proposals&merger reports 1/2

Telefonica SA 16 May 2006 RAMIRO SANCHEZ DE LERIN General Secretary and Secretary of 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 reports the following: SIGNIFICANT EVENT Further to the notice sent on May 12th, 2006 and because of the official calling of the Annual General Shareholders' Meeting of the Company to be held on June 20th and 21st, 2006, at first and second call respectively, the proposals to be submitted for approval at the Meeting are enclosed to this report. Similarly, in relation to the proposed resolution regarding the Merger Proposal of Telefonica, S.A. and Telefonica Moviles, S.A., we enclose to this document the Report of the Directors of Telefonica, S.A., together with the Report of the Independent Expert addressed to the Directors of Telefonica, S.A. and Telefonica Moviles, S.A., as required by article 236 of the Spanish Consolidated Text of the Business Corporations Law (Texto Refundido de la Ley de Sociedades Anonimas). The aforesaid proposals and reports, and additional information on the proposals are available to shareholders, debenture holders and holders of special rights other than shares, as well as to the employee representatives, for examination, at the Company's registered office. Additionally, these documents will be accessible on - line via de Company's website: (www.telefonica.es/ accionistaseinversores) Madrid, May 16th, 2006 ANNUAL GENERAL SHAREHOLDERS' MEETING OF 'TELEFONICA, S.A.' - YEAR 2006 - PROPOSED RESOLUTIONS SUBMITTED BY THE BOARD OF DIRECTORS FOR A DECISION OF THE SHAREHOLDERS AT THE GENERAL SHAREHOLDERS' MEETING 20/21 June 2006 Proposal regarding Item I on the Agenda: Examination and approval, if deemed appropriate, of the Individual Annual Accounts, of the Consolidated Financial Statements (Consolidated Annual Accounts) and of the Management Report of both Telefonica, S.A. and its Consolidated Group of Companies, as well as of the proposed application of results of Telefonica, S.A. and of the management of the Board of Directors thereof, all with respect to Fiscal Year 2005. A. To approve the Individual Annual Accounts (Balance Sheet, Profit and Loss Statement and Notes), the Consolidated Financial Statements -Consolidated Financial Accounts- (Balance Sheet, Profit and Loss Account, Cash Flow Statement, Statement of Recognized Income and Expenses, and Notes), and the Management Reports of Telefonica, S.A. and its corresponding Consolidated Group of Companies for the Fiscal Year 2005 (ended December 31 of such year), as drawn up by the Board of Directors of the Company at its meeting on February 28, 2006, as well the management performed by the Board of Directors of Telefonica, S.A. during such Fiscal Year. In the Individual Annual Accounts, the Balance Sheet as of December 31, 2005 reflects assets and liabilities in the amount of 50,934.94 million Euros each, and the Profit and Loss Account as of the end of the fiscal year reflects positive results of 1,754.39 million Euros. In the Consolidated Financial Statements (Consolidated Annual Accounts), the Balance Sheets as of December 31, 2005 reflect assets, and equity and liabilities in the amount of 73,173.77 million Euros each, and the Profit and Loss Account as of the close of the Fiscal Year reflects positive results of 4,445.85 million Euros. B. To approve the following Proposal for the Allocation of the Results of Telefonica, S.A. for Fiscal Year 2005: To distribute the profits obtained by Telefonica, S.A. during Fiscal Year 2005, amounting to 1,754,393,498.01 Euros, as follows: â€¢ 64,149,297.20 Euros to fund the Legal Reserve (thus reaching 20% of share capital). â€¢ 1,230,282,599.25 Euros, as a maximum, to pay dividends (maximum amount to be allocated corresponding to a fixed dividend of 0.25 Euros per share for all 4,921,130,397 shares into which the Company's share capital is divided). â€¢ The remainder of profits (459,961,601.56 Euros, at a minimum), to the Voluntary Reserve. It is expressly noted for the record that the amount allocated to the payment of dividends is discharged in full with the payment on May 12, 2006 of a dividend against profits for Fiscal Year 2005 in the fixed gross amount of 0.25 Euros for each of the issued and outstanding shares of the Company entitled thereto, as approved by the Board of Directors at its meeting of February 28, 2006. Telefonica has submitted to the UK Listing Authority a copy of the following documents: â€¢ Account Auditor's Report, Annual Accounts and Management Report of 'Telefonica, S.A.', all for the 2005financial year â€¢ Account Auditor's Report, Annual Accounts and Management Report of the Consolidated Group of Companies, all for the 2005 financial year. These documents will shortly be available for inspection at the UK Listing Authority's Document Viewing Facility, which is situated at: Financial Services Authority 25 The North Colonnade Canary Wharf London E14 5 HS Proposal regarding Item II on the Agenda: Examination and approval, if deemed appropriate, of the Merger Plan of Telefonica, S.A. and Telefonica Moviles, S.A. and approval, as the Merger Balance Sheet, of the Balance Sheet of Telefonica, S.A. as of December 31, 2005. Approval of the merger of Telefonica, S.A. and Telefonica Moviles, S.A. through the absorption of the latter by the former, with the termination of Telefonica Moviles, S.A. and the transfer en bloc and as a whole of all of its assets to Telefonica, S.A., with the provision that the exchange of shares will be carried out by means of the delivery of treasury shares of Telefonica, S.A., all of the foregoing in compliance with the provisions of the Merger Plan. Application to the merger of the special tax regime set forth in Chapter VIII of Title VII of the Restated Text of the Corporate Income Tax Law. Establishment of the procedure to facilitate the exchange. Delegation of powers. A. Examination and approval, if applicable, of the Plan of Merger of Telefonica, S.A. and Telefonica Moviles, S.A. by means of the absorption of the latter by the former. To approve in its entirety the Plan of Merger by absorption of Telefonica Moviles, S.A. by Telefonica, S.A., drawn up and signed by the Directors of both companies upon the terms set forth in the Merger Plan itself, and approved by their respective Boards of Directors at meetings of both held on March 29, 2006. The Merger Plan was deposited with the Commercial Registry of Madrid on April 3, 2006, with the corresponding marginal notations therein, and publication of such deposit was made in the Official Gazette of the Commercial Registry on April 17, 2006. The text of the Merger Plan approved by this resolution is included as an exhibit to the Minutes of the General Meeting. B. Examination and approval, if deemed appropriate, as the Merger Balance Sheet, of Telefonica, S.A.'s Balance Sheet as of December 31, 2005. To approve, as the Merger Balance Sheet of Telefonica, S.A., of the Balance Sheet as of December 31, 2005 drawn up by the Board of Directors of Telefonica, S.A. at its meeting of February 28, 2006, duly verified on March 1, 2006 by Ernst & Young, S.L., the Auditor of Telefonica, S.A., and approved by the shareholders at this General Meeting under item I of the Agenda. The text of the Merger Balance Sheet and the corresponding verification of the Company's Auditor is included as an exhibit to the Minutes of the General Meeting. C. Examination and approval, if applicable, of the merger of Telefonica, S.A. and Telefonica Moviles, S.A., through the absorption of the latter by the former, with the termination of Telefonica Moviles, S.A. and the transfer en bloc and as a whole of all of its assets to Telefonica, S.A., with the provision that the exchange of shares will be carried out by means of the delivery of treasury shares of Telefonica, S.A., all of the foregoing in compliance with the provisions of the Merger Plan. Application to the merger of the special tax regime set forth in Chapter VIII of Title VII of the Restated Text of the Corporate Income Tax Law (Texto Refundido de la Ley del Impuesto de Sociedades). I. Approval of the merger of Telefonica, S.A. and Telefonica Moviles, S.A. To approve the merger of Telefonica, S.A. and Telefonica Moviles, S.A., through the absorption of the latter company by the former, with the dissolution without liquidation of Telefonica Moviles, S.A. and the en bloc transfer of all of its property, including all of the items that make up its assets and liabilities, to Telefonica, S.A., which, through a general devise, will acquire all of the rights and obligations of Telefonica Moviles, S.A. Pursuant to the provisions of the Merger Plan, in order to carry out the exchange under the merger, Telefonica, S.A. will deliver to the shareholders of Telefonica Moviles, S.A. the appropriate number of shares of Telefonica, S.A. resulting from the exchange ratio established in the Merger Plan. The exchange shall not be effected in respect of the shares of Telefonica Moviles, S.A. held by such company, by Telefonica, S.A. or by any person acting in such person's own name but on behalf of Telefonica Moviles, S.A. or Telefonica, S.A., because they are affected by the provisions of Section 249 of the Business Corporations Law in accordance with the resolution to be adopted below. Given that, taking into account the current terms and conditions of the MOS Plan and the liquidation transactions carried out to date regarding said plan, the number of Telefonica Moviles, S.A. shares to remain in treasury as of the date of registration of the merger will amount to a minimum of 19,009,513 shares, and that therefore, the number of Telefonica Moviles, S.A. shares that will participate in the exchange will not exceed 305,640,634 shares, the number of shares of Telefonica, S.A. required to satisfy the exchange will amount to a maximum of 244,512,507 shares. Considering that Telefonica, S.A. owns a total number of treasury shares that exceeds such maximum, the merger exchange may be carried out entirely with treasury shares of Telefonica, S.A., without the need for a capital increase. As from the date of the merger resolution, Telefonica, S.A. will freeze 244,512,507 treasury shares, provided that, once the definitive number (within the above-mentioned maximum) of shares of Telefonica, S.A. needed to satisfy the exchange is determined, only this final number of shares is frozen. It is also stated for the record that, of the maximum amount of 244,512,507 Telefonica Moviles, S.A. shares required to satisfy the exchange, a total of 1,363,163 are shares re-purchased from Caja de Ahorros y Pensiones de Barcelona with respect to the stock option plan for managers of Terra Networks, S.A., which was approved by this company on October 1, 1999 (regarding which, due to the merger in 2005, Telefonica, S.A. succeeded Terra Networks, S.A. as the responsible entity). Since the underlying options have not been exercised, said shares will not be delivered to the potential beneficiaries of the plan and, although in such circumstances and pursuant to the terms and conditions of the plan, they would normally be cancelled and Telefonica, S.A.'s capital decreased, it is expressly resolved to modify said plan and use those 1,363,163 shares to satisfy the exchange, thus saving resources and avoiding two transactions with opposite effects (capital reduction at Telefonica, S.A. and the use of additional shares to satisfy the exchange, either with outstanding shares or by means of a capital increase). The exchange of shares of Telefonica Moviles, S.A. will be carried pursuant to the procedure and the exchange ratio described in the Merger Plan. Shares from the treasury of Telefonica, S.A. used to satisfy the exchange shall be shares of the same class and series as the other shares of Telefonica, S.A. that are currently outstanding, and shall give their holders, as from delivery thereof, the right to participate in corporate earnings beginning on January 1, 2006, upon the same terms as the other outstanding shares. A delegation is made to the Board of Directors, with authorization to delegate in turn to the Executive Commission or the Executive Chairman, all of the powers required such that, within the maximum amount set out above and under the condition set forth below, it may specify the exact number of shares of Telefonica, S.A. needed to satisfy the exchange of currently outstanding shares of Telefonica Moviles, S.A. pursuant to the above-mentioned exchange ratio. The condition that the Board of Directors and, if applicable, the Executive Commission or the Executive Chairman shall take into account is that the exact figure of the number of shares of Telefonica, S.A. to be delivered out of its treasury stock shall be the figure necessary on the basis of the exchange ratio of four (4) Telefonica, S.A. shares for every five (5) shares of Telefonica Moviles, S.A., taking into account that, pursuant to Section 249 of the Business Corporations Law, the shares of the latter company held by it, by Telefonica, S.A. or by any other person acting in such person's own name but on behalf of Telefonica Moviles, S.A. or of Telefonica, S.A. will not be exchanged and will be cancelled and voided as a result of the merger. In addition, the Board of Directors is empowered, with the authorization to so delegate to the Executive Commission or the Executive Chairman, to set the conditions for the delivery of the shares to the extent not provided by the shareholders at the General Meeting, including the further development of the procedure for the exchange of shares. All of the foregoing shall be carried out in accordance with the Merger Plan dated as of March 29, 2006, and deposited with the Commercial Registry of Madrid, pursuant to the procedure governed by the Second Section of Chapter VIII of the Business Corporations Law, and in view of the report of the independent expert KPMG Auditores, S.L., issued on May 10, 2006 in compliance with the provisions of Section 236 of the Business Corporations Law. Furthermore, in compliance with Section 228 of the Regulations of the Commercial Registry, and as an integral part of the content of this merger resolution, the following details are stated: 1. Identification of the Entities Participating in the Merger. 