Description

NTL offers a high likelihood opportunity for a 18% return by the end of 2017 as Telecom Argentina simplifies its share structure in advance of its merger with Cablevision. NTL shares will be worth 1.346 shares of TEO when Telecom Argentina’s plan of reorganization is completed by year end.

I think shares of TEO are somewhat undervalued and will continue to go up as a result of the proposed Cablevision merger, but am recommending a hedged long NTL/short TEO pair trade for the purpose of this write up.

Company Structure and Background

Telecom Argentina (ticker TEO) is the dominant mobile and fixed communications company in Argentina. The company was created in 1990 as a result of a government privatization of the monopoly telecom operator. The privatization created two companies, with TEO given the northern territory (including Buenos Aires). Nortela was organized the same year by investors to acquire a controlling interest in TEO. Nortela owns 55.6% of TEO and is a pure holding company with no other operations. Nortela has two share classes, common shares and Series B preferred. The Series B preferred is what is traded as ticker NTL. The common shares and preferred shares have equal dividend rights but the common shares have all of the voting and control rights of Nortela. The common shares are privately owned by Sofora, which is now fully owned by Fintech. The B preferred shares own a 48.96% economic interest in Nortela.

TEO shares represent the public traded (non-Nortela owned) 44.4% of Telecom Argentina, with a 5 to 1 share ratio for the ADRs. NTL represents the series B preferred shares of Nortela which owns a 27.22% economic interest in TEO. Nortela has a 1/20 ADR ratio, with 1 share of NTL equalling 1.79 shares of TEO on an economic basis.

Due to a lack of liquidity and no voting rights, NTL has historically traded at a wide discount to its economic value to TEO’s trading price. TEO is a quality company with a good balance sheet, dominant market position, and reliable, steadily increasing cashflows. TEO itself has also traded pretty cheaply due to the Argentina political risk. Under the Kirchner administration,  the company was restricted on the amount of dividends it was allowed to declare due to capital controls as a result of rapid currency depreciation. Since taking office in 2015, the new president, Macri, has cut export taxes, eliminated currency controls that artificially supported the Argentinean peso, and sought closer ties to the U.S. He's also loosened antimonopoly laws to permit combinations of cable TV and phone services.

Historical Discount

The Setup

On March 20th, Telecom Argentina and Nortel announced a plan of reorganization to simplify the company structure. With the reorganization, Nortela will be dissolved with shares of TEO distributed to Nortela shareholders. Since the of reorganization announcement, as planned, Fintech has completed buying out the 22% owner of Sofora, consolidating its ownership in Sofora to 100%. The reorganization plan needs to be approved by Telecom shareholders and the regulatory approval from Ente Nacional de Comunicaciones - “ENACOM”. Shareholder approval should be assured as a result of the Fintech controlling TEO/Sofora/Nortela. The shareholder vote is set for August 31st. Regulatory approval is also highly likely as it does not affect consumers in any way, and simplification should be better for all stakeholders. Approval of the reorganization plan is not dependent on the recently announced merger with Cablevision.

As part of the reorganization plan, Fintech set an exchange ratio at a 25% discount for the B shares. Nortella will be getting transferred its full 55.6% stake of TEO, with the shortfall to B shares being transferred to the benefit of the common shares owned by Fintech. Based on the official plan of reorganization share distribution ratios, NTL shares will be worth 1.346 shares of TEO when the reorganization plan is completed, with NTL shares converting to the more liquid TEO shares.

The 25% discount was stated as being selected based on historical trading history. As Fintech has full control of Nortela, they could effectively set the discount at whatever % they wanted. They screwed over NTL B holders, but not as much as they could have. Below is the justification as described in the reorganization filings:

“Agreement on the Share distribution ratios referred to above (which are certified by Independent External Auditors) was based on the following...(5) the historic lack of liquidity and the absence of vote rights of Nortel B Preferred Shares; (6) the fact that, historically, such lack of liquidity and voting rights has caused Nortel’s B Preferred Shares to have a market price significantly lower than the value of Nortel’s shareholding in Telecom Argentina and its economic rights vis a vis the market price of Telecom Argentina’s Class B Shares in the New York Stock Exchange. This difference in price has been of an average of 38.29 % during the last five years, and 28.71% during the last year. Therefore, it was considered reasonable to fix a Nortel’s Preferred B Share distribution ratio that reflects a 25% discount on such preferred shares’ current economic rights, and deliver Telecom Argentina Class B Shares to the holders of Nortel’s Preferred B Shares in proportion to their economic rights newly adjusted by the above mentioned discount; and (7) the valuation report prepared by the Participating Companies’ working team on Telecom Argentina, Telecom Personal and the relative discount of Nortel’s Preferred B Shares for purposes of determining the reasonableness of the Share distribution ratios and the Market Price.”

Cablevision Meger

Cablevision is the dominant TV and Broadband supplier in Argentina. It is owned by Grupo Clarin (ticker GCLA in Argentina) who also owns a small newspaper division. A merger between Cablevision and Telecom Argentina  was announced on July 3rd. Cablevision will be given 1.184b share of TEO, owning 55% of the combined company. The merger should be highly accretive with lots of potential synergy on the cost side and the revenue side through bundling opportunities offering customers mobile, fixed, TV, and internet plans. The merger also has to be approved by ENACOM, but should go through as a result of the law changes made by the more business friendly Macri administration. The merger is expected to be completed by the end of the year.

Conclusion

While the proposed Cablevision merger is likely the reason for the reorganization plan, it is not dependent on the completion of the merger. The plan of reorganization is highly likely to go through. Buying NTL and shorting TEO offers the chance to earn a low-risk 18% return in less than 6 months. Shares of NTL should convert to shares of TEO at a 1 to 1.346 ratio sometime between August 31st (shareholder vote) and the end of the year.

Catalyst

Approval of shareholder vote August 31st

Regulatory approval and completion of reorganization plan for shares to convert to TEO by year end