TEF-Terra Merger / Reports

Telefonica SA
15 April 2005


PART 2




                         Notes to the English version:

           Free translation of a report originally issued in Spanish
       In the event of discrepancy, the Spanish Language version prevails
  This report does not express an opinion on the fairness of the transaction,
 the value of the security or the adequacy of the consideration to shareholders





             Independent expert report in relation to the plan for

                          the merger by absorption of

                  Terra Networks, S.A. by TelefOnica, S.A.







                              KPMG Auditores, S.L.
                         This report contains 28 pages
                               Ref: 05m31abm1.doc







To the Directors of
Telefonica, S.A. and
Terra Networks, S.A.



Pursuant to the provisions of article 236 of the Revised Text of the Spanish
Corporations Law Ms. Eloisa Bermejo Zofio, Mercantile Registrar number IV for
Madrid and its province, appointed KPMG Auditores, S.L. as independent expert to
prepare this single report regarding the plan to carry out a merger by
absorption of Terra Networks, S.A. by Telefonica, S.A. (hereinafter jointly
referred to as the Companies) and about the net equity contributed by the
company that will disappear and, in particular, as to whether or not the share
exchange ratio is justified, the methods that have been used to calculate it and
whether these are appropriate, stating the values determined and any specific
valuation difficulties that may exist, as well as stating whether the net equity
contributed by the company that will be dissolved is at least equal to the
increase in share capital of the acquiring company.


1     Description of the Transaction

1.1     Identification of the entities participating in the merger


  • Telefonica, S.A. (hereinafter Telefonica)

Telefonica, domiciled in Madrid, at Gran Via, 28, was incorporated for an
indefinite period by means of a notarial instrument executed before Mr.
Alejandro Rosello Pastor, a Madrid Notary, on April 19, 1924, at entry No. 141
in his notarial register.

Telefonica is registered with the Commercial Registry of Madrid, in Book 12.534,
Folio 21, Page M-6.164.

Telefonica's Taxpayer ID number is A-28.015.865.


  • Terra Networks, S.A. (hereinafter Terra)

Terra, domiciled in Barcelona, at Nicaragua, 54, was incorporated for an
indefinite period as Telefonica Comunicaciones Interactivas, S.A. by means of a
notarial instrument executed before Mr. Jose Antonio Escartin Ipiens, a Madrid
Notary, on December 4, 1998, at entry No. 5,276 in his notarial register, and
changed its name to the current one by virtue of an instrument dated October 1,
1999, drawn up before Mr. Francisco Arriola Garrote, a Madrid Notary, and
recorded under entry No. 1,269 in his notarial register. Terra moved to its
current domicile by resolution adopted at the ordinary general shareholders'
meeting held on June 8, 2000, converted into a public instrument before Mr.
Nicolas Ferrero Lopez, a Notary of Pozuelo de Alarcon, on August 3, 2000, and
recorded under entry No. 2,893 in his notarial register.

Terra is registered with the Commercial Registry of Barcelona, in Book 32.874,
Folio 165, Page B-217.925.

Terra's Taxpayer ID number is A-82.196.080.

1.2     Merger share exchange ratio

In accordance with the Merger Plan prepared by the boards of directors of
Telefonica and Terra (hereinafter, the Plan or the Merger Plan), approved on
February 23, 2005, the exchange ratio for the shares of the entities
participating in the merger, which was determined by the Boards of Directors of
Telefonica and Terra on the basis of the actual value of the corporate assets
and liabilities of Telefonica and Terra, will be as follows (with no
supplemental cash compensation):


    Two (2) shares of Telefonica, each having a par value of one euro (euro1),
    for every nine (9) Terra shares, each having a par value of two euro (euro
    2).

The dividends that both companies plan to distribute (see section 1.6) have been
taken into consideration in determining the share exchange ratio.

Furthermore, as mentioned in the Plan, Morgan Stanley & Co. Limited,
(hereinafter Morgan Stanley) as Telefonica's financial advisor for this
transaction (hereinafter, the Transaction) has expressed to the company's board
of directors in its fairness opinion that the agreed-upon exchange ratio
to be paid by Telefonica was fair from a financial point of view to Telefonica's
shareholders. For their part, Lehman Brothers Europe Limited International
(Europe), Spanish Branch, (hereinafter the Lehman) and Citigroup Global Markets
Limited, (hereinafter the Citigroup) as Terra's financial advisors for the
Transaction, have expressed to the latter company's board of directors in their
fairness opinion that from a financial point of view the agreed-upon
exchange ratio is fair for the shareholders of Terra other than its majority
shareholder, Telefonica.



1.3 Merger balance sheets

For the purposes set forth in Article 239 of the Revised Text of the Spanish
Corporations Law, the balance sheets for the merger shall be deemed to be the
individual balance sheets of Telefonica and Terra as of December 31, 2004. These
balance sheets were prepared by the respective boards of directors on February
23, 2005 and verified by the auditors of both companies and will be submitted
for the approval of the shareholders at the general shareholders' meetings of
each of the companies that must decide on the merger, prior to the adoption of
the merger resolution itself.

The merger balance sheet as at December 31, 2004 of Telefonica has been audited
by Deloitte, S.L. who issued an unqualified audit report thereon dated March 4,
2005.

The merger balance sheet as at December 31, 2004 of Terra has been audited by
Deloitte, S.L who issued an audit report on the individual annual accounts dated
February 24, 2005 including the following emphasis paragraphs which are
transcribed literally:


    '3) Since the Company is the head of a group and meets certain requirements,
    it is obliged under current legislation to prepare separate consolidated
    financial statements, on which we issued our auditors' report on this same
    date which was qualified for the same uncertainty as that described in
    paragraph 5 to this report. The effect of consolidation, which was performed
    on the basis of the individual accounting records of the companies composing
    the Terra Group, with respect to the individual financial statements
    referred to above, was to decrease assets and the income for the year by &
    euro;303,399 thousand and euro26,945 thousand, respectively, and to
    increase reserves by euro27,717 thousand (see Note 4-c to the
    financial statements referred to above).

    4) On February 23, 2005, the Board of directors of Terra Networks, S.A.,
    approved the plan for the merger of Telefonica, S.A. and the Company. This
    merger has not yet been approved by the respective Stockholders' Meetings.
    In this connection, the financial statements referred to above were prepared
    without taking into account the effects, if any, that could arise from the
    aforementioned merger.

    As of December 31, 2004, the 'Long-Term Investments' caption
    included a balance of euro287,009 thousand, relating to prepaid income
    taxes and tax assets capitalized for tax losses incurred in 2001 and prior
    years (see Note 9). The directors of Terra Networks, S.A. consider that,
    subject to the materialization of certain circumstances and the fulfillment
    of certain assumptions, and based on the projections and business plans
    prepared by their external advisers for the next ten years, in the context
    of the aforementioned merger, this amount is recoverable in the
    aforementioned period of time. In view of the nature of any business plan,
    which is based on future expectations, significant differences may arise
    between the projected and actual results. Management of Terra Networks, S.A.
    intends to update the plan every year and, in any case, whenever the
    evolution of the business makes this necessary.'

