Telefonica SA (TEF), Europe's largest telecommunications company by market value, Friday pledged to increase shareholder returns with a EUR1.40 dividend next year, but revised downwards its guidance until 2012 amid falling revenue in mature European markets.

In a filing to the Spanish market regulator ahead of its Investors Day Friday, the Madrid-based company said its revenue compound annual growth rate, or CAGR, until 2012 would increase 1% to 4%. In its last Investor Day two years ago Telefonica had set out a revenue CAGR of between 5% to 8% for the period 2006 to 2010.

Telefonica also lowered its earnings per share target to EUR2.10 for 2010, down from previous guidance of EUR2.304.

But the company said it would pay a EUR1.40 dividend for 2010, up 21.7% from EUR1.15 last time, and that its 2012 dividend would be at least EUR1.75 a share.

Analysts were upbeat on Telefonica's forecasts. Banesto, in a research note, described the dividend guidance as a "positive surprise," adding the shares would likely react well, at least in the short term.

At 0723 GMT, Telefonica shares traded up 1.6% at EUR19.54, outpacing a higher overall Spanish market.

In a separate presentation, Telefonica said it would use any additional cashflow for a future share buyback, but didn't provide further details. Telefonica in the past has used aggressive buybacks to reward shareholders. The company said it targets a free cash flow in excess of EUR40 billion between 2009 and 2012.

Telefonica also said it would be selective with mergers and acquisitions, limiting this to consolidation in markets where it already operates and to spectrum auctions. The company also reiterated it wants to increase its stake in China Unicom to 10% from the 8.4% it has now, giving it a stronger foothold in the world's largest telephony market.

In a show of force, Telefonica bid $3.7 billion for Brazilian telecommunications company GVT Holding SA (GVTT3.BR) Wednesday, in a move to preserve its market share in Brazil, topping a previous bid from French media and telecoms conglomerate Vivendi SA (VIV.FR).

Telefonica has relied increasingly on solid revenue growth in its Latin American markets as the economic downturn, regulation and increased competition hits its mature markets in Europe, especially in Spain.

Company Web site: www.telefonica.com

-By Jason Sinclair, Dow Jones Newswires, 34 913958127, jason.sinclair@dowjones.com