolved by Terra's
Board of Directors at its meeting on February 23, 2005 and will be
submitted for approval by the Shareholders' Meeting to be called to
resolve on the merger. In any event, this dividend is to be paid
prior to registration of the merger of Telefonica and Terra at the
Mercantile Registry. Only Terra shareholders will benefit from this
distribution.
ii. By Telefonica:
a. Payment on May 13, 2005, of an interim dividend for the year
ended December 31, 2004. This dividend was announced by the
Board of Directors at its meeting on January 26, 2005, and was
establish as a fixed amount of euro0.23 per share. Terra
shareholders who become Telefonica shareholders as a result of
the merger will not benefit from this dividend.
b. The distribution of Telefonica treasury stock, in a ratio of one
share of treasury stock for every twenty-five shares
held by the shareholder, with a charge to the additional paid
-in capital reserve. The proposed distribution was
resolved by the Board of Directors at its meeting on November
24, 2004, and will be submitted for approval by the Annual
Shareholders' Meeting of Telefonica. Because the shares are to
be delivered on June 28, 2005 and, in any case, before the
merger of Telefonica and Terra is registered at the Mercantile
Registry, Terra shareholders who become Telefonica shareholders
as a result of the merger will not benefit from this dividend.
c. The payment of a dividend with a charge to the additional paid
-in capital reserve to be made on November 11, 2005,
provided that the merger deed has been registered at the Madrid
Mercantile Registry before then. If the merger is registered at
the Mercantile Registry after that date, the dividend will be
paid on the sixth stock exchange business day after the date of
registration. The proposed dividend was announced by
Telefonica's Board of Directors at its meeting on November 24,
2004, and will be submitted for approval by the Annual
Shareholders' Meeting of Telefonica. The fixed amount of the
dividend is euro0.27 per share. Unlike the provisions for
dividends described above in subsections (a) and (b), this
dividend will be received by both Telefonica shareholders and
the Terra shareholders who become Telefonica shareholders as a
result of the merger.
2.4 Actual net worth of Terra and Telefonica
2.4.1 Actual net worth of Telefonica
In the case of Telefonica, the valuation by the Board of Terra was
based on the company's market price. This valuation method is
justified by the high liquidity of the Telefonica share.
The application of this method results in the allocation to
Telefonica of an actual value of euro66,361 million, which was
then used to set the exchange ratio. As mentioned, this amount was
calculated having regard to the market price of Telefonica at the
close of the stock market session on February 21, 2005 (euro14.19
per share), discounting a total of euro0.80 per share for the
dividends that Telefonica plans to distribute prior to registration
of the merger, which entails a value of euro13.39 per share. The
foregoing figure (euro66,361 million) is the result of multiplying
the price per share by the total number of Telefonica shares (4,956
million).
2.4.2 Actual net worth of Terra
In the initial proposal of Telefonica, the implied actual value of
Terra amounted to euro1,690 million, equal to euro2.98 per
share.
With a view to comparing the reasonableness of this implied value,
the investment banks advising Terra on the transaction, Citigroup
Global Markets Limited ('Citigroup') and Lehman Brothers Europe
Limited ('Lehman Brothers') performed a valuation analysis of
Telefonica and Terra, in the latter case primarily using a
methodology involving a sum-of-the-parts
discounted cash flow analysis for operating assets, according to
section 2.5 below.
In the light of these valuations, Terra negotiated with Telefonica
and Telefonica agreed to allow Terra to distribute an anticipated
dividend of euro0.60 per share prior to the merger, which entails
a total amount of approximately euro337 million.
Once this amount is discounted, the actual values of Terra
considered by the Board of Directors of Terra are lower than euro
1,690 million, the implied premium in the exchange ratio ranging
between approximately 10% and 15%.
2.5 Valuation methods
Terra contracted the services of Citigroup and of Lehman Brothers as
financial advisors for the merger and to assist Terra with the valuation
process of Terra and Telefonica (collectively, the 'Companies') and
Terra's determination and justification of the exchange ratio proposed
for the merger.
