Europe's largest telecoms company, Telefonica (TEF.MC), announced a bigger than expected dividend on Friday despite a major planned acquisition, with an upbeat business outlook justifying its open-handedness in the downturn.

The Spanish operator, which made a 6.5 billion reais ($3.7 billion) bid for Brazilian peer GVT (GVTT3.SA) this week, also forecast 1-4 percent annual revenue growth from 2008-12, and a rise in operating income of 4-7 percent a year. 

Although it seemed difficult for Telefonica to surprise the market at this stage, they have done it again with these forecast which are clearly above expectations, Juan Tuesta, analyst at brokerage Banesto, said.

Latin America is expected to continue powering Telefonica forward, with mobile accesses alone expected to increase by up to 140 million by 2012 as the region's population gets richer. 

ROBUST TELECOMS

Telefonica said it would pay a 2010 dividend of 1.40 euros, up from 1.15 euros this year and ahead of analyst expectations for 1.27 euros, according to Thomson Reuters I/B/E/S. The dividend will rise to a minimum 1.75 euros in 2012.

Chairman Cesar Alierta spoke of the robust nature of telecoms at a Telefonica investor day, saying that despite a world economic slump, the company expected massive broadband penetration... and an explosion of (telecoms) traffic.

The group sees worldwide connections rising to over 320 million in 2012 from 264 million at present, with telephony traffic up 40 percent.

Analysts got reassurance that Telefonica, long an acquisitive beast, will be able to keep purchases selective, and limited to consolidation in markets where it is already present, although the group would look at possible candidates.

We do think that more likely than not more opportunities will present themselves, and weaker players will have to think about their future, finance director Santiago Valbuena said.

Analysts anticipated upgrades to forecasts on the news, although one said the rise in the 2010 dividend was worth around 500 million euros, less than a buyback of up to 3.0 billion euros expected by some.

Alierta said tactical share buybacks may be considered for free cash flow excesses.

Telefonica shares were up 0.8 percent to 19.375 euros at 0945 GMT, having risen 21 percent this year versus a 7.3 percent gain for the DJ Stoxx telecoms sector .SXKP.

BLACKSPOT SPAIN

We prefer higher dividends over buybacks as we see them as more sustainable, especially when driven by better operational targets, analysts at Citigroup said.

Telefonica's blackspot is its home market, which still provides a quarter of its 58 billion euros annual revenues. Telefonica does not expect the Spanish market, where customers have been drawn to cheaper operators, to recover until 2011.

The company also scaled back its earnings ambitions for next year to 2.10 euros per share, which had been a stress case scenario, from 2.30 euros. Analysts had spoken of the company having indicated the 2.10 level, but Telefonica had not officially revised the 2.30 euros target until now.

Despite that, a Thomson Reuters I/B/E/S poll had seen consensus EPS of 1.83 euros in 2010.

According to CSFB, Telefonica's 2010 dividend represents a yield of 7.3 percent versus the sector's 6.6 percent. The 2012 DPS implies a dividend yield of 9.1 percent versus the sector's 7 percent.