Description

AMX

Thesis

We are recommending a great value opportunity with upside of between 75 and 120% based on our DCF Valuation on America Movil, the largest telecom provider in Latin America and one of the top 5 global wireless operators by subscribers… America Movil dominates Mexico’s mobile telephony market with more than 73% of the market share and is an important player in the all the region’s countries. Its large scale allows AMX to make significant cost efficiencies, translated into great FCF generation and cash returns to shareholders. Its competitive advantages had leaded the company to the highest levels of profitability in the world industry and should allow it to continue to deliver attractive returns on capital. Additionally AMX is the best positioned company to take advantage of the growth that the region is facing over the next years, as it has: the best network, great spectrum position in all of its countries, already has a dominant market position in all Latin America and financial strength to seize opportunities that may arise.

The Business

America Movil is the largest wireless provider in Latin America, reaching about 176 million subscribers and covering almost all of Latin America: 16 Latam countries in addition to the US. And it is the fourth biggest mobile company in the world, by subscribers. It also provides fixed-line services in some of its markets to 3.8 million users. Historically AMX has dominated the Mexican wireless market, and still continues controlling more than 73% of the subscriber base.

As well the company has built a solid record of buying troubled companies, transforming them into important players in their markets and making them profitable, through management restructures and improving operations. As a result AMX has a leading position in most of its markets.

The company’s Mexican operations generate some of the highest margins in the world wireless industry, reaching a mid 50’s EBITDA margin. Profitability in its foreign markets is much lower than Mexico’s, this because of the higher cost of service, however its overall margin remains on the 40’s, making the whole company one of the most profitable companies in the global industry.

Investment highlights

1. The Industry.  In the last years the Latin American telecom industry has followed the world trend of migrating from fixed-line to wireless services. In 2004 there were 91 millions of fixed-lines and 166 millions of mobile lines in all Latin America; as for 2007 the number of fixed-lines remained practically flat in 98 million and the wireless services grew at a 30% CAGR to 357 million lines, in these same period AMX subs base grew at a 36% CAGR.

Despite the sustained growth in mobile lines, the region still is under penetrated as the average penetration rate of the zone remains at 69% and its main markets, Mexico and Brazil, are under the average Latam level. The company management estimates that its main countries will reach a 90% penetration by 2010, implying a net addition of 50 million subs for AMX.

Market Share. America Movil controls the overall Latin American wireless market with 42% of the total subscribers followed by Telefonica with 31% and Telecom Italia’s 14%. In its main markets AMX is one of the most important players: controlling the Mexican market with more than 73% and occupying the second place in Brazil.

2. AMX competitive Advantages. Its large scale has helped AMX to lower its operating costs; allowing the firm to avoid high interconnection rates (one of the sector main costs) and giving it negotiation power on equipment prices, as it is one of the mayor buyers of network infrastructure and handsets on global basis. Because of this the company has been able to generate better margins than global operators, especially in Mexico.

Strong FCF generation due to low CAPEX needs in comparison with its global peers. Has given AMX the capacity to internally finance its growth, acquire last technologies and make acquisitions while returning cash to shareholders.

As well AMX has the only high-quality integrated network in Latin America as it is the only operator that offers 3G services in all its 16 countries; while its larger competitor, Telefonica, offers 3G services only in 3 countries.

3. Migration to contract users. Contrary to other wireless providers strategies (targeting post-paid users as they generate much higher average revenue per user ARPUs) America Movil’s strategy has been focused on prepaid users, this has shown to be the best strategy for the past years in the AMX region and has resulted in higher penetration and an impressive subscriber growth, as a result, 89% of AMX’s subs are pre-paid users. The 11% contract users contribute approximately 35% of the total revenue. The migration to a contract base should increase ARPUs significantly, giving the company more room for future growth. In the short term the post-paid customer additions will be seen in more developed markets like Mexico and Brazil.

4. Mexico: more competition ahead? We think not. Since Telefonica started its operations in Mexico the market has shown a more competitive environment and local ARPMs (average revenue per minute) have been declining. Telefonica-Movistar Mexico is approaching its management market share goal of 23-25% (actual 20%), and is still far from its EBITDA margin goal of 35-40% (vs. its actual 23%). This shows that wile local competition will remain, it will be less aggressive. We are starting to see Movistar changing its strategy focusing more on profitability than subscriber growth: add-campaigns are turning from pricing strategies to customer services like coverage. This is also shown when analyzing the Telefonica’s ARPM trend, which in 2008 stopped its contraction and has stabilized with AMX ARPMs.  

5. 3G. AMX is migrating to a 3G network in all of its Latam countries, this will benefit the company in many ways: i) it will improve margins as the operations of a 3G network are cheaper than the older one, ii) it will increase its data revenues, and will help AMX maintain ARPUs as pricing in voice service becomes more competitive, iii) it will give the company the ability to offer value added services to attract contract users.

Being the only large 3G provider in most of its countries will give AMX an important competitive position.

6. Low CAPEX needs = great FCF generation. AMX has relatively lower CAPEX needs than its global peers because of two main factors: i) Higher rates of urbanization in Latin America relatively to other emerging countries (low rural CAPEX), ii) Good spectrum position in its entire region. As the network already has been upgraded to 3G, we see lower CAPEX increasing risk for the coming years than its peers. As a result AMX has an unique combination of “developed country” wireless company CAPEX needs and the room for growth of an “emerging market” operator.

FCF and FCF Yield.  At current prices the great cash flow generation of the company traduces on a FCF Yield well above global peers.  

7. Profitability. Great comparative margins and ROE above 40’s over time places AMX as an impressive profitability story.

AMX Mexican operations are one of the most profitable around the world with an EBITDA margin around mid 50’s.

8. Cash returned to Shareholders. AMX has provided equity investors with a rare combination of substantial growth and increasing dividends. In the last 5 years the company has returned to its shareholders more than US $8.8 billion in the form of dividends and stock repurchases, representing 15% of its current market cap. It is expected that the company will continue with its aggressive cash refunding to shareholders in the coming years. The only factor that could slowdown the returns to investors could be a potential acquisition.

9. Debt position. America Movil has a very healthy balance sheet with a 0.78x Net Debt/EBITDA ratio. As well AMX has a considerable lower debt outstanding than its peers.

Risks

The company is subject to regulatory risks, in Mexico the government has stated its intention of looking into the telecom market for anticompetitive behavior.

America Movil has a significant amount of its debt denominated in US dollars. Depreciation of its operating currencies against US dollar could result in higher debt.

Deeper than expected economic slowdown. 

Valuation

AMX has a great record for of FCF growth over the past years. In our valuation we suppose a growth scenario in witch the company’s FCF will have a 10% annual growth rate for the first 5 years and of 5% in the next 5. These estimates are conservative in our view as its low CAPEX needs and strong market position will let the company continue generating strong FCF growth.

We have modeled 2 simple DCF exercises, in witch we included our FCF growth estimates for 10 years and the sale of the business at 15x and 10x FCF. This threw us an upside range between 119% and 76%. We see the higher valuation as more rational for a business like AMX; however a more conservative valuation is in order as we wanted to expand our margin of safety.

Sale of the business at 15x in the 10^th year.

Sale of the business at 10x in the 10^th year.

Multiples vs Peers.

Catalyst