This idea is simple.  For non-fundamental and most likely temporary reasons, NTL is trading well below intrinsic value.  And there is a near-term potential catalyst.  It must be said, however, this is not the most liquid security; probably only suitable for PAs.

While NTL has been posted on VIC previously, there have been some changes in the capital structure and more importantly the upcoming elections inArgentinacould serve as a catalyst.

Summary

NTL is the trading symbol for the preferred stock of the Nortel, the holding company of TelecomArgentina(“Telecom”), which trades under the symbol TEO.

The intrinsic value of NTL is 1.8x TEO:

Nortel owns 54.9243% of Telecom Argentina (TEO).

At Nortel, holders of Pfd B (NTL) are entitled to 48.96% of the economics (dividends or liquidation).

There are 29.4 million shares of NTL

There are 196.2 million shares of TEO

If Telecom were worth a total of $196.2 million, then one TEO = $1.0

Nortel $107.8 million, holders of Pfd B $52.8 million, and one NTL $1.79

I see good risk/reward in long NTL, short TEO at current levels.

Background

For cash flow reasons, Telecom was unable to pay dividends for a long time until 2010.  During this time, the Pfd A –the most senior security- at Nortel kept accruing dividends and became due.  Once Telecom resumed its dividends, substantially all the cash that Nortel received went to pay and ultimately redeem the Pfd A in June 2012.

While the Pfd A was in default, a reasonable case could have been made for NTL to trade at a discount to TEO.  And that is indeed where it traded for a long time.  However, once Telecom’s cash flow generation began to improve, the market eliminated the discount.  During the great market dislocation of 2008 and 2009 the discount reappeared temporarily.  As Telecom’s business continued to prosper, the prospects for NTL became more favorable and it consistently traded at a premium to TEO.  Unfortunately, just as NTL was starting to get ready to receive its first dividend, the regime inArgentinarestricted distributions and access to foreign exchange.  At which point the premium disappeared for the most part.

Telecom is doing well; strong b/s, top line growth and cash generation.  Given the restriction on dividends, instead of paying in 2013 the dividend corresponding to FY12, the company has reserved ArPs$1.0 billion for future dividends and ArPs$1.2 billion for local buybacks.  In 2q13 (essentially June) Telecom bought back 3.3 million shares, which increased Nortel economic interest to 54.9243% as ofJune 30, 2013.

Why now?

While the discount is not as wide as it was in the recent past, there is some evidence that the regime might not do that well in the house elections this October.  In particular, pundits believe it is highly unlikely that her party will win the two-thirds majorities in both houses in October that she would need to change the constitution to run for a third term.  In such scenario, I speculate that either the repression of the regime would tend to ease, or get much worse.  Either situation is likely to be positive for the trade. Even in the extreme case in which the regime decides to nationalize Telecom, the trade would probably not have significant downside.

Is NTL a solid security?

Telecom Italia, the ultimate controlling shareholder of Nortel and Telecom, holds 8% of the NTL outstanding.  While not perfect alignment of interest, it offers some level of comfort to NTL holders.  Further, it makes economic sense for the controlling shareholders to tender for all NTL once the regime’s restrictions ease. 

In any event, NTL seems to have enough legal rights:

- Not redeemable

- Covenants:

 (i) not to issue any additional Series B Preferred Shares except to satisfy preemptive rights or as a free payment to existing holders to capitalize reserves, revaluation surpluses or similar concepts;

(ii) to annually apply all cash derived from earnings legally and financially available for the payment of shareholder dividends to the Series B Preferred Shares;

(iii) not to permit Telecom to merge or consolidate with or into, or sell, lease or convey all or substantially all of its assets (whether in one transaction or a series of transactions) to any other entity, except a merger in which Telecom is the surviving corporation;

(iv) not to create, incur, assume, guarantee or otherwise become liable with respect to or responsible for the payment of, any indebtedness (not including accounts payable or other indebtedness to trade creditors in the ordinary course of business) other than the Series A Notes, the Series B Notes, any indebtedness the proceeds of which are used to pay interest on the Series A Notes or the Series B Notes, indebtedness in an aggregate principal amount not to exceed US$50,000,000 (or the equivalent thereof) at any one time outstanding, guarantees of the indebtedness of Telecom or indebtedness to any subsidiary in which Nortel owns directly or indirectly more than 50% of the capital stock and has the power in ordinary circumstances to elect at least a majority of the Board of Directors, managers or syndics;

(v) not to sell, transfer, assign or otherwise dispose of, or pledge, hypothecate or otherwise encumber any shares of voting common stock of Telecom (except as required under the Transfer Contract), unless after giving effect to such transaction, more than 50% of the Telecom common stock shall be owned directly or indirectly by Nortel free of any lien;

(vi) not to permit Telecom Argentina to create, incur, assume, guarantee or otherwise become liable with respect to or responsible for the payment of, any indebtedness (not including accounts payable or other indebtedness to trade creditors in the ordinary course of business), if, as a result thereof, the ratio, on a pro forma basis, of the total liabilities of Telecom Argentina to its net worth would exceed 1.75 to 1;

(vii) with certain exceptions, not to, and not to permit any subsidiary to, assume any encumbrance that restricts its ability to pay dividends or other distributions on its capital stock or indebtedness, make loans to Nortel or its subsidiaries, or transfer any of its property to Nortel or any of its subsidiaries;

(viii) to provide certain financial statements, annual reports and certain reports filed with the Securities and Exchange Commission in English to holders of Series B Preferred Shares; and

(ix) not to consolidate with, or merge with or into, or sell or convey all or substantially all of its assets in one transaction or a related series of transactions to any other entity, other than a merger in which Nortel is the surviving corporation.

Under the terms and conditions of the Series B Preferred Shares, failure to comply with the above-mentioned covenants will result in the Series B Preferred Shares acquiring voting rights.

Happy to discuss further in the Q&A thread…