1.1 Telefonica, S.A. (Acquiring Company). Telefonica, S.A.: domiciled in Madrid, calle Gran Via 28, incorporated for an indefinite period of time under a notarial instrument executed before the Madrid Notary Mr. Alejandro Rosello Pastor on April 19, 1924 under number 141 of his book of notarial records. Telefonica, S.A. adapted its by-laws to the Business Corporations Law currently in force under a notarial instrument executed before the Madrid Notary Mr. Miguel Mestanza Fraguero on July 10, 1990. Telefonica, S.A. is registered with the Commercial Registry of Madrid in Volume 12534, Folio 21, Section 8, Page M-6164. The Tax ID Code of Telefonica, S.A. is A-28015865. 1.2 Telefonica Moviles, S.A. (Acquired Company). Telefonica Moviles, S.A.: domiciled in Madrid, calle Goya 24, incorporated for an indefinite period of time under a notarial instrument executed before the Madrid Notary Mr. Jose Antonio Escartin on February 14, 2000 under number 582 of his book of notarial records. Telefonica Moviles, S.A. is registered with the Commercial Registry of Madrid in Volume 14837, Folio 155, Section 8, Page M-246786. The Tax ID Code of Telefonica Moviles, S.A. is A-82573759. 2. Bylaw Amendments. No amendments will be made to the by-laws of Telefonica, S.A as a result of the merger. 3. Merger Exchange Ratio. The exchange ratio for the shares of the entities participating in the merger, which has been determined on the basis of the actual value of the assets of Telefonica, S.A. and Telefonica Moviles, S.A., will be as follows, without any additional cash compensation: Four (4) shares of Telefonica, S.A., each having a par value of one (â‚¬ 1) Euro, for every five (5) shares of Telefonica Moviles, S.A., each having a par value of fifty (â‚¬0.50) Euro cents. In determining the exchange ratio, account has been taken of the dividends that both companies plan to distribute and to which reference is made in section 8 of the Merger Plan and in section 5 below. 4. Share Exchange Procedure. The procedure for exchanging the shares of Telefonica Moviles, S.A. for shares of Telefonica, S.A. will be as follows: a. Once the merger is approved by the shareholders acting at the General Shareholders' Meetings of both companies, the equivalent documents mentioned in Sections 26.1 d), 41.1 c) and related provisions of Royal Decree 1310/2005 of November 4 are filed with the National Securities Market Commission (Comision Nacional del Mercado de Valores) (hereinafter, the 'CNMV') and the merger instrument is registered with the Commercial Registry of Madrid, the exchange of shares of Telefonica Moviles, S.A. for shares of Telefonica, S.A. will proceed. b. The exchange will commence on the date specified in the notices to be published in one of the most widely circulated newspapers in Madrid, in the Listing Bulletins of the Spanish Stock Exchanges and, if applicable, in the Official Bulletin of the Commercial Registry. For such purpose, a financial institution will be appointed to act as Agent and will be named in the above-mentioned notices. c. The exchange of the shares of Telefonica Moviles, S.A. for shares of Telefonica, S.A. will 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) (IBERCLEAR) that are depositaries thereof, in accordance with the procedures established for the book-entry system, pursuant to the provisions of Royal Decree 116/1992 of February 14 and applying such provisions of Section 59 of the Business Corporations Law as may be applicable. d. Shareholders holding shares that represent a fraction of the number of shares of Telefonica Moviles, S.A. designated as the exchange ratio may purchase or transfer shares in order to exchange them in accordance with such exchange ratio. Notwithstanding the foregoing, the companies participating in the merger may implement mechanisms designed to make such exchange easier for shareholders of Telefonica Moviles, S.A. who hold a number of shares that, according to the agreed exchange ratio, does not entitle them to receive a whole number of shares of Telefonica, S.A., including the appointment of an Odd-Lot Agent. e. As a result of the merger, the shares of Telefonica Moviles, S.A. will be terminated. As of the date of the Merger Plan, Telefonica, S.A. owned, directly and indirectly, four billion, three million, nine hundred thousand, seven hundred and forty-nine (4,003,900,749) shares of Telefonica Moviles, S.A., representing 92.457% of its share capital. It is noted for the record that between the date of the Merger Plan and the date of this resolution, Telefonica, S.A. has acquired, as provided in the Merger Plan, the shares of Telefonica Moviles, S.A. theretofore held by Telefonica Internacional, S.A. Unipersonal, as well as an additional two million (2,000,000) shares of Telefonica Moviles, S.A. As a result of such acquisitions, Telefonica, S.A. now directly owns four billion, five million, nine hundred thousand, seven hundred and forty-nine (4,005,900,749) shares of Telefonica Moviles, S.A., representing 92.50% of its share capital. As provided in Section 249 of the Business Corporations Law and pursuant to the regulations governing treasury shares, all such shares of Telefonica Moviles, S.A. held by Telefonica, S.A. will not be exchanged for Telefonica, S.A. shares. In addition, it is stated for the record that as of the date of the Merger Plan, Telefonica Moviles, S.A. owned one thousand five hundred and ninety-nine (1,599) treasury shares. In addition, in connection with the coverage of the share option plan of Telefonica Moviles, S.A. (the MOS Plan), the latter had as of said date a call option on twenty million, nine hundred and fifty-seven thousand, seven hundred and eighty-four (20,957,784) shares of Telefonica Moviles, S.A. (the 'Hedging Shares') owned by Caja de Ahorros y Pensiones de Barcelona and Banco Bilbao Vizcaya Argentaria, S.A., subscribed for by those entities on the terms of the summary prospectus verified by the National Securities Market Commission on September 28, 2001. The MOS Plan expired on January 3, 2006 and is currently in liquidation, which will be concluded prior to the registration of the merger, notwithstanding which Telefonica, S.A. will succeed Telefonica Moviles, S.A. as the entity liable for any pending obligation derived from such liquidation. Upon the exercise of the aforementioned call option, Telefonica Moviles, S.A. shall maintain in its treasury the shares that are not used to liquidate the Plan (a maximum of 20,957,784 shares, and a minimum of 19,007,914). These shares, together with the 1,599 shares mentioned above, also cannot participate in the exchange, as provided in Section 249 of the Business Corporations Law and related provisions. 5. Date as from which the New Shares Delivered in Exchange Carry the Right to Participate in the Profits of the Company and Specific Characteristics of Such Right. January 1, 2006 is set as the date as from which the shares delivered in exchange will entitle the holders thereof to participate in the earnings of Telefonica, S.A. For this reason, the existing shares of Telefonica, S.A. of the same class and series as the other shares of Telefonica, S.A. currently outstanding used to effect the exchange will entitle the holders thereof, as from the date of delivery, to participate in the earnings of the company posted as from January 1, 2006, on the same terms as the other outstanding shares. In distributions made after the merger instrument is registered with the Commercial Registry, all the shares of Telefonica, S.A., including those delivered in order to carry out the exchange, will participate with the same rights in proportion to the par value of each share. It is stated for the record that, in accordance with the provisions of the Merger Plan, Telefonica, S.A. has made or, as the case may be, plans to make the following dividend distributions: (i) Payment of a gross interim dividend of 0.25 Euro per share, based on the earnings of the fiscal year ended December 31, 2005, which was paid on May 12, 2006. This dividend was approved by the Board of Directors at its meeting of February 28, 2006 and announced to the market the same day. Such dividend does not benefit shareholders of Telefonica Moviles, S.A. who become shareholders of Telefonica, S.A. as a result of the merger. This has therefore been taken into account for the formulation of the exchange ratio. (ii) As was announced to the market on February 28, 2006, the Board of Directors of Telefonica, S.A. intends to distribute, during fiscal year 2006, an additional gross dividend of 0.25 Euro per share, to which end the required corporate resolutions will be adopted. In any event, such dividend will be paid after the merger is registered with the Commercial Registry of Madrid. Unlike the dividend mentioned in paragraph (i) above, this dividend will benefit both Telefonica, S.A. shareholders and the shareholders of Telefonica Moviles, S.A. who become shareholders of Telefonica, S.A. as a result of the merger. Accordingly, it was not taken into account for the calculation of the exchange ratio. For its part, in accordance with the provisions of the Merger Plan, Telefonica Moviles, S.A. plans to make the following dividend distributions: i. Previously-announced dividend: Payment of a gross dividend of 0.205 Euro per share of Telefonica Moviles, S.A. to be charged to the unappropriated retained earnings of fiscal year 2005 and to unrestricted reserves. The proposal for such distribution was approved by the Board of Directors of Telefonica Moviles, S.A. at its meeting of February 27, 2006 and was announced to the market the following day. The effectiveness of the distribution is subject to approval thereof by the shareholders acting at the Annual General Shareholders' Meeting of Telefonica Moviles, S.A. It is expected that this dividend will be paid on July 21, 2006 and, in any event, prior to the registration of the merger of Telefonica, S.A. and Telefonica Moviles, S.A. with the Commercial Registry, for which reason, since it will only benefit the shareholders of Telefonica Moviles, S.A., it was taken into account in formulating the exchange ratio. ii. Dividends proposed by the Board of Directors of Telefonica Moviles, S.A. for approval by the shareholders acting at the General Shareholders' Meeting, within the framework of the negotiation between Telefonica, S.A. and Telefonica Moviles, S.A. and whose effectiveness is contingent upon the approval of the merger by the shareholders acting at the General Shareholders' Meetings of both companies: â€¢ Payment of a gross dividend of 0.085 Euro per share of Telefonica Moviles, S.A. to be charged to the reserve for the issuance premium and other unrestricted reserves. The Board of Directors of Telefonica Moviles, S.A., at its meeting of March 29, 2006, agreed to submit this proposal for approval of the shareholders acting at the Annual General Shareholders' Meeting of Telefonica Moviles, S.A. â€¢ Payment of a gross interim dividend of 0.35 Euro per share of Telefonica Moviles, S.A. to be charged to the profits posted between January 1 and March 28, 2006. The Board of Directors of Telefonica Moviles, S.A., at its meeting of March 29, 2006, agreed to submit this proposal for approval of the shareholders acting at the Annual General Shareholders' Meeting of Telefonica Moviles, S.A. As previously stated, the two proposals mentioned above are contingent upon approval of the planned merger by the shareholders acting at the General Shareholders' Meeting of both companies. If these proposals are approved by the shareholders at the Annual General Shareholders' Meeting of Telefonica Moviles, S.A. and if the condition described above is met, payment of the dividends to which the proposals refer (in the aggregate gross amount of 0.435 Euro per Telefonica Moviles, S.A. share) will be made on the same date as the date set for payment of the previously announced dividend, mentioned in subsection (i) above, i.e., July 21, 2006. Accordingly, this distribution will only benefit the shareholders of Telefonica Moviles, S.A. and it has therefore been taken into account in formulating the exchange ratio. 6. Date of Accounting Effects of the Merger. January 1, 2006 is set as the date as from which all transactions of Telefonica Moviles, S.A. will, for accounting purposes, be deemed to have been made on behalf of Telefonica, S.A. 7. Special Rights. There are no special shares or special rights in Telefonica Moviles, S.A. other than the shares. However, it is noted for the record that, as set forth in section 4 above, the stock option plan of Telefonica Moviles, S.A. (the MOS Plan) expired on January 3, 2006 and is currently in liquidation, which will be concluded prior to the registration of the merger. Notwithstanding the foregoing, Telefonica, S.A. will succeed Telefonica Moviles, S.A. as the entity responsible for any possible pending liability stemming from the above-mentioned liquidation. The shares of Telefonica, S.A. that are delivered to the shareholders of Telefonica Moviles, S.A. by virtue of the merger will not grant any special rights to the holders thereof. 8. Benefits Accorded to the Directors and to the Independent Expert. No benefits of any kind will be accorded to the Directors of either of the entities participating in the merger or to the Independent Expert that has participated in the merger process. II. Subjecting the Merger to the Special Tax Regime Provided for in Chapter VIII of Title VII of the Consolidated Text of the Corporate Income Tax Law. To resolve that the approved merger transaction be governed by the tax regulations set forth in Chapter VIII of Title VII and in the second additional provision of the Consolidated Text of the Corporate Income Tax Law, approved by Royal Legislative Decree 4/2004. For such purpose, and pursuant to Section 96 of the above-mentioned Consolidated Text, the merger transaction will be reported to the Ministry of Economy and Finance as required under current regulations. D. Establishment of Procedure to Facilitate the Exchange. Pursuant to the provisions of the Merger Plan, Telefonica Moviles, S.A. shareholders owning shares that represent a fraction of the number of Telefonica Moviles, S.A. shares set as the exchange ratio may acquire or transfer shares in order to exchange them at such exchange ratio. Each shareholder must individually make timely decisions for such purpose to either purchase or sell shares of Telefonica Moviles, S.A. on the market in order to secure a number of shares of Telefonica Moviles, S.A. that is a multiple of five (5). Notwithstanding the foregoing and as provided in the Merger Plan, it is resolved to establish a mechanism designed to facilitate the exchange for those Telefonica Moviles, S.A. shareholders who are holders of a number of shares that is not a multiple of five (5). The basic terms and conditions of such mechanism are as follows: (i) Taking into account that the exchange ratio for the merger is equivalent, in unitary terms, to the delivery of one share of Telefonica, S.A. for every 1.25 shares of Telefonica Moviles, S.A. as of the close of the last session for trading in Telefonica Moviles, S.A. on the Spanish stock exchanges (hereinafter, the 'Reference Date'), each shareholder of Telefonica Moviles, S.A. who, by application of such unitary exchange ratio of one share of Telefonica, S.A. for every 1.25 shares of Telefonica Moviles, S.A., is entitled to receive a whole number of Telefonica, S.A. shares and who has an odd-lot residue of less than 1.25 shares of Telefonica Moviles, S.A. 