On February 23, 2005, the two advisors issued fairness opinions relating
to the merger, addressed to the Board of Directors of Terra. In those
opinions they concluded that, on the basis of and subject to the
provisions of said documents, the exchange ratio of the merger, taking
into account the anticipated dividend of euro0.60 per share to be
distributed by Terra to its shareholders pursuant to the Merger Plan, is
fair from a financial point of view for the Terra shareholders other
than Telefonica. It is also stated for the record that Morgan Stanley &
Co. Limited, as financial advisor of Telefonica for this transaction,
expressed its fairness opinion to the Board of Directors of Telefonica,
stating that the exchange ratio agreed is fair for Telefonica
shareholders.
Based on the advice of both advisors, Terra performed the relevant
evaluation of the Companies and, on the basis thereof and after
negotiating with Telefonica on market conditions, it decided on the
economic terms of the merger set forth in the Merger Plan. At this
regard, it is stated for the record that the anticipated dividend of &
euro;0.60 per share to be distributed by Terra to its shareholders prior
to the merger was not initially included in the merger proposal of
Telefonica and is the result of such negotiation.
Citigroup and Lehman Brothers performed various valuation analyses of
the Companies as a basis for the preparation of their respective
fairness opinions. The following sections 2.5.1 and 2.5.2 are a summary
of each of the material analyses performed by each of the aforesaid
advisors.
2.5.1 Citigroup
The following is a summary of the main financial analyses performed
by Citigroup as a basis for the preparation of its fairness opinion.
For this purpose, Citigroup took into account, among other factors,
the proposed dividend of euro0.23 per Telefonica share in respect
of 2004 and the proposed distribution by Telefonica of one
Telefonica share for every 25 Telefonica shares, in which Terra
shareholders will not participate, and the proposed dividend of &
euro;0.60 per Terra share to be paid by Terra to all Terra
shareholders.
A) Past Share Price Performance
Citigroup reviewed the relationship between movements in prices
of Terra shares and Telefonica shares and the implied offer
price for the merger for the period between July 25, 2003 (the
date on which Telefonica officially announced to the CNMV the
number of Terra shares it acquired in the tender offer) and
February 11, 2005 (the last trading day before Telefonica
publicly announced its intention to make an offer for a merger
with Terra).
The implied offer price for the merger was calculated by
multiplying the adjusted Telefonica share price by the exchange
ratio of 2/9 and then adding euro0.60 for the effect of the
anticipated dividend on Terra shares to be paid before
consummation of the merger.
The adjusted Telefonica share price was calculated by
subtracting the anticipated cash dividend of euro0.23 from the
Telefonica unadjusted share price and then adjusting the result
for the anticipated stock dividend on Telefonica shares of one
share for every 25 outstanding shares, in which cash and stock
dividends Terra shareholders will not participate.
Citigroup also adjusted the Terra share price for the euro2.00
cash dividend per Terra ordinary share paid in July 2004 in the
period prior to the payment of such dividend.
In addition, Citigroup compared the implied offer price with the
trading price of a Terra share on February 11, 2005 (the last
trading day prior to the public announcement of Telefonica's
intention to make an offer) and the one, three and six-
month trailing averages in the period prior and up to February
21, 2005, in the case of Telefonica, and up to February 11,
2005, in the case of Terra.
The following table sets forth the results of this analysis:
Terra Networks Implied Offer Premium
Ordinary Share Price Price (euro)
(euro)
February 11, 2005 3.19 3.58 12%
Last Month Trailing Average 3.11 3.56 14%
Last 3 Month Trailing Average 2.96 3.49 18%
Last 6 Month Trailing Average 2.90 3.35 16%
B) Precedent Transactions Analysis
Noting that Telefonica currently controls Terra, Citigroup
compared the premium that the implied offer price for the merger
represented over the price on the last trading day before the
announcement and the three and six month trailing averages
thereof with the premium on similar last trading days and for
similar trailing periods represented by:
• the cash consideration for four recent de-listing
tender offers by Spanish companies;
• the consideration in three recent mergers involving
significant shareholders (owning less than half of the
equity) of Spanish companies acquiring the remainder of the
equity of those companies; and
• the consideration for two recent offers by controlling
shareholders (owning in excess of half of the equity) of
European internet service providers to acquire the remainder
of the equity of those companies.