    The report also includes the following qualification:

    '5) As indicated in Note 14-d)1, as of the date of this Auditors'
    Report no decision had yet been handed down in relation to the claim for
    damages of an unquantified amount, filed by IDT (International Discount
    Telecommunications Corporation) against Terra Networks, S.A., Terra Networks
    USA, Inc. and Telefonica, S.A. The Company's directors and their external
    legal advisers consider that Terra Networks, S.A., has solid arguments on
    which to oppose the claims; although at the present stage of the proceedings
    they consider that they cannot predict the final outcome thereof.'

1.4     Maximum increase in capital of Telefonica

The Merger Plan states that, at the date of the Plan, Telefonica held four
hundred and thirty-six million two hundred and five thousand four
hundred and nineteen (436,205,419) Terra shares, representing seventy five point
eighty seven percent (75.87%) of the share capital.

The share capital of Terra is represented by 574,941,513 shares. The report also
states that at that date, Terra held seven million (7,000,000) treasury stock,
which were allocated for redemption following the amendment of the hedging
system for the various Terra stock option plans for employees and management.
The above-mentioned seven million (7,000,000) shares will not be part of
the exchange, in compliance with the provisions of Article 249 of the Revised
Text of the Spanish Corporations Law and similar provisions, although, following
the registration of the merger, Telefonica will succeed Terra as the entity
bound by such plans, which will be amended in accordance with the share exchange
ratio established in this Plan. To avoid prejudice to the interests of the
beneficiaries of these plans, Telefonica will establish, if necessary,
mechanisms to ensure that due attention will be given to the commitments assumed
by Terra in connection with the above-mentioned stock option plans.

Considering that the share capital of Terra is represented by 574,941,513 shares
and that at the date of the merger Terra will hold 7,000,000 treasury stock, the
maximum number of Terra shares that may be subject to the exchange would be
131,736,094 and, therefore, the maximum number of Telefonica shares to be
conveyed to the Terra shareholders in the exchange would amount to
29,274,687.555.

Considering that the shares are indivisible and that fractions of shares cannot
be issued or conveyed, it is imperative that the total number of Terra shares on
the market for the share exchange must be a multiple of the share exchange ratio
for the exchange to be properly carried out. Consequently, Telefonica plans to
acquire seven additional Terra shares. In this case, the maximum number of
shares necessary to perform the share exchange would be 29,274,686.

The Plan states that, if necessary, Telefonica will increase its share capital
by the exact amount needed to make the exchange for Terra shares in accordance
with the exchange ratio established in the Merger Plan.

The increase would be carried out through the issuance of the precise number of
shares, each having a nominal value of one euro (euro1), belonging to the same
single class and series as the current Telefonica shares, as represented by book
-entry accounts, with the application, in any event, of the provisions
of Article 249 of the Corporations Law. In particular, the Terra shares held by
Telefonica will not be exchanged, and will be cancelled.

The difference between the net book value of the assets and liabilities received
by Telefonica by virtue of the merger covered by the Plan and the par value of
the new shares issued by Telefonica - adjusted, if necessary, by the proportion
represented by the new shares of the total shares delivered in exchange - shall
be treated as share issuance premium.

Both the par value of such shares and the corresponding share issuance premium
shall be entirely paid-up as a result of the en bloc conveyance of the
corporate assets and liabilities of Terra to Telefonica, which, through
universal succession, shall acquire the rights and obligations of Terra.

Based on Terra's individual annual accounts at December 31, 2004, the value of
shareholders' equity of Terra amounted to Euros 1,633,964 thousand at that date.
The value of shareholders' equity of Terra, net of treasury stock, at that date
amounted to Euros 1,618,844 thousand.

Prior to execution of the merger, Terra plans to distribute a dividend of euro
0.60 per share issued with dividend-receipt rights, which should be
taken into account in determining the book value of the assets and liabilities
of Terra that will be transferred to Telefonica. The total amount of this
dividend, considering that Terra's treasury stock currently totals 7,000,000
shares, would be Euros 340,765 thousand.

Consequently, the total amount of the share capital increase that Telefonica
would be required to make would amount to Euros 29,274,686. The maximum share
issuance premium, calculated on the basis of the net assets and liabilities of
Terra at December 31, 2004 less the total amount of the dividends that Terra
plans to distribute prior to the inscription of the merger in the Commercial
Registry would amount to Euros 267,180 thousand.

Not withstanding the above, the maximum amount of the capital increase to be
carried out by Telefonica pursuant to the established exchange ratio may be
reduced through the delivery to Terra shareholders of old own shares held by
Telefonica as treasury stock.

1.5     Date from which the shares delivered in exchange will carry the right to
participate in corporate earnings

Shares that may be issued by Telefonica in connection with the capital increase
mentioned in the previous paragraph, will entitle their owners to participate in
the corporate earnings obtained by Telefonica as from January 1, 2005.

Previously existing Telefonica shares and shares delivered or issued in
connection with the exchange will participate, with equal rights in proportion
to the par value of each share, in distributions made after the date that the
merger deed is recorded with the Commercial Registry.

1.6     Dividends

For the preparation of this Merger Plan and the determination of the share
exchange ratio indicated in Section 1.2 above, the boards of directors of
Telefonica and Terra took into consideration the following dividend-
payment plans:


 a. Telefonica plans to make the following distributions:


     i. Payment of an interim dividend on account of the earnings for the fiscal
        year ended December 31, 2004, which will be paid on May 13, 2005. This
        dividend was announced by the board of directors at its meeting held on
        January 26, 2005 and amounted to euro0.23 per share.

        As indicated in Section 1.5 above, Terra shareholders who become
        Telefonica shareholders as a result of the merger will not benefit from
        this dividend. This has been taken into consideration in the calculation
        of the share exchange ratio.
    ii. The distribution of Telefonica's treasury stock, at the ratio of one
        share of treasury stock for every twenty-five shares owned by
        the shareholders, to be charged against the share issuance premium. The
        proposal for this distribution plan was approved by the board of
        directors at its meeting held on November 24, 2004. The distribution is
        subject to the corresponding approval by the shareholders of Telefonica
        at their ordinary general meeting. The payment is expected to be made
        during the days following the meeting and, in any event, before the
        merger of Telefonica and Terra is recorded with the Commercial Registry.

        Terra shareholders who become Telefonica shareholders as a result of the
        merger will not benefit from such distribution. This was therefore taken
        into consideration in the determination of the share exchange ratio.
    iii. The payment of a dividend with a charge against the share issuance
        premium which should be paid on November 11, 2005. The proposal for this
        dividend was announced by the board of directors at its meeting held on
        November 24, 2004. The distribution is subject to the corresponding
        approval by shareholders at the ordinary general shareholders' meeting
        of Telefonica. The exact amount of this dividend is expected to be &
        euro;0.27 per share.