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 Telefonica Moviles, S.A. shares forming such position will be computed. Likewise, a Telefonica Moviles, S.A. shareholder who owns less than 1.25 shares of Telefonica Moviles, S.A. will be able to transfer such shares to the Odd-Lot Agent. It shall be deemed that each shareholder of Telefonica Moviles, S.A. accepts the odd-lot acquisition system established herein, without having to remit instructions to the relevant entity participating in IBERCLEAR, which shall inform the shareholder of the result of the transaction once it has concluded. (ii) 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 Telefonica Corresponding Odd-lot shares of Moviles shares Telefonica, S.A. Telefonica Moviles, S.A. shares by virtue subject to the odd-lot of the exchange acquisition system 1 0 1 2 1 0.75 3 2 0.50 4 3 0.25 5 4 0 Therefore, in any shareholder position, an odd-lot will range between a minimum of 0.25 shares of Telefonica Moviles, S.A. and a maximum of 1 share of Telefonica Moviles, S.A. (iii) The acquisition price of the odd-lots will be determined based on the arithmetical mean of the average weighted price of the shares of Telefonica Moviles, S.A. on the Automated Quotation System (Sistema de Interconexion Bursatil) (Continuous Market) for the last three trading sessions for Telefonica Moviles, S.A. on the Spanish stock exchanges. If the odd-lot in question consists of one share of Telefonica Moviles, S.A., its purchase price will be the arithmetical mean of the average weighted price of the shares of Telefonica Moviles, S.A. on the Automated Quotation System (Continuous Market) for the last three trading sessions of Telefonica Moviles, S.A. stock; similarly, if the odd-lot in question is other than one share, its acquisition price will be calculated based on the same procedure described herein, but in a proportion corresponding to the specific amount of the odd-lot. (iv) The entity appointed as 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 of Telefonica Moviles, S.A. on the Reference Date. The shares or fractional shares of Telefonica Moviles, S.A. acquired by the Odd-Lot Agent will be exchanged for the corresponding number of Telefonica, S.A. shares as provided in the Merger Plan. (v) Authorization is granted to the Board of Directors, with the express power of substitution to the Executive Commission or the Executive Chairman, to develop the mechanism for the acquisition of odd-lots or fractions of stock provided for herein, including, but not limited to, the determination of the Reference Date in order to carry out the acquisition of odd-lots at the end of such day; the drafting of the corresponding announcement of the exchange; the designation of the entity to act as Odd-Lot Agent; and any other powers that are necessary or merely appropriate to properly carry out the merger exchange and the odd-lot acquisition mechanism approved herein. All of the foregoing is without prejudice to Telefonica, S.A. and/or Telefonica Moviles, S.A., prior to the merger, acquiring the odd-lot shares of Telefonica Moviles, S.A. required for the number of shares of Telefonica Moviles, S.A. that must participate in the exchange to be an exact multiple of the exchange ratio. E. Delegation of powers to formalize, interpret, remedy and carry out this resolution. To jointly and severally authorize the Executive Chairman of the Board of Directors and the Secretary of the Board of Directors, such that, without prejudice to any other delegations included in this resolution and any powers-of-attorney to convert the resolution into a public instrument, any of them may formalize and execute it, with the power for such purpose to execute the public or private documents that are necessary or appropriate (including those of interpretation, clarification, correction of errors and the curing of defects and publication of any announcements that are required or merely convenient) for the most correct performance hereof and for the registration hereof, to the extent required, with the Commercial Registry or any other Public Registry. The delegation includes, upon the broadest possible terms, the power to guarantee the claims of those creditors, if any, who oppose the merger. â€¢ The Merger Plan. â€¢ The report of the Independent Expert on the Merger Plan. â€¢ The reports of the Directors of each of the companies taking part in the merger on the Merger Plan. â€¢ The Annual Accounts and Management Reports for the last three years for each of the companies taking part in the merger, with the corresponding Auditors' reports. â€¢ The Merger Balance Sheet for each of the companies taking part in the merger, accompanied by the verification report issued by the Auditor (in both cases this Balance Sheet is the Balance Sheet for the year ended December 31st, 2005, to be approved by their respective Annual General Shareholders' Meetings). â€¢ The current Bylaws of each of the companies taking part in the merger. â€¢ The list of first names, surnames, ages, nationalities and addresses of the Directors of each of the companies taking part in the merger, the date on which they took office and, where appropriate, the same information in relation to the people who are going to be proposed as Directors as a result of the merger. These documents will shortly be available for inspection at the UK Listing Authority's Document Viewing Facility, which is situated at: Financial Services Authority 25 The North Colonnade Canary Wharf London E14 5 HS Proposed Resolutions Regarding Item III on the Agenda: Re-election, Ratification and Appointment, as Applicable, of Directors: III.1 To re-elect as a Director Mr. Carlos Colomer Casellas, appointing him for a new period of five years. III.2 To re-elect as a Director Mr. Isidro Faine Casas, appointing him for a new period of five years. III.3 To e-elect as a Director Mr. Alfonso Ferrari Herrero, appointing him for a new period of five years. III.4 To re-elect as a Director Mr. Luis Lada Diaz, appointing him for a new period of five years. III.5 To re-elect as a Director Mr. Antonio Massanell Lavilla, appointing him for a new period of five years. III.6 To ratify the interim appointment as a Director of the Company, as previously approved by the Board of Directors, of Mr. David Arculus, appointing him as a Director for a period of five years, pursuant to the provisions of Law and the By-Laws. Mr. David Arculus was appointed as a Director on an interim basis by resolution of the Board of Directors on January 25, 2006, to fill the vacancy produced by the resignation of Mr. Jose Fonollosa Garcia. III.7 To ratify the interim appointment as a Director of the Company, as previously approved by the Board of Directors, of Mr. Peter Erskine, appointing him as a Director for a period of five years, pursuant to the provisions of Law and the By-Laws. Mr. Peter Erskine was appointed as a Director on an interim basis by resolution of the Board of Directors on January 25, 2006, to fill the vacancy produced by the resignation of Mr. Antonio Alonso Ureba. III.8 To ratify the interim appointment as a Director of the Company, as previously approved by the Board of Directors, of Mr. Julio Linares Lopez, appointing him as a Director for a period of five years, pursuant to the provisions of Law and the By-Laws. Mr. Julio Linares Lopez was appointed as a Director on an interim basis by resolution of the Board of Directors on December 21, 2005, to fill the vacancy produced by the resignation of Mr. Jose Antonio Fernandez Rivero. III.9 To ratify the interim appointment as a Director of the Company, as previously approved by the Board of Directors, of Mr. Vitalino Manuel Nafria Aznar, appointing him as a Director for a period of five years, pursuant to the provisions of Law and the By-Laws. Mr. Vitalino Manuel Nafria Aznar was appointed as a Director on an interim basis by resolution of the Board of Directors on December 21, 2005, to fill the vacancy produced by the resignation of Mr. Jesus Maria Cadenato Matia. Furthermore, the ratification of any interim appointments of Directors that may have been approved by the Board of Directors since the call to the General Shareholders' Meeting and the meeting event, will be proposed, if applicable. Proposal Regarding Item IV on the Agenda: Approval, if appropriate, of a long-term incentive plan consisting of the delivery of shares of and which is linked to changes in the listing price of shares of Telefonica, S.A. To approve a long-term incentive plan (hereinafter, the 'Plan'), directed toward the executive Directors and management personnel of Telefonica, S.A. and other companies within the Telefonica Group (hereinafter, as defined below, 'Grupo Telefonica'), as described below. The Plan consists of the delivery for such purpose to the selected participants, after compliance with the requirements of the Plan, of a certain number of shares of Telefonica, S.A. as variable compensation. The basic conditions are as follows: 1. Participants in the Plan: Executive Directors, Senior Managers and other management personnel of Grupo Telefonica, which involves a total of approximately 1,900 potential participants. Without prejudice to the foregoing, new participants who meet the aforesaid requirements due to promotion, new hires within the Group or other reasons, may be added to the Plan without modification of its other terms and conditions. 2. Term: The total expected initial duration of the Plan will be seven years. The Plan is divided into five cycles of three years each (i.e., with the delivery of shares corresponding to each of the cycles three years after commencement thereof), that are independent of each other, with the first cycle commencing on July 1, 2006 (with delivery of shares beginning on July 1, 2009) and the fifth cycle commencing on July 1, 2010 (with delivery of shares beginning on July 1, 2013). 3. Maximum Number of Shares to be Delivered: The maximum number of shares of Telefonica, S.A. to be delivered to the participants in the execution of the Plan at the end of each of the cycles will be the number resulting from dividing the maximum sum allocated to the Plan in each of the cycles by the average weighted listing price of Telefonica, S.A. shares for the thirty stock exchange business days prior to July 1 of the first year of the corresponding cycle of the Plan (hereinafter, the 'Reference Value'), except with respect to the first cycle, 2006-2009, when the arithmetical mean of the average weighted prices of the shares of Telefonica, S.A. shares for the thirty stock exchange business days prior to May 11, 2006. The maximum amount allocated to the Plan during each of the cycles will be determined each year by the Board of Directors of Telefonica, S.A. after receiving a report from the Nominating, Compensation and Corporate Governance Subcommittee, and may not exceed the amount of 754,000,000 Euros over the entire effective period of the plan (i.e., over seven years). In any event, the total number of shares to be delivered in execution of the Plan at the end of each cycle may never exceed 0.20% of the share capital of Telefonica, S.A. as of July 1, 2006. The participants in this plan include the current executive Directors of Telefonica, S.A., who, at the end of the first cycle, and if they fully comply with the requirements and conditions established in the Plan, would have the right to receive up to the maximum number of shares herein set forth: Mr. Cesar Alierta Izuel: 129,183 shares; Mr. Peter Erskine: 181,762 shares; Mr. Luis Lada Diaz: 62,354 shares; Mr. Julio Linares Lopez: 65,472 shares, and Mr. Antonio Viana-Baptista: 62,354 shares. For each of the remaining cycles, the Board of Directors, after receiving a report from the Nominating and Compensation and Corporate Governance Subcommittee, shall determine the maximum amounts to serve as the basis for establishing the maximum number of shares that may be delivered as a function of the Reference Value, without such amount in any event being able to exceed the total amount of 29,814,000 Euros for all of the executive Directors as a group over the effective period of the plan (i.e. over seven years). The specific number of shares that are delivered under the Plan to each executive Director at the end of each cycle, as well as the number of effective shares delivered to Senior Management personnel and other Management personnel, will be reported pursuant to applicable legal provisions. 