The precedent transactions considered by Citigroup Global
Markets Limited were the following:
Spanish De-Listing Offers
Date Announced Company
April 22, 2002 Hidroelectrica del Cantabrico
December 9, 2003 Aceralia Corporacion Siderurgica SA
May 31, 2004 Centros Comerciales Carrefour SA
June 4, 2004 Cementos Molins SA
Spanish Significant Shareholder Mergers
Date Announced Acquirer Target
April 16, 2002 FCC Portland Valderrivas
July 1, 2003 ACS Grupo Dragados
August 1, 2003 Metrovacesa Bami
Offers by Controlling Shareholders of European ISPs
Date Announced Acquirer Target
February 23, 2004 France Telecom Wanadoo
October 9, 2004 Deutsche Telekom T-Online
With respect to the financial information for the foregoing
transactions and the companies involved therein, Citigroup
relied on information available in public documents. The
following table summarizes the median premium (discount) offered
in these transactions over the price on the last trading day
before announcement and the three- and six-month
trailing averages thereof and, in the far right column, sets
forth for comparative purposes the same information for the
implied offer price in the proposed merger between Terra
Networks and Telefonica:
Period Median Spanish Median Spanish Merger Median European ISP Implied Offer Price
De- Consideration Premium Premium Premium For
Listing Offer Proposed Merger
Premium
(Discount)
1 day (2.2)% 9.3% 8.6% 12%
3 month 2.7% 2.4% 17.3% 18%
6 month 7.0% 7.0% 19.0% 16%
Citigroup observed that none of the foregoing transactions was
identical to the proposed merger of Terra and Telefonica.
C) Terra Networks Valuation
Discounted Cash Flow Analysis
Citigroup's primary methodology for reviewing the value of Terra
was a sum-of-the-parts discounted cash
flow analysis for each of Terra's individual operating assets
and certain non-operating assets.
Citigroup applied country-specific discount rates based
on weighted average cost of capital assumptions to calculate the
net present value of Terra's management's forecasted free cash
flows from its operating assets, the benefits of future tax
savings relating to net operating losses and payments to be
received by Terra under its strategic alliance agreement with
Telefonica. Citigroup applied greater discount rates, however,
to calculate the net present value of a potential additional tax
credit resulting from the August 2, 2004 sale by Terra of Lycos
Inc. as Terra's ability to realize value from this contingent
asset is speculative and difficult to predict.
Citigroup then adjusted the value of Terra to reflect Terra's
net cash (including amounts due from Telefonica under tax
sharing arrangements) and other non-operating assets
(including investments in unconsolidated and other non-
wholly owned affiliates and anticipated proceeds from
dispositions).
The result of this sum-of-the-parts
discounted cash flow analysis was an implied value per Terra
share of euro2.90 to euro3.71.
Comparable Companies Analysis
Using publicly available information, Citigroup reviewed the
relative share price performance from July 2003 to February 2005
of Terra and the following five publicly held European internet
service providers, as well as a market-weighted index
comprised of such companies:
• freenet.de
• Iliad
• Telecom Italia Media
• Tiscali
• United Internet
Citigroup also compared the listed companies' multiples of firm
value (equal to equity value plus straight debt, minority
interest, straight preferred stock, all out-of-
the-money convertibles, less investments in
unconsolidated affiliates and cash) to forecasted revenues,
gross profit and EBITDA for 2005 - 2007 with such
multiples for Terra.
Citigroup then calculated a range of illustrative valuations for
Terra's operating assets by applying deviations of plus or minus
10% from the medians of such multiples for the comparable
companies to Terra's management's forecasts and then adding
Terra's net cash and other non-operating assets valued
in a manner consistent with the methodology employed in the
analysis described above under the heading '-Discounted Cash
Flow Analysis'.
The result of this comparable companies analysis was an implied
value per Terra share of euro2.73 to euro3.77.
Citigroup observed that none of the selected companies was
identical to Terra. In particular, Citigroup noted that Terra's
relatively lower expected 2005-2007 profitability would
suggest a valuation of Terra toward the lower end of the
valuation range.
Research Analyst Target Prices
Citigroup reviewed research analysts' target prices for Terra
shares published between July 1, 2004 (after adjusting for the &
euro;2.00 cash dividend per Terra share paid in July 2004) and
February 15, 2005.
The range of these target prices (excluding the highest and
lowest values) was from euro2.80 to euro3.17.
D) Telefonica Valuation
Citigroup was not provided with any non-publicly
available business or financial information, including financial
forecasts, for Telefonica and Citigroup had no access to
Telefonica's management. This limited the valuation analyses
with respect to Telefonica that were available to Citigroup.