        Unlike the provisions for dividends described above in subsections (i)
        and (ii), this dividend will be received by both the Telefonica
        shareholders and the Terra shareholders who become Telefonica
        shareholders as a result of the merger. This was therefore not taken
        into consideration in the determination of the share exchange ratio.


 b. Terra expects to distribute a dividend of euro0.60 per share, with a charge
    to the share issuance premium. The proposal for this distribution was
    approved by the board of directors at its meeting held on February 23, 2005.
    The distribution is subject to the corresponding approval by the
    shareholders at the ordinary general shareholders' meeting of Terra. Payment
    is expected to be made during the days following the meeting and, in any
    event, before the merger of Telefonica and Terra is recorded with the
    Commercial Registry.

Only the shareholders of Terra will benefit from such distribution. This was
therefore taken into consideration in the determination of the share exchange
ratio.

1.7     Date of the accounting effects of the merger

January 1, 2005 is established as the date from which the transactions of Terra
shall be deemed for accounting purposes to be for the account of Telefonica.

1.8     Administrative authorizations

The effectiveness of the planned merger shall be subject to the provision of
notices and the procurement of the applicable relevant authorizations and
registrations in Spain and in the other jurisdictions in which both companies
are present.


2     Valuation methods used to determine the share exchange ratio

A description of the methods followed by the Board of Directors of Telefonica
and Terra to determine the share exchange ratio, based on information received
from these companies, is as follows:



2.1     Telefonica

The actual value of Telefonica used by the Board of Directors to determine the
share exchange ratio amounted to euro66,361 million. This amount has been
calculated based on the closing trading price of Telefonica on February 21, 2005
(euro14.19 per share), discounting a total of euro0.80 per share. This
adjustment has been made on the basis of the dividends that Telefonica intends
to distribute prior to registration of the merger and which, accordingly, will
not be attributable to the shareholders of Terra once the share exchange has
taken place. The dividends considered are as follows: (i) a dividend of euro
0.23 per share on account of profits for the year ended December 31, 2004, which
will be paid to the current shareholders of Telefonica on May 13, 2005; and (ii)
a non-monetary dividend, with a charge to the share issuance premium, of
one share from Telefonica treasury stock for every twenty five shares held by
the Telefonica shareholders which is planned to be paid immediately after the
ordinary general meeting of shareholders is held to decide upon the merger. The
estimated value of this dividend is euro0.57 per share. The euro0.27
dividend per share that is planned to be paid on November 11, 2005 has not been
taken into consideration in making the adjustment because it will be paid
subsequent to the registration of the merger and, consequently will benefit both
the shareholders of Telefonica and the shareholders of Terra and will therefore
not affect the share exchange ratio.

The closing trading price of Telefonica shares adjusted for the aforementioned
dividends amounts to euro13.39 per share and, multiplied by a total of 4,956
million Telefonica shares amounts to euro66,361 million.

The Companies, after consultation with their financial advisors, consider that
the valuation method based on the market quotation of the company is justified
given the high level of liquidity of Telefonica shares.

Based on the information received from Telefonica, management of Telefonica
contracted the services of Morgan Stanley as financial advisors for the
Transaction, and to assist Telefonica with the valuation process of the
Companies and Telefonica's determination and justification of the merger
exchange ratio.

Appendix I includes the report prepared by Telefonica summarizing the valuation
analyses and the justification of the share exchange ratio prepared by
Telefonica with the financial advice of Morgan Stanley.

2.2     Terra

The actual value of Terra used by the Board of Directors to determine the share
exchange ratio is euro1,690 million. This actual value has been based on the
sum-of-the-parts method, principally based on the
discounting of cash flows, which has been contrasted with the following
valuation methods: (i) multiples of comparable quoted companies, (ii) multiples
paid in comparable transactions (iii) market quotations, and (iv) target prices
of equity analysts. Furthermore, a dividend of euro0.60 has been discounted
which Terra plans to distribute prior to the registration of the merger. The
resulting unit value of the Terra share is euro2.98.

Based on the information received, Terra contracted the services of Citigroup
and Lehman as financial advisors for the Transaction, and to assist Terra with
the valuation process of the Companies and Terra's determination and
justification of the merger share exchange ratio.

Appendix II includes the reports prepared by Terra summarizing the valuation
analyses and the justification of the share exchange ratio prepared by Terra
based on the advice of its financial advisors Citigroup and Lehman.


3     Scope and procedures applied in our work

Our analyses and confirmations have been carried out solely to comply with the
requirements of article 236 of the Revised Text of the Spanish Corporations Law.
The following procedures have been employed in our work:



3.1 Procurement and analysis mainly of the following information:


  • The Merger Plan of February 23, 2005 formulated and approved by the boards
    of directors of Telefonica and Terra.

  • Certificates of agreements of the boards of directors of Telefonica and
    Terra relating to the approval of the Merger Plan of February 23, 2005.

  • Fairness opinions and valuation analysis documents on the Companies
    prepared by Morgan Stanley & Co. Limited, Lehman Brothers International
    (Europe), Spanish Branch and Citigroup, upon request of the respective
    boards of directors of the respective Companies.

  • Information prepared by Terra and Telefonica in reply to the information
    required by the CNMV relating to the merger transaction dated February 25,
    2005 and March 23, 2005.

  • Individual and consolidated audited annual accounts of Telefonica and
    Terra for the years ended December 31, 2003 and 2004, audited by Deloitte,
    S.L. Audited annual accounts of Terra Networks Espana, S.A., Sociedad
    Unipersonal for the year ended December 31, 2004 audited by BDO Audiberia
    Aduitores, S.L.

  • Strategic Plan of Terra for the period from 2005 to 2008 both inclusive.

  • Budget for Terra in respect of 2005.

  • Financial projections of the statements of profit and loss of Terra
    prepared by management for the period from January 1, 2005 to December 31,
    2008.

  • Analytical financial information for Terra, by line of business, for the
    years ended December 31, 2003 and 2004.

  • Financial projections of the statements of profit and loss of Telefonica
    prepared by management for the period from January 1, 2005 to December 31,
    2008.

  • Tax and legal reports relating to the planned merger, prepared for or by
    the management of each Company.

  • Strategic Alliance Framework Agreement signed between Telefonica and
    Terra.

  • Other commercial and shareholder contracts of the Companies, including
    those relating to options and binding offers for the purchase/sale of
    significant shareholdings or those under negotiation, which were considered
    relevant to the performance of our work.

  • Stock exchange information on the quotations of Telefonica and Terra
    shares.

  • Stock exchange information on shares of companies comparable to Telefonica
    and Terra.

  • Public information on transactions concerning shares of companies with
    similar activities to those of Terra and Telefonica or any of their
    businesses, where appropriate.