4. Requirements and Conditions for the Delivery of Shares: The specific number of shares within the established maximum that are delivered at the end of each cycle will be subject to and determined by the Total Shareholder Return (hereinafter, as defined below, the 'TSR') of Telefonica, S.A. shares (from the Reference Value) during each cycle, with respect to the TSRs experienced by the shares of companies in the telecommunications industry making up the 'FTSE Global Telecoms Index,' which, for the purposes of the Plan, will be the Comparison Group. In this sense, the TSR is considered to be the metric for determining the generation of value at Grupo Telefonica in the short and long term, as it measures the return on investment for the shareholder and is defined for purposes of the Plan and for each cycle as the sum of the increase in Telefonica, S.A. share prices plus dividends or other similar items received by the shareholder during the cycle in question. The Plan will forecast that the number of shares to be delivered will range between 30% of the number initially allocated in the event that changes in the TSR for Telefonica, S.A. shares are equal to the median of the Comparison Group, and 100% in the event that such changes are equal to or greater than the third quartile of the companies making up the Comparison Group, using linear extrapolation to calculate the percentage in cases between the median and the aforementioned third quartile. If changes in the TSR are lower than the median, no shares will be delivered. For the foregoing purposes, the companies making up the aforementioned index as of July 1 of the first year of each cycle will be taken into account, excluding those companies belonging to Grupo Telefonica, and keeping them without change for the entire duration of each cycle. The companies making up such index as of May 12, 2006 are indicated below, although there may be some changes at the time the first cycle commences: Alltel Corp, AT&T, BCE Inc, Belgacom, Bellsouth Corp, BT Group, China Mobile Hong Kong, China Netcom GP, China Unicom, Deutsche Telekom, France Telecom, KDDI , Nipon Telg. & Tel. NTT Docomo Inc., Portugal Telecom. SGPS, Qwest Comms. Intl., KPN Kon, Singapore Telecom, Sprint Nextel, Swisscom R, Telefonica, Telefonica Moviles, Telekom Austria Telecom Italia, Telenor, Teliasonera, Telstra, Telus, Verizon Communications and Vodafone Group. If the above-referenced index ceases to be published during the term of the Plan or undergoes substantial modification in the makeup thereof, the Board of Directors shall in all events adopt appropriate measures in order to continue with the preparation and establishment of the relevant index, solely for purposes of the Plan, based on grounds that are homogenous and equivalent to those constituting the basis of the Plan. In addition, regardless of the other conditions and requirements that may be established, in order for each of the participants to have the right to receive shares of Telefonica, S.A. covered by the Plan, they must remain as an employee of Grupo Telefonica on the date of delivery of the shares corresponding to each cycle. 5. Date of Delivery of the Shares: The delivery of the shares will take place at the end of each cycle, i.e., in 2009, 2010, 2011, 2012 and 2013, respectively, with the specific delivery date determined by the Board of Directors or the body or person to whom this power is delegated. 6. Grupo Telefonica: For purposes of the provisions of the Plan, Grupo Telefonica shall be understood as the companies making up such group pursuant to he provisions of Section 4 of Law 24/1988, of July 28, on the Securities Market. 7. Origin of the Shares: The shares of Telefonica, S.A. to be delivered to the participants may be (a) shares of Telefonica, S.A. held in treasury that are acquired or have been acquired by Telefonica, S.A. itself as well as any companies within its group, after compliance with the legal requirements for such purpose; or (b) newly-issued shares resulting from the capital increase made at any time for such purpose. To the extent advisable under the legal rules applicable to any of the participants or subsidiary companies, the basic conditions stated above may be adjusted (including, if necessary, the possibility of making payments under the Plan in cash, without the physical delivery of shares), without making substantive changes and, in any event, without changing the conditions described in paragraphs 1 to 6 above. Furthermore, and without prejudice to the generality of resolution seven, the Board of Directors of Telefonica, S.A. is authorized to put the Plan into effect, and may clarify wherever necessary the rules set forth herein and the content of the contracts to be signed by the Plan Participants, and may also ratify, to the extent necessary, the actions taken for such purpose through the date hereof. The Board of Directors is also authorized such that, in its discretion, it may decide not to carry out or cancel one or more cycles of the Plan at any time prior to the date of commencement of such cycle. The Board of Directors may in turn delegate these powers to the Executive Commission or to the Nominating and Compensation and Corporate Governance Subcommittee of Telefonica, S.A. All of the foregoing is understood to be without prejudice to the exercise by any applicable decision-making bodies of Telefonica, S.A.'s subsidiaries of the powers they have to put the Plan into practice with respect to their employees. Proposal Regarding Item V on the Agenda: Authorization to Acquire the Company's Own Shares, Directly or Through Companies within the Group. A) To authorize, pursuant to the provisions of Sections 75 et. seq. and the first additional provision, paragraph 2, of the current Business Corporations Law, the derivative acquisition, at any time and as many times as deemed appropriate, of Telefonica, S.A.'s own fully paid-in shares -either directly or through any subsidiaries it controls- by purchase or by any other legal means of consideration. The minimum acquisition price or consideration shall be equal to the par value of the shares acquired, and the maximum price or consideration shall be equal to the listing price of the shares acquired on an official secondary market at the time of acquisition. Such authorization is granted for a period of 18 months from the date of this Meeting and is made expressly subject to the limitation that at no time may the nominal value of the Company's shares acquired through the use of this authorization, added to those already possessed by Telefonica, S.A. and any of its controlled subsidiaries, exceed 5 percent of the share capital thereof at the time of acquisition, and the limitations established by the regulatory authorities in the markets where shares of Telefonica, S.A. are admitted for listing must also be respected. It is expressly stated for the record that the authorization to acquire the Company's own shares may be used in whole or in part for the acquisition of shares of Telefonica, S.A. that it must deliver or transfer to administrators ro employees of the Company or companies within its group, either directly or as a result of the exercise by them of options, all within the framework of duly approved compensation systems linked to the listing price of the Company's shares. B) To authorize the Board of Directors, upon the broadest terms possible, to exercise the authorization covered by this resolution and to carry out the other provisions hereof, and such powers may be delegated by the Board of Directors to the Executive Commission, the Executive Chairman of the Board of Directors, or any other person that the Board of Directors expressly authorizes for such purpose. C) To rescind the unutilized portion of the authorization granted under item VI of the Agenda of the Company's General Shareholders' Meeting of May 31, 2005. Proposal Regarding Item VI on the Agenda: Authorization to the Board of Directors to Increase the Share Capital Under the Terms and Conditions of Section 153.1.b) of the Business Corporations Law, with a Delegation of the Power to Exclude Preemptive Rights Pursuant, in this Latter Case, to the Provisions of Section 159.2 of the Business Corporations Law. To authorize the Board of Directors, as fully and effectively as possible under the Law and pursuant to the provisions of Section 153.1.b) of the Business Corporations Law in effect so that, within a maximum term of five years from the resolution adopted at the General Meeting and without the need to subsequently call any such General Meeting or for any resolution to be subsequently adopted thereat, the Board may resolve to increase of Company's share capital, on one or more occasions, when and as required by the Company's needs in the judgment of the Board itself, by the maximum amount of 2,460,565,198 Euros, equal to one-half of the current share capital of the Company, by issuing and putting into circulation for such purpose the corresponding new shares, be they common shares or of any other kind among those permitted by the Law, including shares with a fixed or variable premium, and in all cases with payment for the issued shares in the form of cash contributions, and expressly providing for the possibility of an incomplete subscription for such shares as may be issued, pursuant to Section 161.1 of the Business Corporations Law. In addition, the Board of Directors is authorized to exclude preemptive rights in whole or in part, pursuant to Section 159.2 of the Business Corporations Law and related provisions. The powers thus delegated include the specification of the various aspects and conditions applicable to each issuance, according to the characteristics of each transaction decided to be conducted under the authorization to which this resolution refers, and will include the power to amend the text of the article of the By-Laws relating to share capital, once the increase has been resolved upon and implemented, and the power to carry out all the formalities required for the new shares covered by the capital increase to be admitted to trading on the domestic and foreign Stock Exchanges on which the Company's shares are listed, in accordance with the procedures established in each of such Stock Exchanges. Pursuant to Section 141, number 1, second paragraph, of the Business Corporations Law, the Board of Directors is also authorized to delegate to the Executive Commission such powers granted by means of this resolution as may be delegated. Telefonica has submitted to the UK Listing Authority a copy of the Mandatory report of the Board of Directors of Telefonica, S.A. on this proposal. This document will shortly be available for inspection at the UK Listing Authority's Document Viewing Facility, which is situated at: Financial Services Authority 25 The North Colonnade Canary Wharf London E14 5 HS Proposal Regarding Item VII on the Agenda: Delegation of Powers to Formalize, Interpret, Remedy and Carry out the Resolutions Adopted by the Shareholders at the General Shareholders' Meeting. To jointly and severally authorize the Executive Chairman of the Board of Directors and the Secretary of the Board of Directors, such that, without prejudice to any other delegations included in this foregoing resolutions and any powers-of-attorney to convert existing resolutions into public instruments, any of them may formalize and execute the foregoing resolutions, with the power for such purpose to execute the public or private documents that are necessary or appropriate (including those of interpretation, clarification, correction of errors and the curing of defects) for the most correct performance thereof and for the registration thereof, to the extent required, with the Commercial Registry or any other Public Registry. * * * REPORT OF THE DIRECTORS OF TELEFONICA, S.A. REGARDING THE MERGER PLAN OF TELEFONICA, S.A. AND TELEFONICA MOVILES, S.A. Madrid, May 12, 2006 REPORT OF THE DIRECTORS OF TELEFONICA, S.A. REGARDING THE MERGER PLAN OF TELEFONICA, S.A. AND TELEFONICA MOVILES, S.A. ______________ 1. INTRODUCTION At meetings held on March 29, 2006, the Boards of Directors of TELEFONICA, S.A. (hereinafter, 'TELEFONICA') and of TELEFONICA MOVILES, S.A. (hereinafter, 'TELEFONICA MOVILES') approved the Merger Plan of TELEFONICA and TELEFONICA MOVILES (the 'Merger Plan' or the 'Plan'), which had 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 and related provisions of the Business Corporations Law (Ley de Sociedades Anonimas) and has been deposited with the Commercial Registry of Madrid on April 3, 2006. In compliance with the provisions of Section 237 of the Business Corporations Law, the directors of TELEFONICA prepare and approve, upon the terms described below, the mandatory report of the directors regarding the Merger Plan (hereinafter, the 'Report'), which, in accordance with the provisions of such Section, provides a detailed explanation of, and rationale for, the legal and financial aspects of the above-mentioned 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 Telecommunications Markets. As described in the Merger Plan, the situation in the telecommunications markets in general and in mobile telecommunications markets in particular has changed significantly in recent years. This change in the competitive and technological environment and in customers' needs makes it advisable to change the strategic model for the growth of the activities carried out to date by TELEFONICA and TELEFONICA MOVILES separately. Briefly, in the opinion of the directors of TELEFONICA, this change is reflected in the following ways: a. There have been decisive changes in the market and in competition, aimed at allowing the sale of combined offerings of fixed and mobile telephony, broadband, and audiovisual services, and which include (i) the emergence of large mobile operators enjoying the benefits of significant economies of scale and scope, (ii) competition from operators combining the benefits of scale with an integrated offering of fixed and mobile services, (iii) the appearance of providers of various services that do not distinguish the network or device used for connection, and (iv) regulatory changes which tend to provide easier entry to new competitors of a specifically commercial nature, fostering the creation of virtual mobile operators and the offering of broadband through the mandatory availability of the customer access loop. b. Decisive technological changes, which can be summarized as (i) the trend towards the development of fixed and mobile telecommunications networks based on the 'IP Protocol,' so that both the construction of communications networks and the development of associated services will take place in this IP environment, thus eliminating many of the barriers between mobile and fixed network services, making it possible to capture large economies of scale in future investments in these networks, with the ensuing savings in networks and platforms; (ii) the development of new hybrid terminals capable of connecting to both fixed and mobile networks and accessing all kinds of multimedia content; and (iii) the development of third-generation mobile networks supporting voice, data, Internet and multimedia content. c. Finally, from the standpoint of demand, customers are beginning to consider mobile telephones as an essential item in their voice communications and no longer only for mobility-related situations. In addition, the rapid penetration of Internet use is resulting in significant growth in broadband and growing demand for such access to be possible from fixed and mobile terminals alike. In short, an ever growing number of customers require communication, information and leisure services and solutions through their fixed broadband access, while also demanding equivalent services and solutions through mobile telecommunications. The changes described above have had a decisive impact on fixed and mobile operators in recent years, forcing them to change their business models and strategies to give them greater flexibility that allows for quicker adjustment to the market and thus, for greater competitiveness and future growth. 