Description

Compania Anonima Nacional Telefonos de Venezuela, or CANTV, (VNT) is the largest telecommunications service provider in Venezuela. As of September 30th 2001, the company had approximately 2.7 million access lines, 2.1 million cellular subscribers and 300,000 Internet users. Similar to telecommunications companies in the United States, CANTV’s traditional wireline business is in decline, while its wireless and Internet businesses are growing.

The company was privatized in 1991 when the government sold a 40% stake in the company to VenWorld, an international consortium 57.8% controlled by Verizon. In 1996 the government sold 35% of the company in an international public offering. CANTV is currently the largest stock on the Venezuelan stock exchange, and has a moderately complex equity structure with four classes (A, B, C, D) of local shares as well as ADS shares traded on the NYSE. All Class A (43% of the company) shares are held by Venworld, Class B (6% of the company) are held by the Venezuelan government, Class C (11%) are held by company employees and retirees, and Class D (41%) are held by the public (37%) and Verizon (4%). With its Class D shares and ownership stake in VenWorld, Verizon owns roughly a combined 25% of the company.

Part of the original VenWorld group was AES Corp. AES recently left the VenWorld group and switched all of its common shares from Class A to Class D (as it was required to do by law). It then launched a tender offer for 43.2% of the outstanding shares (which would give it 50.1% of the total shares) at $24 per ADS (1 ADS is equivalent to 7 local shares). AES’ goal in this action was to gain control of the company, distribute excess cash to the shareholders, and sell off the wireless part of the company, thus unlocking shareholder value. The unsolicited takeover bid was in no way a strategic move, as AES’ core business lies in power rather than telecommunications. Rather, it was a move by a frustrated shareholder that wanted to realize an increased return on its investment. Indeed, AES from the start publicly stated it would be willing to sell its shares in VNT for the right price.

In an attempt to counter AES’ offer, VNT proposed a counter offer to shareholders: $30 per ADS for 15% of the shares outstanding and two special dividends, one in December and one in March, totaling roughly $4.80 per ADS. (The $30 per share is based in dollars, the two special dividends are based in Bolivares.) The company also stated it would review its current dividend policy in response to Verizon’s suggestion that at least 50% of free cash flow should be paid in recurring dividends. In my opinion, a conservative normalized free cash flow for VNT is around $500 mil (the company is expecting free cash flow for 2001 to be around $750 million) which leads to a $2.22 per ADS dividend assuming 50% of the company’s free cash flow is distributed.

Both tender offers were set to expire on November 23rd. However, with a competing bid on paper, AES on November 7th announced it was withdrawing its tender offer. VNT quickly praised the action and affirmed its commitment to its own offer.

Valuation:

Based on the current management offer, VNT appears to be exceptionally undervalued. Based on each shareholder tendering the full amount to the company (15%), the ‘stub’ of VNT (after the tender offer and the two special dividends) is currently valued at $13.63 per ADS. Assuming VNT adopts a 50% free cash flow dividend policy, and the company issuing an ongoing divided of around $2.22 per ADS beginning next year, the stub is offering a 17.7% yield based on the ADS price. If the stub were to offer an 8% yield (still fairly high), the stub would be worth $27.79, translating into a current ADS price of $34.40. Also, there is potential upside to this valuation given that over 10% of the company’s stock is held by employees who most likely will not tender their shares (they have their own special tender offer for the same $30 per ADS due after the first special dividend is paid). And, there is a strong possibility that CANTV will decide to distribute more than 50% of free cash flow going forward. Hence, I consider $36.45 the floor value of the shares.

Risks:

The largest risk is the future of the company’s dividend. I am expecting the company to follow Verizon’s suggestion and distribute at least 50% of all future free cash flow to shareholders. While Verizon is the largest shareholder, it is possible that VNT will not consider Verizon’s suggestion although the company has publicly stated it will review its dividend policy going forward.

Unfortunately, the risk of the dividend does not end with VNT’s new dividend policy. VNT being a Venezuelan company, shareholders face Venezuelan currency and economic risk that could have a material adverse effect on the company’s dividend. So, even if VNT adopts a large payout dividend policy, the dividend may not be too stable going forward. In my valuation, I have assumed a fairly constant $2.22 per ADS annual dividend. If the dividend proves substantially less going forward, the intrinsic value of the company diminishes.

Catalyst

The catalyst for VNT is the tender offer (expiring November 23rd), the special dividends (in December and March) and most importantly, the adoption of the anticipated new dividend policy.