  • Financial reports prepared by equity research analysts on Telefonica and
    Terra.

  • Other information considered relevant to our work.

3.2     Review and analysis using available information of each of the valuation
analysis documents and the Fairness Opinions provided by the respective
investment banks.

3.3     Review of the valuation methodologies employed and the respective
parameters used by the Board of Directors to determine the share exchange ratio
for the projected merger, with available supporting documentation.

3.4     Sensitivity analysis of the most significant variables which could
affect the business of the Companies and, consequently, their estimated values
and the corresponding share exchange ratio.

3.5     Meetings with management of both Companies and their advisors and
auditors to gather other information, where applicable, which may be considered
relevant to our work.

3.6 Procurement of a letter signed by the management of each Company confirming
that, to the best of their knowledge, we have been provided with all information
considered relevant for the preparation of our independent expert report, and
that no other events have taken place between the date of the auditors' reports
of Telefonica and Terra for the year ended December 31, 2004 and the date of our
report that have not been brought to our attention and which may substantially
modify the true and fair view of the Companies' net equity and/or financial
position at that date and, consequently, affect the merger share exchange ratio.

Our work has been based on audited and/or unaudited information provided by
Management of the Companies. For the purposes of our work we have assumed that
this information is complete and accurate, and that it reflects the Companies'
Management's best estimates of the future operating and financial prospects of
the businesses.

Our work has also been based on information taken from public sources. However,
our work did not include contrasting this information with external evidence.
Nonetheless, we have confirmed, to the extent possible, that information
provided is consistent with other data that has been provided to us during the
course of our work.

We have assumed that all the required authorisations and registrations in Spain
and other jurisdictions, in which the companies are present necessary to carry
out the proposed merger transaction will be obtained without any adverse effect
to Telefonica or Terra or the expected benefits of the merger transaction which
could have a significant effect on our analysis.

We would also point out that our work is of an independent nature and therefore
does not represent any kind of recommendation to Companies' management,
shareholders or to third parties in relation to the position which should be
taken regarding the planned merger Transaction or other transactions involving
the Companies' shares. Our work does not address the relative merits of the
current or past business strategies of the Companies or the planned merger
transaction as compared to other business strategies or transactions that might
be available to the Companies, nor does it address the underlying business
decision of the Companies to proceed with the proposed merger transaction.


4     Special valuation difficulties

4.1     In addition to objective factors, all valuation work involves subjective
factors which require the use of judgment. Consequently, the 'value' obtained
represents only a point of reference for the parties interested in carrying out
a transaction. It is therefore not possible to provide assurance that third
parties would necessarily agree with the conclusions reached.

4.2     It should also be taken into consideration that, in the context of an
open market, different prices could exist for a particular business due to a
number of subjective factors.

4.3 The discounted cash flow method used, among others, by the Companies and
their financial advisors for the valuation of Terra and Telefonica has been
based on the financial projections of the Companies prepared in accordance with
the assumptions determined by the Companies' management, comprising their best
estimates and judgments based on current circumstances and expected
developments. Given the uncertainties inherent in any information concerning the
future, certain assumptions may not materialize as initially defined and
unexpected events could occur. It should be also taken into consideration that
Terra forms part of the Telefonica group and the policies of both companies
could therefore be more closely inter-related. Considering both of these
circumstances, the estimated results and cash flows may not materialize as
defined. If Telefonica were not a shareholder of Terra, the results and cash
flows could differ from those used and the values obtained could therefore be
affected.

4.4 Based on the information received in relation with Terra's sale of its
participation in Lycos Inc. in 2004, Telefonica is considering the possibility
of reporting additional tax losses for the 2004 tax year, under the procedure
established in the third additional provision of Royal Decree 1163 of 21
September 1990, up to a maximum additional amount of euro7,418 million. The
additional tax loss carried forward would arise as a result of using, as the tax
acquisition value of the shares in Lycos Inc, their fair market value at
acquisition date rather than their net book value at which they were accounted
for. Although, based on the interpretation of applicable tax legislation,
certain technical arguments exist to support the rectification of the income tax
return to claim the additional tax losses, the absence of identical or similar
precedents that permit their application gives rise to reasonable uncertainties
as to their possible acceptance by the tax authorities and, consequently, the
possible effective use of such tax credits by the consolidated tax group of
Telefonica, as well as the period in which these tax credits would become
available for use.

4.5 We would point out that in accordance with information obtained and meetings
held it is not possible to reliably estimate the terms or probability of renewal
of the Strategic Alliance Framework contract between Telefonica and Terra dated
February 12, 2003 when it expires on December 31, 2008. By virtue of this
contract Telefonica guaranteed Terra a minimum margin of euro78.5 million per
annum until December 31, 2008 measured as the difference between the income
resulting from the services rendered as a result of this agreement and the
directly associated costs and investments.

4.6 The audit report on the consolidated annual accounts of Terra for the year
ended December 31, 2004 included the following qualification:


    '5) As indicated in Note 17-d)1, as of the date of this Auditors'
    Report no decision had yet been handed down in relation to the claim for
    damages of an unquantified amount, filed by IDT (International Discount
    Telecommunications Corporation) against Terra Networks, S.A., Terra Networks
    USA, Inc. and Telefonica, S.A. The Company's directors and their external
    legal advisers consider that Terra Networks, S.A., has solid arguments on
    which to oppose the claims; although at the present stage of the proceedings
    they consider that they cannot predict the final outcome thereof.'

Consequently, the estimated range of values might have been affected had the
outcome of the current uncertainty regarding this claim been known.


5     Conclusions

Based on the work carried out, with the sole purpose of complying with article
236 of the Revised Text of the Spanish Corporations Law and considering those
matters described in section 4 above, we consider that:


  • The valuation methodologies used by the Board of Directors to determine
    the actual value of the Companies are appropriate in the context and the
    circumstances of the proposed transaction, and justify the share exchange
    ratio proposed in the Merger Plan.

  • The net equity transferred by the company that will be dissolved is at
    least equal to the maximum increase in capital of the acquiring company as
    foreseen in the Merger Plan.

Our conclusion should be interpreted within the context of the scope of our
verifications, which does not include responsibilities other than those relating
to the reasonableness of the methods employed and the proposed share exchange
ratio.

This report has been prepared exclusively to comply with the provisions of
article 236 of the Revised Text of the Spanish Corporations Law and should not
be used for any other purpose.





/s/Ana Martinez Ramon

Partner



12 April 2005



Appendix I

Telefonica engaged Morgan Stanley & Co. Limited (hereinafter Morgan Stanley) to
provide financial advisory services, including the assistance to Telefonica in
the valuation of the companies, and the determination of the proposed merger
exchange ratio. On February 23, 2005 Morgan Stanley rendered a fairness opinion
to the Board of Directors of Telefonica in relation to the Transaction, in which
it concluded that, based upon and subject to the considerations set forth in the
said document, the exchange ratio to be paid by Telefonica and the extraordinary
dividend of euro0.60 per share to be distributed by Terra to its shareholders
pursuant to the Merger Plan were fair from a financial point of view for
Telefonica.