2.2 Reasons for the Merger. Within the context described in Section 2.1 above, and as explained in the Merger Plan, the Boards of Directors of TELEFONICA and TELEFONICA MOVILES believe that a strategy more centered on the need for communication, leisure and information services of customers as a group and, specifically, for each given customer segment, optimally combining the communications platforms available in each market, will have a highly positive effect, ensuring greater penetration of mobile and fixed broadband services and greater customer loyalty through the development of a wider offering of new services and solutions, strengthening competitive position and speeding up the rate of growth, which is crucial, particularly in those markets where penetration is higher. It will also make it possible to boost efficiency in the use of infrastructure, particularly in the development of fixed and mobile broadband networks, creating greater utility for our customers and thus, greater value for the shareholders of TELEFONICA and TELEFONICA MOVILES and making it easier to achieve profitable and sustainable growth. The proposed merger of TELEFONICA and TELEFONICA MOVILES stems from this need to bring their business strategy into line with the new competitive environment described above. The Boards of Directors of both companies believe that the proposed merger is the most effective mechanism to deal with new customer demands, technological change and the new competitive environment in the market, making it possible to create greater value for the shareholders of TELEFONICA MOVILES and TELEFONICA and making it easier for the shareholders of TELEFONICA MOVILES to become shareholders of TELEFONICA, which will strengthen the shareholder base of both companies and ensure liquidity for TELEFONICA MOVILES shareholders, who will receive in exchange shares of TELEFONICA, probably the shares with the highest level of liquidity in the Spanish market. 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 TELEFONICA MOVILES is the merger by absorption of TELEFONICA MOVILES (the acquired company) into TELEFONICA (the acquiring company) with the dissolution without liquidation of TELEFONICA MOVILES and the en bloc transmission of all its assets to TELEFONICA, which, through a general devise, will acquire all of the rights and obligations of TELEFONICA MOVILES. Such en bloc transfer entails the acquisition by TELEFONICA, in a single act, of all the items comprising the assets and liabilities of TELEFONICA MOVILES. Therefore, there will be a transfer of all of TELEFONICA MOVILES' rights and obligations and, in general, of 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 specific legal relationship entails the termination thereof. At the same time, the merger entails the shareholders of TELEFONICA MOVILES 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 interests in the capital stock of TELEFONICA MOVILES, pursuant to the terms set forth in the Plan and described below. Finally, it is also stated for the record that, as provided in Section 1.2 of the Merger Plan, within the framework of the proposed merger and by way of reorganization of its interest, TELEFONICA has acquired the nine hundred twenty-seven million, nine hundred seventeen thousand, six hundred and twenty (927,917,620) shares of TELEFONICA MOVILES, representing 21.427% of its share capital, held by TELEFONICA INTERNACIONAL, S.A., Unipersonal, a company that is, in turn, wholly owned by TELEFONICA. Such transfer within the group allows TELEFONICA's interest in TELEFONICA MOVILES to become a direct interest in its entirety, thus avoiding the indirect generation of treasury shares as a result of the merger, and was made at the average listing price of TELEFONICA MOVILES shares from the date of their listing on the Stock Exchange to the date of signing of the Merger Plan (calculated as the average weighted volume of each day's closing price from the date of the listing of the shares on the Stock Exchange through March 28, 2006), which amounts to 8.653 Euros per share. The basic commercial regulations of merger transactions are contained in Sections 233 et seq. of the Business Corporations Law and in Sections 226 to 234 of the Regulations of the Commercial Registry. 3.2 Analysis of the Legal Aspects of the Merger Plan The absorption Merger Plan has been prepared following the rules set out in Sections 234 and 235 of the Business Corporations Law. In addition to the minimum disclosures required by the Business Corporations Law, the Merger Plan includes and expands upon other aspects, the inclusion of which has been deemed appropriate by the directors of TELEFONICA and TELEFONICA MOVILES. All of the foregoing is analyzed below: 3.2.1 Identification of the Entities Participating in the Merger Pursuant to the provisions of Section 235(a) of the Business Corporations Law, 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 greater size and market capitalization and to the fact that, as of the date of the Merger Plan, TELEFONICA MOVILES is an approximately 92.5% directly- and indirectly-owned subsidiary of TELEFONICA, but also to the fact that, as indicated in the Merger Plan, liquidity is thus ensured for the shareholders of TELEFONICA MOVILES, who will receive in exchange shares of TELEFONICA, which probably are the most liquid shares in the Spanish market. 3.2.2 Merger Exchange Ratio Pursuant to Section 235(b) of the Business Corporations Law, Section 3 of the Plan sets forth 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 four (4) shares of TELEFONICA, each having a par value of one (â‚¬1) Euro, for every five (5) shares of TELEFONICA MOVILES, each having a par value of fifty (â‚¬0.50) Euro cents. 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 detailed financial analysis of the merger exchange ratio. 3.2.3 Merger Balance Sheets Section 4 of the Merger Plan specifies that, for the purpose set forth in Section 239.1 of the Business Corporations Law, the balance sheets for the merger shall be deemed to be the balance sheets of TELEFONICA and TELEFONICA MOVILES for the period ended December 31, 2005. Such balance sheets were prepared by the respective Boards of Directors on February 28, 2006 and February 27, 2006, respectively, have been verified by their respective auditors and will be submitted for the approval of the shareholders at their respective General Shareholders' Meetings prior to the adoption of the merger resolution. 3.2.4 Exchange of Shares 3.2.4.1 Exchange Procedure Section 5 of the Plan complies with the requirement set forth in Section 235(c), of the Business Corporations Law that mention be made of the procedure for exchanging the shares of companies that are to be dissolved. Accordingly, once the merger is approved by the shareholders acting at the General Shareholders' Meetings of both companies, the equivalent documents mentioned in Sections 26.1 d), 41.1 c) and related provisions of Royal Decree 1310/2005 of November 4 are filed, if necessary, with the National Securities Market Commission (CNMV), and the merger instrument is registered with the Commercial Registry of Madrid, the exchange of shares of TELEFONICA MOVILES for TELEFONICA shares will proceed. The exchange will commence on the date specified in the notices to be published in one of the most widely circulated newspapers in Madrid, in the Listing Bulletins of the Spanish stock exchanges and, if applicable, in the Official Bulletin of the Commercial Registry. For that purpose, a financial institution will be appointed to act as Agent and will be named in the above-mentioned notices. The exchange of the shares of TELEFONICA MOVILES for TELEFONICA shares will 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) (Iberclear) that are depositaries thereof, in accordance with the procedures established for the book-entry system, pursuant to the provisions of Royal Decree 116/1992 of February 14 and applying such provisions of Section 59 of the Business Corporations Law as may be applicable. Shareholders holding shares that represent a fraction of the number of TELEFONICA MOVILES shares designated as the exchange ratio may purchase or transfer shares in order to exchange them in accordance with such exchange ratio. Notwithstanding the foregoing, the Boards of Directors of the companies participating in the merger have agreed to submit a mechanism, described in Section 3.2.5, for approval at their respective General Shareholders' Meetings, designed to make such exchange easier for shareholders of TELEFONICA MOVILES who hold a number of shares that, according to the agreed exchange ratio, does not entitle them to receive a whole number of shares of TELEFONICA shares. 3.2.4.2 Use of Treasury Stock to Satisfy the Exchange Resulting from the Merger Section 6 of the Plan calls for TELEFONICA to increase its share capital by the necessary amount and to issue the exact number of shares required for the exchange of the shares of TELEFONICA MOVILES, in accordance with the exchange ratio established in the Plan, pursuant to the provisions of Section 249 of the Business Corporations Law. Such section also provides that the capital increase may be reduced by delivering existing treasury shares of TELEFONICA to the shareholders of TELEFONICA MOVILES. Pursuant to such provision, the Board of Directors of TELEFONICA will propose to the shareholders acting at the Meeting that the exchange be made entirely using existing shares of TELEFONICA held as treasury shares, taking into account that, according to the calculations and estimates made by TELEFONICA and TELEFONICA MOVILES, the maximum number of shares required to satisfy the exchange is lower than the current number of TELEFONICA treasury shares, as will be explained below. As of the date of the Merger Plan, TELEFONICA owned, directly and indirectly, four billion, three million, nine hundred thousand, seven hundred and forty-nine (4,003,900,749) shares of TELEFONICA MOVILES, representing 92.457% of its share capital. Following the signing of the Merger Plan, TELEFONICA has acquired two million (2,000,000) shares of TELEFONICA MOVILES and, as provided in the Plan, the shares of TELEFONICA MOVILES theretofore held by Telefonica Internacional, S.A. Unipersonal. As a result of such acquisitions, TELEFONICA now directly owns four billion, five million, nine hundred thousand, seven hundred and forty-nine (4,005,900,749) shares of TELEFONICA MOVILES, representing 92.50% of its share capital. As provided in Section 249 of the Business Corporations Law and pursuant to the regulations governing treasury shares, all such shares of TELEFONICA MOVILES held by TELEFONICA will not be exchanged for TELEFONICA shares. As of the date of the Merger Plan, TELEFONICA MOVILES owned one thousand five hundred and ninety-nine (1,599) treasury shares. In addition, in connection with the coverage of the share option plan of TELEFONICA MOVILES (the MOS Plan), the latter had as of said date a call option on twenty million, nine hundred and fifty-seven thousand, seven hundred and eighty-four (20,957,784) shares of TELEFONICA MOVILES (the 'Hedging Shares') owned by Caja de Ahorros y Pensiones de Barcelona and Banco Bilbao Vizcaya Argentaria, S.A., subscribed for by those entities on the terms of the summary prospectus verified by the National Securities Market Commission on September 28, 2001. The MOS Plan expired on January 3, 2006 and is currently in liquidation, which will be concluded prior to the registration of the merger, notwithstanding which TELEFONICA will succeed TELEFONICA MOVILES as the entity liable for any pending obligation derived from such liquidation. Following the exercise of the call option mentioned above, TELEFONICA MOVILES will hold as treasury shares the shares not used for the liquidation of the Plan (not to exceed 20,957,784 shares). These shares, together with the 1,599 shares mentioned above, will also not participate in the exchange, as provided in Section 249 of the Business Corporations Law and related provisions. Accordingly, assuming that (i) the share capital of TELEFONICA MOVILES, currently represented by 4,330,550,896 shares, each having a par value of 0.5 Euro, will not change until the registration of the merger, that (ii) TELEFONICA will not change its current interest in TELEFONICA MOVILES (4,005,900,749 shares, representing 92.50% of the share capital), and that (iii) on the date of the exchange, TELEFONICA MOVILES will have no treasury shares other than the 1,599 treasury shares mentioned in Section 5 of the Merger Plan and, if applicable, the number of Hedging Shares remaining in the treasury of TELEFONICA MOVILES following the exercise of the call option mentioned above and the liquidation of the MOS Plan, the number of shares of TELEFONICA MOVILES that would participate in the exchange would range between 303,690,764 and 324,648,548 shares, depending on the amount for which the call option of TELEFONICA MOVILES described in the previous paragraphs is exercised, following the liquidation of the MOS Plan and, thus, on the final amount of treasury shares of TELEFONICA MOVILES. In turn, the number of TELEFONICA shares to be delivered would range between 242,952,611 and 259,718,838, respectively, i.e., between 4.94% and 5.28% of TELEFONICA's share capital. Nevertheless, considering the current terms and conditions of the MOS Plan and the liquidation transactions carried out to date, TELEFONICA and TELEFONICA MOVILES have concluded that the number of TELEFONICA MOVILES to remain in treasury as of the time of registration of the merger will amount to a minimum of 19,009,513 shares, and therefore, the number of TELEFONICA MOVILES shares that will participate in the exchange will not exceed 305,640,634 shares. This logically means that the number of TELEFONICA shares required to effect the exchange will be a maximum of 244,512,507 shares. In view of such calculation, and considering that TELEFONICA owns at the present time a total of 244,527,541 treasury shares, the merger exchange may be carried out entirely with these shares, without the need for a capital increase. For this purpose, as from the date of the merger resolution, TELEFONICA will freeze 244,512,507 treasury shares, provided that, once the definitive number (within the above-mentioned maximum) of shares of TELEFONICA needed to satisfy the exchange is determined, only this final number of shares is frozen. It is also stated for the record that, of the maximum amount of 244,512,507 TELEFONICA MOVILES shares required to satisfy the exchange, a total of 1,363,163 are shares re-purchased from Caja de Ahorros y Pensiones de Barcelona with respect to the stock option plan for managers of Terra Networks, S.A., which was approved by this company on October 1, 1999 (regarding which, due to the merger in 2005, TELEFONICA succeeded Terra Networks, S.A. as the responsible entity). Since the underlying options have not been exercised, said shares will not be delivered to the potential beneficiaries of the plan and, although in such circumstances they would normally be cancelled and TELEFONICA's capital decreased, the Company will propose to the shareholders at the General Shareholders' Meeting that those 1,363,163 shares be used to satisfy the exchange, thus saving resources and avoiding two transactions with opposite effects (capital decrease at TELEFONICA and the use of additional shares to satisfy the exchange). Finally, it is stated for the record that the shares of TELEFONICA MOVILES will be cancelled as a result of the merger. 