Description

I recommend buying Nortel Inversora ADR Preferred B (NTL) shares while selling Telecom Argentina (TEO) shares against it.

NTL’s sole substantial asset is its investment in 54.7% of Telecom Argentina. TEO provides telecommunications services, including local, long distance and international service, in Argentina. TEO also, through its subsidiaries, provides cellular telecommunications services, publishes telephone directories and offers paging services.

* There is a substantial valuation discount between the TEO stake owned by the NTL B shareholders and TEO’s equity valuation: Nortel has no holding company debt. It incurred $212mm in debt when it acquired its ownership stake in TEO, which was paid off in 2001. It has two classes of preferred equity (A’s and B’s) and common equity. The A’s are manditorily redeemable preferred securities that receive a fixed 6% dividend and are senior to the B’s. The A’s don’t really trade (though there have been a few blocks) and have a liquidation value of about AR$ 600mm, which is about US$ 200mm.

The B’s have no voting rights, but have the right to 48.96% of the economics of NTL (the common shareholders have the rights to 51.04%, despite having full voting rights). This means that the market valuation of NTL should be (48.96% * (54.7% * TEO)) - US$ 200mm.

TEO has a market capitalization of $2.5bn. This implies a market capitalization of about $480mm for NTL, or $16.34/share. NTL’s current market capitalization is $267.3mm, or $9.09/share. This represents a 79.7% discount to NAV.

* Telecom Argentina recently completed its restructuring: TEO has not paid dividends in more than three years, as it struggled under a large debt burden. Consequently, TEO undertook the largest debt restructuring in Argentina since the 2002 economic crisis. This process was completed in Argentina on 8/31, following approval by the Argentine court. Subsequently, on 12/13, TEO filed for creditor protection in the U.S. to protect its assets from creditors who haven’t signed off on the Argentine restructuring (the trustee for Argo Fund Ltd was refusing to cancel old notes because Argo had not consented to the restructuring). My understanding is that the U.S. court is highly likely to enforce the Argentine court’s ruling and that this phase of the process should within six months to one year. Analysts are predicting that TEO will then return to profitability and recommence its dividends to shareholders. The completion of the restructuring and the reinstitution of the common dividend could be events that spur investors to close the valuation gap between NTL and TEO. If, for whatever reason, this restructuring is held up, there is certainly limited downside here, since you’ve hedged all valuation issues out.

* Takeout candidate: Furthermore, both during the restructuring process and after it is complete (until the valuation gap has been substantially reduced), NTL is a potential takeout candidate for a large investor that is looking to buy a large share of TEO at a very cheap price.


I don’t want to mislead anyone here - there are some very legitimate reasons for the discount: Basically, the discount to NAV is attributable to two factors:

- NTL shares are illiquid: the average daily trading value for NTL over the past year (12/28/04 - 12/28/05) is 63,782 shares, or $592,095, versus 365,586 shares, or $4.5mm, for TEO. Still, NTL is liquid enough to allow a fund to be able to create a meaningfully-sized position. This is especially true since, until the completion of the reorganization process and the subsequent reinstitution of the TEO dividend, investors will likely not focus that heavily on NTL. This should give ample time to accumulate positions under the radar. Further, large shareholders are in discussions with NTL to get the company to take steps to increase liquidity (such as a stock split), which would surely boost value and narrow the discount to TEO, even before the TEO restructuring is complete.

- NTL shares represent the non-voting shares of Nortel: While the NTL shares have voting rights as long as Nortel has missed dividend payments, ordinarily (that is, under “normal”, dividend-paying circumstances), the NTL shareholders have no voting power. Given that TEO will likely resume dividend payments within a year or so, the situation at Nortel should soon revert to a “normal” scenario, where the B shares have no voting rights. While there should be some discount for such a lack of voting power, I’m not sure that it should really be 75%

Catalyst

CATALYSTS

1) Completion of Telecom Argentina’s debt restructuring
2) Reinstatement of Telecom Argentina’s dividend
3) Potential for alleviation of liquidity issues
4) Potential for a takeout