Telefonica determined the financial terms of the Transaction reflected in the
Merger Plan based on valuation work performed, the advisory services of Morgan
Stanley and negotiations with Terra under market conditions.

As part of its financial advisory services to Telefonica, Morgan Stanley carried
out various analyses of the valuation of the companies in relation to the
preparation of its fairness opinion. The analyses, summarized below, were based
on closing prices for the ordinary shares of Telefonica and Terra as of February
21, 2005, adjusted to reflect the following dividend distributions announced by
each of the two companies:


 i. Telefonica's share price: adjusted for a total of euro0.80 per share in
    dividends announced by Telefonica (which will not be payable to Terra's
    current shareholders in respect of the Telefonica shares they will receive
    following the merger, pursuant to the Merger Plan) as follows: (a) euro
    0.23 per share cash dividend payable to Telefonica's current shareholders on
    May 13, 2005; on account of profits for the year ended December 31, 2004;
    and (b) the distribution of one Telefonica share held in treasury stock for
    every 25 Telefonica shares held by current Telefonica shareholders with a
    charge to the share premium reserve following the annual general
    shareholders' meeting to be held on May 25, 2005 (estimated at euro0.57
    per share at Telefonica's closing share price as of February 21, 2005).

ii. Terra's share price: adjusted for the extraordinary cash dividend of euro
    0.60 per share announced by Terra's board on February 23, 2005, which will
    be distributed to Terra's current shareholders prior to inscription of the
    merger in the Commercial Registry.



Trading Range Analysis

Morgan Stanley reviewed the range of closing prices of Telefonica and Terra
ordinary shares for various periods ended February 21, 2005. Morgan Stanley
observed the following:

Period ended February 21, 2005                         Telefonica                          Terra

Last Three Months                                     euro12.18 - euro13.76    euro2.20 - euro2.70

Last Six Months                                       euro10.66 - euro13.76    euro2.17 - euro2.70

Last Twelve Months                                    euro10.40 - euro13.76    euro2.17 - euro2.70

Morgan Stanley calculated that the exchange ratio of 2 Telefonica ordinary
shares for every 9 Terra ordinary shares pursuant to the Merger Plan represented
a 15% premium on the unaffected share price of Terra ordinary shares as of
February 11, 2005, and a 14% premium on the average price of Terra ordinary
shares for the 30 trading days prior to February 21, 2005.

Comparable Companies Analysis

Morgan Stanley compared certain financial information of Telefonica and Terra
with publicly available consensus financial projections in analysts' reports for
other companies that shared similar business characteristics to Telefonica and
Terra, respectively. The companies used in this comparison were as follows:


 i. With respect to Telefonica: Belgacom, British Telecom, Deutsche Telekom,
    France Telecom, KPN, Hellenic Telecommunications (OTE), Portugal Telecom,
    Swisscom, Tele Danmark (TDC), Telecom Italia, TeliaSonera, Telekom Austria
    and Telenor; and

ii. With respect to Terra: using as reference the unaffected closing share price
    of T-Online as of October 8, 2004 (prior to Deutsche Telekom's
    announcement of a minority buy-out tender offer followed by a merger
    with T-Online)

For the purposes of this analysis, Morgan Stanley analyzed the ratio of
enterprise value (defined as market capitalization plus total debt less cash and
cash equivalents, plus other adjustments) to estimated calendar year 2005
earnings before interest, taxes, depreciation and amortization for Telefonica
and to estimated calendar year 2006 earnings before interest, taxes,
depreciation and amortization for Terra. Morgan Stanley applied this multiple to
Telefonica's 2005 and Terra's 2006 earnings before interest, taxes, depreciation
and amortization, utilizing as information sources for Telefonica, publicly
available consensus financial projections analysts' reports, and for Terra,
financial projections prepared by the management of Terra.

Based on Telefonica's and Terra's current number of outstanding ordinary shares
and options, Morgan Stanley estimated the implied value per Telefonica and Terra
ordinary share, respectively, as of February 21, 2005, as follows:
                                                                         Comparable Companies'
                                               Relevant data Statistic         Multiples        Implied Value Per Share
               Financial data
                                                       (EBITDA)

Telefonica Aggregate Value to Estimated 2005         euro14,301 million     5.6x - 6.6x         euro10.89 -  euro13.77
Earnings Before Interest, Taxes, Depreciation                                                        
and Amortization (EBITDA)

Terra Aggregate Value to Estimated 2006               euro60 million              12.6x                euro2.67
Earnings Before Interest, Taxes, Depreciation
and Amortization (EBITDA)

None of the companies utilized in the comparable companies analysis are
identical to Telefonica or Terra. In evaluating comparable companies, Morgan
Stanley made judgments and assumptions with regard to industry performance,
general business, economic, market and financial conditions and other matters,
many of which are beyond the control of Telefonica or Terra, such as the impact
of competition on the businesses of Telefonica or Terra and the industry
generally, industry growth and the absence of any adverse material change in the
financial condition and prospects of Telefonica or Terra or the industry or in
the financial markets in general. Mathematical analysis (such as determining the
average or median) is not in itself a meaningful method of using comparable
company data.

Discounted Cash Flow Analysis

Morgan Stanley calculated the range of equity values per ordinary share for
Telefonica and Terra based on a discounted cash flow analysis. With respect to
Telefonica, Morgan Stanley relied on publicly available consensus financial
projections in analysts' reports for calendar years 2005 through 2010 and
extrapolations from these projections for calendar years 2011 through 2014. In
arriving at a range of equity values per share of Telefonica ordinary shares,
Morgan Stanley calculated the terminal value by applying a range of perpetual
growth rates ranging from 1.0% to 1.5%. The unlevered free cash flows for
calendar year 2005 through 2014 and the terminal value were then discounted to
present values using a range of discount rates (weighted average cost of
capital) of 8.0% to 9.0%. With respect to Terra, Morgan Stanley relied on
Terra's financial projections provided by the management of Telefonica (which in
turn had received them from Terra) for calendar years 2005 through 2008 and
extrapolations from such projections for calendar years 2009 through 2014.

With respect to those financial projections and other information and data
relating to Terra, including information as to Terra's tax situation, Morgan
Stanley was advised by the Telefonica management that these projections and
other information and data were prepared on bases of best current estimates and
judgments of the management of Telefonica as to the future financial performance
of Terra and of its tax situation. In arriving at a range of equity values per
share of Terra ordinary shares, Morgan Stanley calculated the terminal value by
applying a range of perpetual growth rates from 3.0% to 4.0%. The unlevered free
cash flows from calendar year 2005 through 2014 and the terminal value were then
discounted to present values using a range of discount rates of 11.5% to 12.5%.
The unlevered free cash flows included the benefits for Telefonica resulting
from the business or future tax or other savings of Terra, as well as payments
to be received by Terra under its strategic alliance agreement signed with
Telefonica.