3.2.5 Procedure to Facilitate the Exchange of the Shares Prior to the execution of the merger, either TELEFONICA or TELEFONICA MOVILES will make a market purchase of the odd-lot of TELEFONICA MOVILES shares required for the number of TELEFONICA MOVILES shares participating in the exchange results in an exact multiple of the exchange rate. Likewise, as provided in Section 5 of the Merger Plan, TELEFONICA MOVILES shareholders owning shares that represent a fraction of the number of TELEFONICA MOVILES shares set as the exchange ratio may acquire or transfer shares in order to exchange them at such exchange ratio. Each shareholder must individually make timely decisions for such purpose to either purchase or to sell shares of TELEFONICA MOVILES on the market in order to secure a number of shares of TELEFONICA MOVILES that is a multiple of five (5). Notwithstanding the foregoing and as provided in the above-mentioned Section 5 of the Plan, the Boards of Directors of TELEFONICA and TELEFONICA MOVILES, after due conversations, will submit for approval to their respective shareholders at their Annual General Shareholders' Meeting a mechanism designed to facilitate the exchange for those TELEFONICA MOVILES shareholders who are holders of a number of shares that is not a multiple of five (5). The basic terms and conditions of such mechanism are as follows: i. Taking into account that the exchange ratio for the merger is equivalent, in unitary terms, to the delivery of one share of TELEFONICA for every 1.25 shares of TELEFONICA MOVILES, as of the close of the last session for trading in TELEFONICA MOVILES stock on the Spanish stock exchanges (hereinafter, the 'Reference Date'), each shareholder of TELEFONICA MOVILES who, by application of such unitary exchange ratio of one share of TELEFONICA for every 1.25 shares of TELEFONICA MOVILES, is entitled to receive a whole number of TELEFONICA shares and who has an odd-lot residue of less than 1.25 shares of TELEFONICA MOVILES 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 TELEFONICA MOVILES shares forming such position will be computed. Likewise, a TELEFONICA MOVILES shareholder who owns less than 1.25 shares of TELEFONICA MOVILES will be able to transfer such shares to the Odd-Lot Agent. It shall be deemed that each shareholder of TELEFONICA MOVILES accepts the odd-lot acquisition system established herein, without having to remit instructions to the relevant entity participating in IBERCLEAR, which shall inform the shareholder of the result of the transaction once it has been concluded. ii. 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 Corresponding TELEFONICA Odd-lot shares of TELEFONICA MOVILES shares by virtue of the TELEFONICA MOVILES shares exchange subject to the odd-lot acquisition system 1 0 1 2 1 0.75 3 2 0.5 4 3 0.25 5 4 0 Therefore, in any shareholder position, an odd-lot will range between a minimum of 0.25 shares of TELEFONICA MOVILES and a maximum of 1 share of TELEFONICA MOVILES. iii. The acquisition price of the odd-lots will be determined based on the arithmetical mean of the average weighted price of the shares of TELEFONICA MOVILES on the Automated Quotation System (Sistema de Interconexion Bursatil) (Continuous Market) for the last three trading sessions for TELEFONICA MOVILES stock on the Spanish stock exchanges. If the odd-lot in question consists of one share of TELEFONICA MOVILES, its purchase price will be the arithmetical mean of the average weighted price of the shares of TELEFONICA MOVILES on the Automated Quotation System (Continuous Market) for the last three trading sessions of TELEFONICA MOVILES stock; similarly, if the odd-lot in question is other than one share, its acquisition price will be calculated based on the same procedure described herein, but in a proportion corresponding to the specific amount of the odd-lot. iv. The entity appointed as 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 of TELEFONICA MOVILES on the Reference Date. The shares or fractional shares of TELEFONICA MOVILES acquired by the Odd-Lot Agent will be exchanged for the corresponding number of TELEFONICA shares as provided in the Merger Plan. 3.2.6 Date as from which the New Shares Delivered in Exchange Entitle the Holders thereof to Participate in the Profits of the Company and Date of Accounting Effects of the Merger In compliance with the second assertion of Section 235 (c) of the Business Corporations Law, Section 7 of the Plan sets January 1, 2006 as the date as from which the shares delivered in exchange will entitle the holders thereof to participate in the earnings of TELEFONICA. For this reason, the existing shares of TELEFONICA of the same class and series as the other shares of TELEFONICA currently outstanding used to effect the exchange will entitle the holders thereof, as from the date of delivery, to participate in the earnings of the company posted as from January 1, 2006 on the same terms as the other outstanding shares. In distributions made after the merger instrument is registered with the Commercial Registry, all the shares of TELEFONICA, including those delivered as part of the exchange, will participate with the same rights in proportion to the par value of each share. Furthermore and pursuant to the provisions of Section 235(d) of the Business Corporations Law, Section 9 of the Plan sets January 1, 2006 as the date as from which all transactions of TELEFONICA MOVILES will, for accounting purposes, be deemed to have been made on behalf of TELEFONICA. 3.2.7 Special Rights and Benefits Extended to Directors and Independent Experts Pursuant to Section 235(e) of the Business Corporations Law, Section 10 of the Plan provides that the shares of TELEFONICA to be delivered to the shareholders of TELEFONICA MOVILES under the merger shall not give any special rights to the holders thereof. Likewise, such Section 10 states there are no special shares or special rights in TELEFONICA MOVILES other than the shares, except for the stock option plan of TELEFONICA MOVILES (the MOS Plan) which, however, expired on January 3, 2006, is currently in liquidation and will be concluded prior to the consummation of the merger. Notwithstanding the foregoing, TELEFONICA will succeed TELEFONICA MOVILES as the entity responsible for any possible pending liability stemming from the above-mentioned liquidation. In compliance with the provisions of Section 235(f) of the Business Corporations Law, Section 11 of the Merger Plan provides that no benefits of any kind shall be extended at TELEFONICA to the directors of either 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. 3.2.8 Other Terms of the Merger Plan The Merger Plan contemplates other matters the mention of which, like some of the contents already commented on, is not expressly required by the Business Corporations Law. As in the cases analyzed above, these are matters whose relevance or 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 TELEFONICA MOVILES expect to make and that have been taken into consideration for the preparation of the Merger Plan and the determination of the exchange ratio for the merger. TELEFONICA plans to make the following distributions: i. Payment of a gross interim dividend of 0.25 Euro per share, based on the earnings of the fiscal year ended December 31, 2005, which has been paid today, May 12, 2006. This dividend was approved by the Board of Directors at its meeting of February 28, 2006 and announced to the market the same day. According to Section 7 of the Plan, such dividend will not benefit shareholders of TELEFONICA MOVILES who become shareholders of TELEFONICA as a result of the merger. This has therefore been taken into account for the formulation of the exchange ratio. ii. As announced to the market on February 28, 2006, the Board of Directors of TELEFONICA intends to distribute, during fiscal year 2006, an additional gross dividend of 0.25 Euro per share, to which end the required corporate resolutions will be adopted. In any event, such dividend will be paid after the merger is registered with the Commercial Registry of Madrid. Unlike the dividend mentioned in paragraph (i) above, this dividend will benefit both TELEFONICA shareholders and the shareholders of TELEFONICA MOVILES who become shareholders of TELEFONICA as a result of the merger. Accordingly, it was not taken into account for the calculation of the exchange ratio. TELEFONICA MOVILES, for its part, expects to make the following distributions: i. Previously-announced dividend: Payment of a gross dividend of 0.205 Euro per share of TELEFONICA MOVILES to be charged to the unappropriated retained earnings of fiscal year 2005 and to unrestricted reserves. The proposal for such distribution was approved by the Board of Directors at its meeting of February 27, 2006 and was announced to the market the following day. The effectiveness of the distribution is subject to approval thereof by the shareholders acting at the Annual General Shareholders' Meeting of TELEFONICA MOVILES. It is expected that this dividend will be paid on July 21, 2006 and, in any event, prior to the registration of the merger of TELEFONICA and TELEFONICA MOVILES with the Commercial Registry, for which reason, since it will only benefit the shareholders of TELEFONICA MOVILES, it was taken into account in formulating the exchange ratio. ii. Dividends proposed by the Board of Directors of TELEFONICA MOVILES for approval by the shareholders acting at the General Shareholders' Meeting, within the framework of the negotiation between TELEFONICA and TELEFONICA MOVILES and whose effectiveness is contingent upon the approval of the planned merger by the shareholders acting at the General Shareholders' Meetings of both companies: â€¢ Payment of a gross dividend of 0,085 Euro per share of TELEFONICA MOVILES to be charged to the reserve for the issuance premium and other unrestricted reserves. The Board of Directors of TELEFONICA MOVILES, at its meeting of March 29, 2006, agreed to submit this proposal for approval of the shareholders acting at the Annual General Shareholders' Meeting of TELEFONICA MOVILES. â€¢ Payment of a gross interim dividend of 0.35 Euro per share of TELEFONICA MOVILES to be charged to the profits posted between January 1 and March 28, 2006. The Board of Directors of TELEFONICA MOVILES, at its meeting of March 29, 2006, agreed to submit this proposal for approval of the shareholders acting at the Annual General Shareholders Meeting of TELEFONICA MOVILES. As previously stated, the two proposals mentioned above are contingent upon approval of the planned merger by the shareholders acting at the General Shareholders' Meeting of both companies. If these proposals are approved by the shareholders at the Annual General Shareholders' Meeting of TELEFONICA MOVILES and if the condition described above is met, payment of the dividends to which the proposals refer (in the aggregate gross amount of 0.435 Euro per TELEFONICA MOVILES share) will be made on the same date as the date set for payment of the previously announced dividend, mentioned in subsection (i) above, i.e., July 21, 2006. Accordingly, this distribution will only benefit the shareholders of TELEFONICA MOVILES and it has therefore been taken into account in formulating the exchange ratio. b) Tax Regulations.- Section 12 of the Plan provides that the merger transaction will be governed by the special tax regulations set forth in Chapter VIII of Title VII of the Consolidated Text of the Corporate Income Tax Law (Texto Refundido de la Ley del Impuesto sobre Sociedades) for which purpose the merger transaction will be reported to the Ministry of Economy and Finance (Ministerio de Economia y Hacienda) as required under current regulations. c) Bylaw Amendments.- Section 13 of the Plan provides that, in the context of the merger transaction, the Board of Directors of TELEFONICA will submit the bylaw amendments that pertain to the Plan itself to the shareholders for approval at the same General Shareholders' Meeting that approves the merger. Given that the merger exchange will be entirely satisfied with treasury shares of TELEFONICA, no amendments of TELEFONICA's by-laws are expected as a result of the merger. The directors of TELEFONICA will not propose any other bylaw amendments to the shareholders at the General Shareholders' Meeting at which the merger will be decided. d) Appointment of Independent Expert.- Section 14 of the Plan provides that, pursuant to Section 236 of the Business Corporations Law, the directors of TELEFONICA and TELEFONICA MOVILES will ask the Commercial Registry of Madrid to appoint a single independent expert to prepare a single report regarding the Merger Plan. This request was made on March 30, 2006, and resulted in the appointment of KPMG Auditores, S.L. (hereinafter, 'KPMG') as the independent expert on April 4, 2006. KPMG accepted its appointment on the same day, April 4, 2006. e) Administrative Authorizations.