Citigroup reviewed the value of Telefonica using a sum-
of-the-parts analysis that used various
valuation methodologies for Telefonica's primary operating
assets, including trading comparables and market value, and then
adjusted for overhead costs, non-operating assets and
liabilities and minority interests.
For Telefonica's principal operating assets-Telefonica Moviles,
the fixed-line Spanish telecommunications business and
Telefonica International-which collectively represent the
substantial majority of Telefonica's firm value, Citigroup's
primary valuation methodology was based on a comparable
companies analysis. Citigroup compared Telefonica Moviles to
Telecom Italia Mobile and Vodafone and its market value; for the
Spanish fixed-line business, to British Telecom; and for
Telefonica International, to Telmex, Telesp, Brasil Telecom and
Tele Norte Leste.
The result of this analysis was an implied value in the range of
euro13.36 to euro16.39 per Telefonica share, as compared to
a market price of euro14.19 per Telefonica share as of
February 21, 2005.
Citigroup also reviewed research analysts' target prices for
Telefonica shares published between June 18, 2004 and February
11, 2005. The range of these target prices (excluding the three
highest and the three lowest values) was from euro13.50 to &
euro;16.50.
2.5.2 Lehman Brothers
The following is a summary of the main financial analysis used by
Lehman Brothers as the basis for the issue of its fairness opinion
to the Board of Directors of Terra.
To this effect, Lehman Brothers took into account, among other
factors, the proposed dividend of euro0.23 per Telefonica share in
respect of 2004 and the proposed distribution by Telefonica of one
Telefonica share for every 25 Telefonica shares, in which Terra
shareholders will not participate, and the proposed dividend of &
euro;0.60 per Terra share to be paid by Terra to all Terra
shareholders.
A) Terra valuation
Sum-of-the-Parts Analysis
Lehman Brothers reviewed the stand-alone valuation of
Terra Networks on the basis of a sum-of-the
-parts approach, utilizing different valuation
methodologies depending on the type of asset.
For Terra's cash position, Lehman Brothers used book value as of
December 31, 2004. For financial investments and interest in
other companies, Lehman Brothers used market value, option value
or net present value of future proceeds from the sale of
interests subject to an offer or a commitment to buy from a
third party.
For the strategic alliance contract between Terra and Telefonica
and Terra's joint venture interests, operating assets and tax
credits, Lehman Brothers used discounted cash flow valuation,
pursuant to which forecasted free cash flows attributable to
such assets were discounted to net present value by weighted
cost of capital rates.
In addition to being valued on a discounted cash flow basis, as
a supplemental comparison, Terra's Spanish operating assets were
also valued by using a comparable companies approach, pursuant
to which multiples derived from implied values from transactions
involving companies in comparable businesses and from EBITDA and
revenue of comparable companies were applied to Terra's Spanish
access business and its other Spanish business. Multiples
derived from subscriber acquisition costs and gross margins of
companies in comparable businesses were also applied to Terra's
Spanish access business.
The result of Lehman Brother's sum-of-the
-parts analysis was an implied value per Terra Networks
ordinary share of euro3.18.
Other Value Sources
Lehman Brothers has also analyzed other potential sources of
value or loss of value not included in the sum-of
-the parts analysis like potential synergies, loss of
past tax credits and the potential ability to realize value from
a tax asset relating to Terra's sale of Lycos Inc.
Accordingly, Lehman Brothers calculated an adjustment to its sum
-of-the-parts implied value per Terra
share described above to take into account an estimate of the
aggregate impact of these other potential effects on value to
arrive at an adjusted merger value per Terra share of euro
3.57.
Comparable Companies Analysis
Lehman Brothers compared Terra as a whole against the following
eight other companies:
• easynet
• freenet.de
• Iliad
• TI Media
• T-Online
• Tiscali
• United Internet
• Web.de
Lehman Brothers applied the average multiple of the listed
companies' enterprise values to forecasted EBITDA for each of
2005 and 2006 to Terra's forecasted EBITDA for such years to
calculate implied firm values for Terra, and then made
adjustments to such firm values for other assets and
liabilities.
The results of this analysis were implied equity values of &
euro;3.05 and euro3.18 per Terra share based on Terra's
forecasted EBITDA for 2005 and 2006, respectively.