The following table summarizes the results of Morgan Stanley's analysis:

                                              Implied Equity        Implied Equity Value
              Key Assumptions                Value (millions)         Per Share (euro)

Telefonica: 1.0% - 1.5% perpetual            euro69,928-euro88,215   euro14.11-euro17.80
growth rate, 8.0% - 9.0% discount    
rate                                                            
Terra: 3.0% - 4.0% perpetual growth          euro1,448-euro1,522     euro2.55 - euro2.68
rate, 11.5% - 12.5% discount rate          
                                                   

Equity Research Analysts' Price Targets

Morgan Stanley reviewed and analyzed the public market trading price targets for
Telefonica and Terra ordinary shares prepared and published by equity research
analysts. These price targets reflect each analyst's estimate of the future
public market trading price of Telefonica and Terra ordinary shares. The range
of equity analyst price targets reviewed for Telefonica and Terra were euro
13.70 - euro15.70 and euro2.30 - euro2.65, respectively.

The public market trading price targets published by equity research analysts do
not necessarily reflect current market trading prices for Telefonica or Terra
ordinary shares and these estimates are subject to uncertainties, including the
future financial performance of Telefonica and Terra and future financial market
conditions.

Precedent Transactions Analysis

Morgan Stanley reviewed Deutsche Telekom's minority buy-out tender offer
for the 26% free float of T-Online it did not own and the follow
-on merger between Deutsche Telekom and T-Online announced on
October 9, 2004.

For the purposes of this analysis, Morgan Stanley analyzed the ratio of
enterprise value, defined as market capitalization plus total debt less cash and
cash equivalents plus other adjustments, to estimated calendar year 2005
earnings before interest, taxes, depreciation and amortization and applied this
multiple to Terra's 2005 earnings before interest, taxes, depreciation and
amortization, included in the financial forecasts prepared by the management of
Terra. Based on Terra's current number of outstanding ordinary shares and
options, Morgan Stanley estimated the implied value per Terra ordinary share as
of February 21, 2005 as follows:
                                                       Multiple applied    Implied
                                           Financial  based on precedent  Value Per
              Financial data               Statistic     transaction        Share

Enterprise Value of Terra to Estimated   euro52million       17.7x        euro2.96
2005 Earnings Before Interest, Taxes,                                
Depreciation and Amortization

None of the companies or transactions utilized in the precedent transaction
analyses were identical to Terra or the merger. In evaluating the precedent
transaction, Morgan Stanley made judgments and assumptions with regards to
general business, market and financial conditions and other matters, many of
which are beyond the control of Terra, such as the impact of competition on the
business of Terra or the industry generally, industry growth and the absence of
any adverse material change in the financial condition of Terra or the industry
or in the financial markets in general, which could affect the public trading
value of the company or enterprise value of the transactions to which they are
being compared.

Exchange Ratio Analysis

Morgan Stanley reviewed the ratios of the closing prices of Terra ordinary
shares divided by the corresponding closing prices of Telefonica ordinary shares
over various periods ended February 21, 2005. Morgan Stanley examined the
premiums represented by from the merger exchange ratio of 0.2222, as set forth
in the Merger Plan, using the benchmarks mentioned below and found them to be as
follows:

                                  Telefonica              Terra        Implied exchange ratio     Implied
                                (euro/share)        (euro/share)                                  premium1
last 90-day                   euro12.18 - euro2.20  euro2.20-euro2.70     0.181 - 0.196         23% - 13%
average                         
                                
last six-month                euro10.66 - euro13.76 euro2.17-euro2.70     0.196 - 0.204          9% - 13%
average                           
last twelve-month             euro10.40 - euro13.76 euro2.17-euro2.70     0.196 - 0.209          6% - 13%
average                           

1Implied premium defined as announced exchange ratio of 0.2222 divided by
implied exchange ratio for each average valuation





Appendix II

Terra engaged Citigroup Global Markets Limited (hereinafter Citigroup) and
Lehman Brothers Europe Limited (hereinafter Lehman Brothers) to provide
financial advisory services in connection with the Transaction and to assist
Terra with the valuation process of Terra and Telefonica and Terra's
determination and justification of the proposed exchange ratio for the merger.
On February 23, 2005 both entities rendered a fairness opinion to the Board of
Directors of Terra in relation to the Transaction in which they concluded that,
based upon and subject to the considerations set forth in their reports, the
merger exchange ratio and the extraordinary dividend of euro0.60 per share to
be distributed by Terra to its shareholders pursuant to the Merger Plan were
fair from a financial point of view for the shareholders of Terra other than
Telefonica.

Terra determined the financial terms of the Transaction reflected in the Merger
Plan based on valuation work performed, the advisory services of both firm and
advisors and negotiations with Telefonica under market conditions.

As part of their financial advisory services to Terra, Citigroup and Lehman
Brothers carried out various analyses of the valuation of Companies in relation
to the preparation of their respective fairness opinions. A summary of the
analysis carried out by each of the aforementioned advisors is set out below:

1     Citigroup

A summary of the principal financial analyses performed by Citigroup in
connection with the preparation of its fairness opinion is set out below. For
these purposes, Citigroup considered, inter alia, the proposed dividend of &
euro;0.23 per share to be distributed by Telefonica with a charge to 2004 and
the distribution proposed by Telefonica of 1 Telefonica share for every 25
Telefonica shares, in which holders of Terra shares would not benefit, as well
as the proposed dividend of euro0.60 per Terra share, which would be paid to
all holders of Terra shares.

Historical Share Price Performance

Citigroup reviewed the relationship between movements in prices of Terra
ordinary shares and the implied offer price for the merger for the period from
July 25, 2003, the date on which Telefonica officially announced to the CNMV the
number of Terra ordinary shares it had acquired in the tender offer, through
February 11, 2005, the last trading day before Telefonica publicly announced its
intention to make an offer for a merger transaction with Terra. The implied
offer price for the merger was calculated by multiplying the adjusted Telefonica
share price by the exchange ratio of 2/9 and then adding euro0.60 for the
effect of the anticipated dividend on Terra ordinary shares to be paid before
consummation of the merger. The adjusted Telefonica share price was arrived at
by subtracting the anticipated cash dividend of euro0.23 from the Telefonica
unadjusted share price and then adjusting the result for the anticipated
dividend in shares on Telefonica ordinary shares of one share for every 25
shares. Terra shareholders will not participate in these cash and stock
dividends. Citigroup also adjusted the Terra share price for the euro2.00 cash
dividend per Terra ordinary share paid in July 2004 in the period prior to the
payment of such dividend.