- Finally, Section 15 of the Plan refers to the notices, authorizations and registrations upon which the effectiveness of the merger of TELEFONICA and TELEFONICA MOVILES is conditioned, both in Spain and in the other jurisdictions where both companies are present. It is not expected that any notices will have to be given or authorizations or registrations secured in Spain or in the other jurisdictions where both companies are present in order for the merger to become effective. Nevertheless, once the merger is completed, certain administrative authorizations may need to be secured in Ecuador and Panama to implement the transaction in those countries. In addition, once the merger is completed, the appropriate authorities will have to be informed of the change of ownership of certain subsidiaries of TELEFONICA MOVILES. Finally, as provided in the Merger Plan, prior to the registration of the merger, the equivalent documents mentioned in Sections 26.1 d), 41.1 c) and related provisions of Royal Decree 1310/2005 of November 4 will be filed, if necessary, with the CNMV. It is the intention of the Board of Directors of TELEFONICA that such equivalent documents consist of this Report and the Merger Plan giving rise to it. 3.3 Implementation of the Legal Procedure of Merger by Absorption The following is a brief description of the principal milestones marking the implementation of the merger process, with special mention of the relevant rules of the Business Corporations Law. 3.3.1 Approval and Signing of the Merger Plan In order to carry out the merger, Section 234.1 of the Business Corporations Law requires the directors of the companies participating in the merger to prepare a merger plan. The Merger Plan, which contains the bases and rules for implementing the merger transaction, was approved and signed by the directors of TELEFONICA and TELEFONICA MOVILES at meetings held on March 29, 2006 (with the abstentions and absences indicated in the Merger Plan itself). A signed specimen of such Merger Plan was deposited with the Commercial Registry of Madrid prior to calling the Annual General Shareholders' Meetings of TELEFONICA and TELEFONICA MOVILES, and the fact of the deposit was published in the Official Gazette of the Commercial Registry of April 17, 2006. 3.3.2 Report of the Independent Expert regarding the Merger Plan Furthermore, and as mentioned above, on March 30, 2006, the Commercial Registry of Madrid was jointly requested by TELEFONICA and TELEFONICA MOVILES, pursuant to the provisions of Section 236.2 of the Business Corporations Law, 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 TELEFONICA MOVILES as a result of the merger. The appointment was made on April 4, 2006 and the independent expert appointed was KPMG, which accepted the appointment on the same date. After having timely requested and obtained an extension for the issuance of the respective report, on May 10, 2006, KPMG issued the required report regarding the Merger Plan, in which it states the following conclusion: â€¢ '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. â€¢ The assets contributed by the acquired company are at least equal to the acquiring company's maximum capital increase as set forth in the Merger Plan.' 3.3.3 Report of the Directors Regarding the Merger Plan Pursuant to Section 237 of the Business Corporations Law, the directors of TELEFONICA have approved this report on the date hereof, which report gives the rationale for and a 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 Business Corporations Law, today the directors of TELEFONICA MOVILES are expected to approve a report that contains their respective rationale for and explanation of the Merger Plan. 3.3.4 Call of the General Shareholders' Meetings The Board of Directors of TELEFONICA will, on the date hereof, resolve to call an Annual General Shareholders' Meeting to be held in Madrid on June 20, 2006 on first call, and on June 21, 2006 on second call. TELEFONICA MOVILES, for its part, plans to call an Annual General Shareholders' Meeting to be held in Madrid on June 20, 2006 on first call and on June 21, 2006 on second call. Among the items comprising the Agenda of such General Shareholders' Meetings will be the debate on and approval, if granted, of the merger of TELEFONICA and TELEFONICA MOVILES, upon the terms set forth in the Merger Plan. Pursuant to Section 238.1 of the Business Corporations Law, upon publication of the call of the respective General Shareholders' Meetings, the documents listed in Section 238.1 and set forth below will be made available to the shareholders, debtholders and holders of special rights other than shares, as well as labor representatives (using the customary communication channels with the employees of TELEFONICA and TELEFONICA MOVILES, since there are no labor representatives), for examination thereof at the respective registered offices of TELEFONICA and TELEFONICA MOVILES. In addition, from the date of publication of the notices of the respective General Shareholders' Meetings, the shareholders, debtholders and holders of special rights other than shares of TELEFONICA and TELEFONICA MOVILES may request the free delivery or shipment of such documents pursuant to the provisions of Section 240.2 of the above-mentioned Business Corporations Law. 3.3.5 Merger Resolutions and Publication of Notices Section 240 of the Business Corporations Law provides that the merger resolution must be adopted by the shareholders at the General Shareholders' Meeting of each of the companies participating in the merger process, in accordance with the provisions of the Merger Plan. Once the merger resolution is adopted, if such be the case, the relevant announcement will be published three times in the Official Gazette of the Commercial Registry of Madrid and once in two widely-circulated newspapers in Madrid, all in compliance with the requirements of Section 242 of the Business Corporations Law. Upon publication of such announcements, which shall set forth the right of the shareholders and creditors of TELEFONICA and TELEFONICA MOVILES to obtain the full text of the merger resolutions and the merger balance sheets, a one-month period will begin for the creditors of the merging companies to challenge the merger until the claims which are not yet due as of the date of publication are secured, in accordance with Section 243 of the Business Corporations Law. 3.3.6 Execution and Registration of the Merger Instrument Once the respective merger resolutions have been adopted, the announcements have been published and the statutory period has passed without any creditor having exercised its right to challenge the merger or, if applicable, the claims thereof, if enforced, have been duly satisfied or secured, the corresponding merger instrument will be executed. Such merger instrument will be filed for registration with the Commercial Registry of Madrid, which will be requested to de-register TELEFONICA MOVILES. 3.3.7 Performance of the Exchange Upon the passage of the merger resolutions at the General Shareholders' Meetings of TELEFONICA and TELEFONICA MOVILES, the filing, if necessary, of the equivalent documents mentioned in Sections 26.1 d), 41.1 c) and related provisions of Royal Decree 1310/2005 of November 4 with the National Securities Market Commission (CNMV), and the registration of the merger instrument with the Commercial Registry of Madrid, the exchange of TELEFONICA shares for TELEFONICA MOVILES shares will proceed on the terms set forth in the Plan. 3.4 Information Regarding the Planned Merger Transaction Pursuant to the provisions of Section 238 of the Business Corporations Law, upon publication of the call of the corresponding General Shareholders' Meeting,the following documents will be made available to shareholders, debtholders and holders of special rights other than shares, as well as to labor representatives, for examination thereof at the registered office of each of the companies participating in the merger: a. The Merger Plan. b. The report of the independent expert (KPMG) on the Merger Plan. c. This report of the directors of TELEFONICA regarding the Merger Plan and the corresponding report of the directors of TELEFONICA MOVILES. d. The annual accounts and management report 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 respective verification report issued by the auditors. f. The full text of the amendments, if any, which are to be made to the bylaws of TELEFONICA. g. The current bylaws of the companies participating in the merger. h. A list of names, surnames, 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, the same information on the persons to be proposed as directors of TELEFONICA as a result of the merger. Pursuant to the provisions Section 240.2 of the Business Corporations Law, 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 websites of TELEFONICA (http://www.telefonica.es) and TELEFONICA MOVILES (http://www.telefonicamoviles.com) beginning on the date of the call to 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 TELEFONICA MOVILES for the period ended December 31, 2005, which have been verified by the respective auditors of those companies, shall be considered the merger balance sheets for purposes of Section 239.1 of the Business Corporations Law, and will be submitted to the shareholders at the respective Annual General Shareholders' Meeting prior to the adoption of the merger resolution. It is hereby stated for the record that, with respect to the possibility given by such legal rule of changing certain valuations in order to reflect 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 TELEFONICA MOVILES. Therefore, such merger balance sheets do not contain any changes with respect to the respective balance sheets as of December 31, 2005. It is further stated for the record that no material changes in the assets of TELEFONICA or TELEFONICA MOVILES 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 does not include any supplemental cash consideration and is four (4) shares of TELEFONICA, each having a par value of one (â‚¬1) Euro, for every five (5) shares of TELEFONICA MOVILES, each having a par value of fifty (â‚¬0.50) Euro cents. As provided in the Merger Plan, the directors of TELEFONICA and TELEFONICA MOVILES have not resolved that the shareholders of TELEFONICA MOVILES are to receive any supplemental cash consideration. 4.3 Determination of the Exchange Ratio. Rationale for the Exchange Ratio and Valuation Analysis As also stated in Section 3 of the Merger Plan, the merger exchange ratio has been determined on the basis of the actual value of the assets of TELEFONICA and TELEFONICA MOVILES. TELEFONICA retained Credit Suisse Securities (Europe) Limited (hereinafter, 'Credit Suisse') to provide it with financial advisory services in connection with the merger of TELEFONICA MOVILES and TELEFONICA as well as to evaluate and render an opinion from a solely financial standpoint on the exchange ratio proposed for the merger. On March 29, 2006, at the meeting of the Board of Directors of TELEFONICA held to evaluate the merger, Credit Suisse rendered a written opinion to the Board wherein it concluded that as of such date and on the basis of, and subject to all the considerations set forth therein -including the assumption that, prior to the consummation of the merger, TELEFONICA MOVILES will pay its shareholders a dividend of 0.435 Euro per share in addition to the previously announced dividend of 0.205 Euro per share- the exchange ratio of four TELEFONICA shares for every five shares of TELEFONICA MOVILES was fair to TELEFONICA from a financial point of view. With the advice of Credit Suisse, TELEFONICA carried out the required work of evaluating TELEFONICA and TELEFONICA MOVILES (hereinafter, collectively, the Companies) and based thereon and after arm's-length negotiations with TELEFONICA MOVILES, decided upon the financial terms of the transaction. In performing its financial advisory work for TELEFONICA, Credit Suisse carried out various valuation analyses of TELEFONICA and TELEFONICA MOVILES in connection with the preparation of its fairness opinion, which are summarized below. Valuation Methodology Credit Suisse adopted the following principal methodologies in analyzing the exchange ratio: â€¢ Historical trading ranges; â€¢ Equity research analysts' target prices; â€¢ Comparable company sum of the parts analyses ('SOTP'); and â€¢ Discounted Cash Flow ('DCF') analyses, based both on SOTP and for Telefonica and Telefonica Moviles taken as a whole. On the one hand, Credit Suisse has performed its analyses based on closing prices for the common shares of TELEFONICA and TELEFONICA MOVILES as of March 24, 2006, adjusted to reflect the dividend distributions both companies expect to make; (i) as to TELEFONICA, adjusted for the dividend of â‚¬ 0.250 per share to be paid on May 12, 2006, prior to the consummation of the merger, and (ii) as to TELEFONICA MOVILES, adjusted for the dividend of & euro;0.205 per share and for two extraordinary dividends of â‚¬0.085 and & euro;0.350, representing a total of â‚¬0.435 per share. All said dividends, subject to the necessary approvals, are to be paid on July 21, 2006 prior to the consummation of the merger. On the other hand, Credit Suisse has also performed these financial analyses making no dividend-related adjustment to TELEFONICA's share price and adjusting TELEFONICA MOVILES' share price only by the proposed extraordinary dividend of â‚¬0.435 per share that TELEFONICA MOVILES expects to pay prior to the consummation of the merger. Given that the results obtained with the dividend-related adjustment approaches presented in the two preceding paragraphs of the prices of TELEFONICA and TELEFONICA MOVILES do not materially differ, Credit Suisse has opted for the latter (described in the immediately preceding paragraph) for purpose of its financial summary. Accordingly, all the prices of TELEFONICA MOVILES shown below are adjusted only for the extraordinary dividend of â‚¬0.435 per share. Trading Range Credit Suisse has reviewed the historic range of closing prices of TELEFONICA and TELEFONICA MOVILES and has performed an analysis based on volume-weighted average prices over various