Lehman Brothers noted that, while the review of comparable
companies served as comparative information, due to the
different profitability and risk profile of Terra, the
comparable companies analysis should not be deemed a meaningful
valuation methodology.
Broker Views
Lehman Brothers also reviewed brokers' target prices for Terra
shares in reports published between April 2004 and February 8,
2005. Lehman Brothers adjusted two of the target prices
published in April 2004 for the euro2.00 dividend on Terra
Networks ordinary shares paid in July 2004.
The average of these target prices was euro3.00 and the median
was euro3.00.
B) Telefonica Valuation
Lehman Brothers was not provided with any non-publicly
available business or financial information, including financial
forecasts, for Telefonica. Therefore, Lehman Brothers analyzed
Telefonica's valuation using a market-based approach.
This method is supported by the share's high liquidity.
Broker Views
Lehman Brothers reviewed brokers' target prices for Telefonica
in reports published between November 11, 2004 and February 21,
2005.
The average of these target prices was euro14.92 and the
median was euro14.55.
Past Share Price Performance
Lehman Brothers reviewed the past share price performance and
trading volumes of Telefonica shares from May 25, 2003 (the
launch date of Telefonica's 2003 tender offer for Terra shares)
through to February 14, 2005( the date that Telefonica announced
its intention to make an offer for a merger with Terra).
Lehman Brothers also calculated the average market price of
Telefonica shares for the one-month, six-month
and one-year periods prior to February 14, 2005 and for
the period from May 25, 2003 to February 14, 2005. The following
table sets forth the results of this analysis:
Period Average Share
Price (euro)
1 month 14.02
6 months 13.05
1 year 12.67
Since Launch of Tender
Offer on May 28, 2003 11.52
C) Relative Valuation
Lehman Brothers performed a relative analysis of the past share
price performance by comparing market prices of Terra shares (as
adjusted for a dividend payment of euro2.00 per share on July
29, 2004) to market prices of Telefonica shares during the
period between May 28, 2003 and February 1, 2005. Lehman
Brothers also calculated the average ratio of the market price
of a Telefonica share to the adjusted price of a Terra share for
the month of January 2005, the six-month period of
August 2004 through January 2005, the one-year period of
February 2004 through January 2005 and for the period between
May 25, 2003 and January 4, 2005.
The following table sets forth the results of this analysis:
Period Average Ratio
1 month 4.49:1
6 months 4.45:1
1 year 4.30:1
Since Launch of Tender
Offer on May 28, 2003 4.02:1
Lehman Brothers Europe Limited noted that the ratios set forth
in the above table were not adjusted to include the effect of
the anticipated cash dividend of euro0.60 to be paid to Terra
shareholders prior to consummation of the merger.
D) Public Market Valuation of Consideration
Lehman Brothers Europe Limited analyzed the implied offer price
for the proposed merger based on the exchange ratio of 4.5:1,
the high and low market prices for Telefonica shares during the
one month period prior to February 22, 2005 and the market price
on such date, and adding the effect of the euro0.60
anticipated dividend on Terra shares.
The results of this analysis are set forth in the table below:
Low High As of February
22, 2005
Implied Terra Networks Share Price in Offer(euro) 3.59 3.84 3.69
Lehman Brothers observed that the range of the implied offer
price set forth in the table above is greater than the adjusted
merger value of euro3.57 per Terra Networks ordinary share
mentioned above under the heading '-Terra Networks Valuation -
Other Value Effects'.
2.5.3 Reference to Tax Credit arising from the sale of Lycos Inc. during
fiscal year 2004
As set forth in Terra's report corresponding to its annual financial
statements for fiscal year 2004, Terra has recognized a tax credit
in the amount of euro272 million, which is the result of
multiplying the applicable tax rate by the difference between the
sale price of Lycos Inc. shares and the value with which the capital
increase used to acquire this company was accounted for, less
corrections that were already deductible for tax purposes prior to
the sale.