In addition, Citigroup compared the implied offer price with the trading price
of a Terra ordinary share on February 11, 2005 (the last trading day prior to
the public announcement of Telefonica's intention to make an offer) and the one
-, three- and six-month averages trading prices in the
periods prior and up to February 21, 2005, in the case of Telefonica, and up to
February 11, 2005, in the case of Terra. The following table sets forth the
results of this analysis:

                        Terra Ordinary Share Price  Implied Offer Price (&  Premium
                                 (euro)                   euro;)
February 11, 2005                  3.19                      3.58           12%
Last Month Average                 3.11                      3.56           14%
Last 3-Month                       2.96                      3.49           18%
Average
Last 6-Month                       2.90                      3.35           16%
Average



Precedent Transactions Analysis

Considering that Telefonica currently controls Terra, Citigroup compared the
premium that the implied offer price for the merger represented over the price
on the last trading day before announcement and over the three- and six
-month trailing averages with the premia paid similar last trading days
and for similar trailing periods represented by:


  • the cash consideration for four recent de-listing tender offers by
    Spanish companies;

  • the consideration in three recent mergers involving significant
    shareholders (owning less than half of the equity) of Spanish companies
    acquiring the remainder of the equity of those companies; and

the consideration for two recent offers by controlling shareholders (owning over
half of the equity) of European internet service providers to acquire the
remainder of the equity of those companies.

The precedent transactions considered by Citigroup were the following:

Spanish De-Listing Offers


                  Date Announced                                          Company
                  April 22, 2002                               Hidroelectrica del Cantabrico
                 December 9, 2003                           Aceralia Corporacion Siderurgica SA
                   May 31, 2004                              Centros Comerciales Carrefour SA
                   June 4, 2004                                     Cementos Molins SA


Mergers with Significant Spanish Shareholder

           Date Announced                          Acquiror                              Target
           April 16, 2002                            FCC                          Portland Valderrivas
            July 1, 2003                             ACS                             Dragados Group
           August 1, 2003                        Metrovacesa                              Bami

Offers by Controlling Shareholders of European Internet companies
           Date Announced                         Acquiror                              Target
February 23, 2004                              France Telecom                          Wanadoo
October 9, 2004                               Deutsche Telekom                     T-Online

Citigroup relied on publicly available for financial information for the
precedent transactions and the companies involved therein. The following table
summarizes the median premia (discount) offered in these transactions over the
price on the last trading day before announcement and the three- and six
-month trailing averages and, in the far right column, sets forth for
comparative purposes the same information for the implied offer price in the
proposed merger between Terra and Telefonica:

       Period          Median Spanish De   Median Spanish Merger   Median European ISP   Implied Offer Price
                       -Listing     Consideration Premia         Premia         Premium For Proposed
                         Offer Premia                                                          Merger
                          (Discount)
1 day                       (2.2)%                  9.3%                  8.6%                   12%
3 month                      2.7%                   2.4%                  17.3%                  18%
6 month                      7.0%                   7.0%                  19.0%                  16%

Citigroup observed that none of the precedent transactions were identical to the
proposed merger of Terra and Telefonica.

Terra Valuation

Discounted Cash Flow Analysis

Citigroup's primary methodology for reviewing the value of Terra was a sum
-of-the-parts discounted cash flow analysis for each of
Terra's individual operating assets and certain non-operating assets.
Citigroup applied country-specific discount rates based on weighted
average cost of capital assumptions to calculate the net present value of Terra
management's forecast free cash flows from its operating assets, the benefits of
future tax savings relating to net operating losses and payments to be received
by Terra under its strategic alliance agreement with Telefonica. Citigroup
applied greater discount rates, however, to calculate the net present value of a
potential additional tax credit resulting from the August 2, 2004 sale by Terra
of Lycos Inc. as Terra's ability to realize value from this contingent asset is
speculative and difficult to predict. Citigroup then adjusted the value of Terra
to reflect Terra's net cash (including amounts due from Telefonica under tax
sharing arrangements) and other non-operating assets (including
investments in unconsolidated entities and other non-wholly owned
affiliates and anticipated proceeds from disposals). The result of this sum
-of-the-parts discounted cash flow analysis was an
implied value per Terra ordinary share of euro2.90 to euro3.71.

Comparable Companies Analysis

Using publicly available information, Citigroup reviewed the relative share
price performance from July 2003 to February 2005 of Terra and the following
five listed European internet service providers, as well as a market-
weighted index comprised of these companies:


  • freenet.de

  • Iliad

  • Telecom Italia Media

  • Tiscali

  • United Internet

Citigroup also compared the listed companies' multiples of firm value (equal to
equity value plus straight debt, minority interests, straight preferred stock,
all out-of-the-money convertibles, less investments in
unconsolidated affiliates and cash) to forecasted revenues, gross profit and
projected EBITDA for 2005 - 2007 with such multiples for Terra.
Citigroup then calculated a range of illustrative valuations for Terra's
operating assets by applying variances of plus or minus 10% from the medians of
such multiples for the comparable companies to Terra's management's forecasts
and then adding Terra's net cash and other non-operating assets valued
in a manner consistent with the methodology employed in the analysis described
above under the section 'Discounted Cash Flow Analysis'. The result of this
comparable companies analysis was an implied value per Terra ordinary share of &
euro;2.73 to euro3.77.

Citigroup observed that none of the selected companies were identical to Terra.
In particular, Citigroup noted that Terra's lower expected profitability for
2005-2007 would suggest a valuation of Terra toward the lower end of the
valuation range.

Research Analysts' Target Prices

Citigroup reviewed research analysts' target prices for Terra ordinary shares
published between July 1, 2004 (after adjusting for the euro2.00 cash dividend
per Terra ordinary share paid in July 2004) and February 15, 2005. The range of
these target prices (excluding the highest and lowest values) was from euro
2.80 to euro3.17.

Telefonica Valuation

Citigroup was not provided with any non-publicly available business or
financial information, including financial projections, for Telefonica and
Citigroup had no access to Telefonica's management. This limited the valuation
analyses with respect to Telefonica that were available to Citigroup.

Citigroup reviewed the value of Telefonica using a sum-of-the
-parts analysis that used various valuation methodologies for
Telefonica's primary operating assets, including trading comparables and market
value, and then adjusted for overhead costs, non-operating assets and
liabilities and minority interests. For Telefonica's principal operating
assets-Telefonica Moviles, the fixed-line Spanish telecommunications
business and Telefonica International-which collectively represent the majority
of Telefonica's firm value, Citigroup's primary valuation methodology was based
on a comparable companies analysis. Citigroup compared Telefonica Moviles to
Telecom Italia Mobile and Vodafone and its market value; the Spanish fixed
-line business was compared to British Telecom, and Telefonica
International to Telmex, Telesp, Brasil Telecom and Tele Norte Leste. The result
of this analysis was an implied value in the range of euro13.36 to euro16.39
per Telefonica share, as compared to a market price of euro14.19 per
Telefonica share as of February 21, 2005.