time periods: Telefonica Telefonica Moviles(1) Implied Exchange Ratio(2) (Weighted Average) Current Share Price (3/24/2006) â‚¬13.26 â‚¬10.49 0.791 Pre-Speculation Price (3/14/2006) 13.40 9.64 0.719 Previous Week's Average 13.36 9.56 0.716 Previous Month's Average 13.13 9.40 0.716 Average of Previous Six Months 13.02 8.77 0.674 Average of Previous Twelve Months 13.13 8.63 0.657 Pre-Market Speculation Price (2/9/2006)(3) 12.80 8.65 0.675 Previous Month's Average 12.62 8.61 0.682 Price Pre O2 Acquisition (10/28/2005) 13.62 8.21 0.602 Previous Month's Average 13.81 8.40 0,609 Telefonica Moviles IPO (11/22/2000) 15.57 10.57 0.679 Source: FactSet. Note: Prices not adjusted for dividends of â‚¬0.250 per Telefonica share and of â‚¬0.205 per Telefonica Moviles share to be paid prior to completion of the merger, as impact on exchange ratios is not material. (1) Telefonica Moviles price adjusted to reflect the extraordinary dividend of & euro;0.435 per share. (2) Number of Telefonica shares per Telefonica Moviles share. (3) Merrill Lynch published a financial report on Telefonica Moviles on February 10, 2006, on which date TELEFONICA MOVILES shares rose 3.5%. This analysis implies an exchange ratio range of 0.60 to 0.72, taking into account the pre-speculation prices of TELEFONICA and TELEFONICA MOVILES. The exchange ratio has been calculated by dividing Telefonica Moviles' share prices adjusted for the extraordinary dividend by Telefonica's corresponding share prices. Equity Research Analysts' Target Prices Credit Suisse has reviewed and analyzed certain trading prices published by financial analysts for TELEFONICA and TELEFONICA MOVILES shares since January, 2006, and has adjusted Telefonica Moviles' target prices for the extraordinary dividend. These target prices reflect estimates of the future trading price of TELEFONICA and TELEFONICA MOVILES shares and result in the following exchange ratios: Telefonica Telefonica Moviles(1) Implied Exchange Ratio(2) Average â‚¬14.48 â‚¬9.11 0.629 Median 14.28 9.07 0.635 High 14.25 10.07 0.706 Low 16.00 9.27 0.579 Note: Prices not adjusted for dividends of â‚¬0.250 per Telefonica share and of â‚¬0.205 per Telefonica Moviles share to be paid prior to completion of the merger, as impact on exchange ratios is not material (1) Telefonica Moviles price adjusted to reflect the extraordinary dividend of & euro;0.435 per share. (2) Number of Telefonica shares per Telefonica Moviles share. The target prices published by financial analysis do not necessarily reflect the current listing prices of the TELEFONICA and TELEFONICA MOVILES shares. Such estimates are subject to uncertainties, such as the future financial performance of TELEFONICA and TELEFONICA MOVILES or future market conditions. Comparable Company Sum-of-the-Parts Analysis Credit Suisse has performed a sum-of-the-parts comparable trading analysis for TELEFONICA and TELEFONICA MOVILES. Credit Suisse has also compared certain financial information of TELEFONICA and TELEFONICA MOVILES to financial estimates published in financial analysts' reports on other listed companies with business models similar to those of TELEFONICA and TELEFONICA MOVILES. Credit Suisse performed this analysis based on publicly available information for TELEFONICA and TELEFONICA MOVILES. For all significant TELEFONICA business units, including TELEFONICA MOVILES and its subsidiaries, Credit Suisse used consensus forecasts based on a number of equity research reports published by a selected number of brokers that cover these stocks. In addition, Credit Suisse has also performed this analysis using publicly available information for TELEFONICA and internal forecasts prepared by TELEFONICA MOVILES management (and provided by TELEFONICA). Some of the companies used in this comparison are: â€¢ With respect to TELEFONICA's businesses: British Telecom, European telecom operators (Deutsche Telekom, Eircom, France Telecom, Telecom Italia), Latin American wireline operators (Brasil Telecom, CTC Chile, Embratel, Telesp, Telmex) and European and Latin American mobile operators (see next paragraph); and â€¢ With respect to the businesses of TELEFONICA MOVILES: European mobile operators (Cosmote, Mobistar, Vodafone) and Latin American mobile operators (America Movil, Telesp Cellular, TIM Participacoes). The results of both approaches are as follows: Implied Exchange Sum of the parts Telefonica Telefonica Moviles(1) Ratio(2) Comparable Companies- Consensus â‚¬11.11 â‚¬14.99 â‚¬8.28 â‚¬9.82 0.745 - 0.655 Comparable Companies - Consensus + Telefonica Moviles Projections(3) â‚¬11.70 â‚¬15.69 â‚¬8.98 â‚¬10.64 0.767 - 0.678 Note: Prices not adjusted for dividends of â‚¬0.250 per Telefonica share and â‚¬0.205 per Telefonica Moviles share to be paid prior to completion of the merger, as impact on exchange ratios is not material (1) Telefonica Moviles price adjusted to reflect extraordinary dividend of & euro;0.435 per share. (2) Number of Telefonica shares per Telefonica Moviles share. (3) Consensus financial projections, except for the projections for companies that are part of the Moviles Group, which were prepared by Telefonica Moviles management and provided by Telefonica. No company utilized in the comparable companies sum-of-the-parts analysis is identical to TELEFONICA or TELEFONICA MOVILES. Further, Credit Suisse believes this analysis to be not as relevant, given the scarcity of true listed comparables for TELEFONICA's and TELEFONICA MOVILES' component businesses. Discounted Cash Flow ('DCF') Analysis - Sum-of-the-Parts Credit Suisse has conducted this analysis based on (i) individual DCFs for the main business operations for both TELEFONICA and TELEFONICA MOVILES, (ii) equity analysts' target prices for listed subsidiaries of TELEFONICA and TELEFONICA MOVILES and (iii) certain ranges of Average Weighted Cost of Capital and perpetual growth rates. Credit Suisse also performed this analysis using internal forecasts prepared by TELEFONICA MOVILES management (and provided by TELEFONICA). Based on these assumptions, the implied exchange ratios between TELEFONICA and TELEFONICA MOVILES share prices are as follows: Sum-of-the-Parts Telefonica Telefonica Moviles(1) Implied Exchange Ratio(2) DCF - Consensus â‚¬13.14 â‚¬18.21 â‚¬8.40 â‚¬10.81 0.640 - 0.594 DCF -Consensus + Telefonica Moviles Forecasts(3) â‚¬15.05 â‚¬20.62 â‚¬10.66 â‚¬13.65 0.708 - 0.662 Note: Prices not adjusted for dividends of â‚¬0.250 per Telefonica share and â‚¬0.205 per Telefonica Moviles share to be paid prior to completion of the merger, as impact on exchange ratios is not significant. (1) Telefonica Moviles price adjusted to reflect extraordinary dividend of & euro;0.435 per share. (2) Number of Telefonica shares per Telefonica Moviles share. (3) Consensus financial forecasts, except for the forecasts for companies that are part of Grupo Moviles, which were prepared by Telefonica Moviles management and provided by Telefonica. Discounted Cash Flow Analysis Credit Suisse has also conducted a discounted cash flow analysis at both TELEFONICA's and TELEFONICA MOVILES' group level. For such analysis, Credit Suisse has used financial projects based on publicly available information and has prepared a 'consensus.' In this case, Credit Suisse has assumed a weighted average cost of capital range of 9.25%-9.75% for TELEFONICA and of 9.75%-10.25% for TELEFONICA MOVILES and a perpetual growth rate range of 1.0%-2.0% for TELEFONICA and of 2.0%-3.0% for TELEFONICA MOVILES: Telefonica Telefonica Moviles(1) Implied Exchange Ratio(2) Group DCF â‚¬12.53 â‚¬16.96 â‚¬8.61 â‚¬10.73 0.687 - 0.632 Note: Prices not adjusted for dividends of â‚¬0.250 per Telefonica share and of â‚¬0.205 per Telefonica Moviles share to be paid prior to completion of the merger, as impact on exchange ratios is not material. (1) Telefonica Moviles price adjusted to reflect extraordinary dividend of & euro;0.435 per share. (2) Number of Telefonica shares per Telefonica Moviles share. Potential Benefits Credit Suisse has had discussions with TELEFONICA with respect to the potential synergies that TELEFONICA estimates could be created as a result of the merger, mainly by way of cost savings and capital expenditure reduction (especially in information technology and infrastructure). Considering the potential synergies to be created based on TELEFONICA's assumptions, the 0.800 ratio would fall within the exchange ratio ranges calculated with all of the methodologies mentioned in the preceding paragraphs. Valuation of TELEFONICA The actual value of TELEFONICA - taken as the actual value of its undertaking or net worth - used to determine the exchange ratio is â‚¬60,960 million. Such amount was calculated on the basis of the closing price of TELEFONICA shares on March 27, 2006 (â‚¬13.14 per share), deducting a total of â‚¬ 0.25 per share. This adjustment was made on the basis of the interim dividend TELEFONICA intends to distribute prior to the registration of the merger and which will therefore not be attributed to the shareholders of TELEFONICA MOVILES following the exchange. It should be noted that the distribution of a dividend of â‚¬0.25 per share was announced on February 28, 2006, subject to the required corporate authorizations, to be paid following the registration of the merger, which was therefore not taken into account for the adjustment since, given that it benefits both TELEFONICA shareholders and the shareholders of TELEFONICA MOVILES, it has no effect on the formulation of the exchange ratio. The amount of the closing price of TELEFONICA shares, adjusted to reflect the above-mentioned dividends, is â‚¬12.89 per share and, multiplied by a total of 4,729 million TELEFONICA shares, net of treasury shares, results in a value of â‚¬60,960 million. Valuation of TELEFONICA MOVILES The actual value TELEFONICA MOVILES used to determine the exchange ratio is â‚¬44,657 million. This actual value was selected within certain ranges to fit the exchange ratio 4:5. The ranges used for this purpose were calculated using different valuation methods described above. The dividends of â‚¬0.435 and â‚¬0.205 per share that TELEFONICA MOVILES intends to distribute prior to the registration of the merger were naturally also deducted. The above results in a unit value for TELEFONICA MOVILES' shares of â‚¬10.312. Comparison with the Criteria for De-Listing Offers Credit Suisse has also examined the requirements set by the CNMV pursuant to the standards established in Royal Decree 1197/1991 and believes that the terms of the tender offer comply with the statutory requirements for de-listing tender offers for shares. Spanish law sets a number of requirements to be complied with in de-listing tender offers with regard to the minimum price to be offered, which may not be lower than whichever is highest of the following: a. Underlying Book Value: â‚¬1.44 per share as of December 31, 2005. b. Average listing price1 of the last six months: â‚¬9.24 per share. c. Price offered in tender offers for shares made in the last year: not applicable. d. Liquidation value (adjusted UBV): ------------------------ 1The average weighted listing price of TELEFONICA MOVILES for the last six months is â‚¬9.64. The calculation of the liquidation value consists of the Adjusted Underlying Book Value (UBV) of a company in the process of liquidation and thus differs from a possible sale by parts of a going concern. Thus, in the case of TELEFONICA MOVILES, where the UBV is substantially lower than the current listing price of the company's shares, the value resulting from using the liquidation value method will be significantly lower than the implied price of the tender offer, particularly owing to the need to pay taxes on the gains on the sale of assets, as well as to the adverse impact a customary quick sale process would have on the liquidation process. Credit Suisse has therefore not calculated a liquidation value for TELEFONICA MOVILES because it will be lower than the price of the tender offer for the reasons described in the previous paragraph. All the foregoing shows that the valuation of TELEFONICA MOVILES taken into account in formulating the exchange ratio (â‚¬10.312) is considerably higher than the highest of the criteria described above. 4.4 Net Book Value of the TELEFONICA MOVILES Assets to be Received by TELEFONICA According to the individual annual accounts of TELEFONICA MOVILES as of December 31, 2005, the value of the equity of TELEFONICA MOVILES that will be received by TELEFONICA was 4,026,674 thousand Euros on that date. In any event, it is stated for the record that, pursuant to the provisions of the Merger Plan, prior to the execution of the transaction, TELEFONICA MOVILES is expected to, upon the relevant corporate resolutions, and in addition to the previously-announced gross dividend of 0.205 Euro per share to be charged to the earnings of fiscal year 2005 and to unrestricted reserves, distribute extraordinary dividends for the respective gross amounts of 0.085 Euro per share to be charged to the reserve for the issuance premium and other unrestricted reserves, and 0.35 Euro per share to be charged to the profits posted between January 1 and March 28, 2006. 5. CONCLUSION For the foregoing reasons, the directors of TELEFONICA state their conviction that: a. the Merger Plan that is the subject of this Report is highly appropriate for both entities and the shareholders thereof, given that the merger is the most efficient mechanism to confront new customer demands, technological change and the new competitive environment, allowing a greater value creation for shareholders; and b. the exchange ratio proposed in the Plan is justified and is fair to the shareholders of both entities, as confirmed by the reports of the financial advisors and of the independent expert appointed by the Commercial Registry. * * * * * This report has been prepared and approved in Madrid on May 12, 2006 by the directors of TELEFONICA. It is stated for the record that the Directors Mr. Jose Fernando de Almansa Moreno-Barreda, Mr. Maximino Carpio Garcia, Mr. Luis Lada Diaz, Mr. Antonio Massanell Lavilla and Mr. Antonio Viana-Baptista have abstained from participating in the preparation and approval of this Report as they understand that they are affected by a potential conflict of interest. This information is provided by RNS The company news service from the London Stock Exchange More to follow MERUNVSRNWRVAAR

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