Such report also notes that the possibility of showing a greater
negative tax basis for fiscal year 2004, in the amount of up to
7.418 billion Euros, as a result of applying the tax acquisition
value resulting from taking the market value of Lycos shares that
were received, instead of the book value with which they were
recorded in application of the provisions of Section 159 of the
Corporations Act. Notwithstanding the foregoing, given the contrary
position stated by the Spanish Revenue Service in response to tax
questions in similar cases, and current uncertainties regarding the
final decision that it might adopt, as of the date of preparation of
the annual financial statements, no accounting effect whatsoever was
taken into account with respect thereto. Despite the fact that the
above-mentioned legal difficulties put the effectiveness of
such tax credits into question, and that in the best of cases under
the current situation, there will probably be a long time before
recovery thereof, according to the advice received, a value of
approximately euro0.40 per share of Terra has been attributed
thereto by the Board of Directors of Terra.
2.6 Comparison with the methods foreseen for de-listing offers
Merely as an indication, the Directors of Terra asked their financial
advisor, Lehman Brothers, to calculate each of the Terra values that
would result from applying the methods stipulated in Article 7.3 of
Royal Decree 1197/1991, having regard to the dividend of euro0.60 per
share Terra plans to pay its shareholders prior to registration of the
merger.
This analysis produced the following values:
•
Underlying book value of Terra: euro2.31 per share (as of
December 31, 2004).
• Liquidation value of Terra: euro2.28 per share.
• Average market price of Terra during the six-month
period prior to February 14, 2005 (weighted average): euro2.30
per share.
•
Price of previously offered consideration, if any tender offer
had been made in the preceding year. No tender offer had been
made for Terra in the preceding year. Nonetheless, Terra was the
subject of a tender offer by Telefonica in May 2003 at a price
of euro5.25 per share. Adjusting the price by the euro2
anticipated dividend distributed by Terra to its shareholders
between that date and the current time, and by the euro0.60
anticipated dividend it plans to distribute before carrying out
the merger, the comparable price would be euro2.65 per share.
Consequently, the implied value of the Terra share in the merger (euro
2.98 per share) is higher than the highest price resulting from the
application of the methods provided for in Article 7.3 of Royal Decree
1197/1991, adjusted by the euro0.60 dividend per share to be
distributed by Terra.
2.7 Conclusions
In the light of the foregoing, the Directors of Terra conclude:
• that the merger examined in this Report is highly advisable for
both merging companies and their shareholders, since the merger will
permit the integration of the telephone and Internet businesses and
thus enable the two companies to deal successfully with the
challenges posed by the development of the industry, technological
change and customers' new needs; and
• that the exchange ratio was calculated on the basis of the actual
values of the two merging Companies; and that the exchange ratio is
deemed fair for the shareholders of Terra other than its majority
shareholder, Telefonica, as confirmed by the financial advisors.
* * *
On the basis of the foregoing considerations, repeating where necessary the
content of the Merger Plan, in accordance with the provisions of article 237 of
the Corporations Law, the Directors of Terra Networks, with the qualifications
indicated below, approve and sign this Report on the Plan for the merger by
absorption of Terra Networks, S.A. into Telefonica, S.A.
* * *
Madrid, April 12, 2005.
/s/ Joaquin Faura Battle /s/ Francisco Moreno de Alboran y Viena
Mr. Joaquin Faura Battle Mr. Francisco Moreno de Alboran y de Vierna
/s/ Alfonso Merry del Val Gracie /s/Carlos Fernandez-Prida Mendez-
Nunez
Mr. Alfonso Merry del Val Gracie
Mr. Carlos Fernandez-Prida Mendez-
Nunez
/s/ Luis Badia Almirall
Mr. Luis Badia Almirall
It is noted for the record that (i) all the Directors appointed as per
indication of Telefonica, S.A., that is, Mr. J. Alfonso Bustamante Bustamante,
Mr. Enrique Used Aznar and Mr. Fernando Labad Sasiain have abstained from
attending and participating in the deliberations of the Board of Directors of
Terra Networks, S.A. on this Report and, consequently, have not signed it,
because it was believed that they are subject to a potential conflict of
interest; and (ii) that D. Luis Bassat Coen has also abstained from
participating in the deliberations in relation to it, because it was believed
that he is subject to a potential conflict of interest, and for this reason his
has not signed this report either.
--------------------------------------------------------------------------------
MORE TO FOLLOW
This information is provided by RNS
The company news service from the London Stock Exchange
MSCIAMLTMMABMMA
Latest directors dealings
- 7 hours ago Marlowe
- 7 hours ago Haleon
- 7 hours ago TUI AG Reg Shs (DI)
- 7 hours ago Georgia Capital
- 7 hours ago Weir Group