Citigroup also reviewed research analysts' target prices for Telefonica ordinary
shares published between June 18, 2004 and February 11, 2005. The range of these
target prices (excluding the three highest and the three lowest values) was from
euro13.50 to euro16.50.

2     Lehman Brothers

A summary of the financial analysis utilized by Lehman Brothers in relation with
the issue of its fairness opinion to Terra's Board of Directors is outlined
below. For this purpose, Lehman Brothers took into account, amongst other
factors, the proposed dividend of euro0.23 per Telefonica share on account of
2004 profits and the distribution proposed by Telefonica of 1 Telefonica share
for every 25 Telefonica shares, from which the holders of Terra shares would not
benefit, and the proposed dividend of euro0.60 per Terra share which Terra
would pay to all Terra shareholders.

Terra Valuation

Sum-of-the-Parts Analysis

Lehman Brothers has carried out the valuation of Terra on the basis of a sum
-of-the-parts approach, utilizing different valuation
methodologies depending on the type of asset. For Terra's cash position, Lehman
Brothers used book value as of December 31, 2004. For financial investments and
interests in other companies, Lehman Brothers used market value, option value or
net present value of future proceeds from the sale of interests subject to an
offer or a commitment to buy from a third party. For the strategic alliance
contract between Terra and Telefonica and Terra's joint venture interests,
operating assets and tax credits, Lehman Brothers used the discounted cash flow
method, whereby forecast free cash flows attributable to such assets were
discounted to net present value by weighted average cost of capital rates.

In addition to using a discounted cash flow methodology, as a supplemental
method, Terra's Spanish operating assets were also valued by using a comparable
companies approach, whereby multiples derived from implied values from
transactions involving companies in comparable businesses and from EBITDA and
revenue of comparable companies were applied to Terra's Spanish access business
and its other Spanish divisions. Multiples derived from subscriber acquisition
costs and gross margins of companies in comparable businesses of Terra Espana
were also applied to Terra's Spanish access business.

The result of Lehman Brother's sum-of-the-parts analysis
was an implied value per Terra ordinary share of euro3.18.

Other Value Effects

Lehman Brothers then observed that potential synergies, loss of historical tax
credits and the potential ability to realize value from a tax credit relating to
Terra's sale of Lycos Inc. were other potential sources of value or of loss of
value not included in the sum-of-the parts analysis of Terra.
Accordingly, Lehman Brothers calculated an adjustment to its sum-of
-the-parts implied value per Terra ordinary share described
above to take into account an estimate of the aggregate impact of these other
potential effects on value to arrive at an adjusted merger value per Terra
ordinary share of euro3.57.

Comparable Companies Analysis

Lehman Brothers compared Terra as a whole against the following eight other
companies:


  • easynet

  • freenet.de

  • Iliad

  • TI Media

  • T-Online

  • Tiscali

  • United Internet

  • Web.de

Lehman Brothers applied the average multiple of the comparable companies'
enterprise values to the forecast EBITDA for each of 2005 and 2006 to Terra's
forecast EBITDA for such years to calculate implied firm values for Terra, and
then made adjustments to such firm values for other assets and liabilities. The
results of this analysis were implied equity values of euro3.05 and euro3.18
per Terra ordinary share based on Terra's forecast EBITDA for 2005 and 2006,
respectively.

Lehman Brothers noted that, while the review of comparable companies served as
comparative information, due to the different profitability and risk profile of
Terra, the comparable companies analysis should not be deemed a meaningful
valuation methodology.

Research Analyst Valuation

Lehman Brothers also reviewed research analyst target prices for Terra ordinary
shares in reports published between April 2004 and February 8, 2005. Lehman
Brothers adjusted two of the target prices published in April 2004 for the &
euro;2.00 dividend on Terra ordinary shares paid in July 2004. The average of
these target prices was euro3.00 and the median was euro3.00.

Telefonica Valuation

Lehman Brothers was not provided with any non-publicly available
business or financial information, including financial forecasts, for
Telefonica. Therefore, Lehman Brothers Limited analyzed Telefonica's valuation
using a market-based approach.

Research Analyst Valuation

Lehman Brothers reviewed research analyst target prices for Telefonica ordinary
shares in reports published between November 11, 2004 and February 21, 2005. The
average of these target prices was euro14.92 and the median was euro14.55.

Historical Share Price Performance

Lehman Brothers reviewed the historical share price performance and trading
volumes of Telefonica ordinary shares from May 25, 2003, the launch date of
Telefonica's 2003 tender offer for Terra shares, through to February 14, 2005,
the date that Telefonica announced its intention to make an offer for a merger
transaction with Terra. Lehman Brothers also calculated the average market price
of Telefonica ordinary shares for the one-month, six-month and
one-year periods prior to February 14, 2005 and for the period from May
25, 2003 to February 14, 2005. The following table sets forth the results of
this analysis:

                            Period                                      Average Share Price (euro)

1 month                                                                            14.02
6 months                                                                           13.05
1 year                                                                             12.67
Since Launch of Tender Offer on May 28, 2003                                       11.52



Relative Valuation

Lehman Brothers performed on analysis of relative valuation by comparing market
prices of Terra ordinary shares (as adjusted for the extraordinary dividend
payment of euro2.00 per share on July 29, 2004) to market prices of Telefonica
ordinary shares during the period from May 28, 2003 to February 1, 2005. Lehman
Brothers also calculated the average ratio of the market price of a Telefonica
ordinary share to the adjusted price of a Terra ordinary share for the month of
January 2005, the six-month period of August 2004 through January 2005,
the one-year period of February 2004 through January 2005 and for the
period from May 25, 2003 to January 4, 2005. The following table sets forth the
results of this analysis:

                            Period                                             Average Ratio

1 month                                                                            4.49:1
6 months                                                                           4.45:1
1 year                                                                             4.30:1
Since Launch of Tender Offer on May 28, 2003                                       4.02:1



Lehman Brothers noted that the ratios set forth in the table above were not
adjusted to include the effect of the anticipated cash dividend of euro0.60 to
be paid to Terra shareholders prior to consummation of the merger.

Public Market Valuation of Consideration

Lehman Brothers then analyzed the implied offer price for the proposed merger
based on the exchange ratio of 4.5:1 Term shares for Telefonica share, the high
and low market prices for Telefonica ordinary shares during the one month period
prior to February 22, 2005 and the market price on such date, and adding the
effect of the euro0.60 anticipated dividend on Terra ordinary shares. The
results of this analysis are set forth in the table below:

                                                           Low         High       As of February 22, 2005
Implied Terra Share Price in Offer (euro)                  3.59        3.84                3.69

Lehman Brothers observed that the range of the implied offer price set forth in
the table above is greater than the adjusted merger value of euro3.57 per
Terra ordinary share discussed above under the heading 'Terra Valuation - Other
Value Effects'.




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