Description

TSP – Telefonica de São Paulo

There is a good probability that Telefonica of Spain (Ticker “TEF”) would make an offer for the remaining shares (14% float) of this important subsidiary; while you wait there is a good dividend yield.

The last tender offer (an exchange for TEF´s shares) was done in June/2000 and according to CVM’s rules (the Brazilian equivalent to SEC), the controlling shareholder can only make a new tender offer after 2 (two) years. If Telefonica (TEF) wants to delist the subsidiary, the offer needs to be accepted by at least 67% of the free floats’ owners. This rule gives to minority shareholders some leverage against TEF and it could force them to offer a generous premium. In the last time the premium on market price was 40%.

TEF had done in the past many tenders to minority shareholders, such as: Telefonica de Peru, Telefonica de Argentina and Tele Sudeste Celular (Brazil).

TEF is valued to higher multiples than TSP, EV/EBITDA (2002) of 7.9x vs. 3.9; therefore the acquisition of TSP’s remaining shares will make sense, because it will be accretive to TEF´s shareholders.

Data:

Price (ADR): US$ 14.10 ( Date: March 6th, 2002)
52 Week Hi/Low: US$ 15.20 – 7.58
NR. Shares/ADRs: 328,354,000 (non-voting shares)
NR. Shares (voting) : 166,042,000
Total Shares: 494,396,000
Mkt. Value: US$ 6,97 billion
Net Debt: US$ 1,57 billion
Enterprise Value: US$ 8,54 billion
P/BV: 1,10
Free Float: 13,7%
BV per Share: US$ 12.81

Ebitda 2001: US$ 1,97 billion
Ebitda 2002E: US$ 2,17 billion

Net Earnings 2001: US$ 680 million
Net Earnings 2002E: US$ 761 million
Net Earnings 2003E: US$ 841 million

Capex 2002E: US$ 900 million

EV/Ebitda 2002: 3.9 x
P/E 2002: 9,2
Dividend Yield: 6,5% (*)

(*): Brazilian companies can pay interest on shareholders equity, therefore dividend plus interest on net worth could be much higher than net earnings. The payment per share will be US$ 0.91.

Background:

TSP´s concession territory is 92,000 sq. miles and it comprises 96% of the São Paulo´s State. This is the richest state in Brazil; it generates 36% of country’s GDP and has 22% of the population. The wireline penetration reaches 37%, and this figure is higher than Chile, Mexico and a little below Spain (41%).

The company has 12,6 million lines in service (LIS) at end of 4Q01, but for comparison purpose Telmex (TMX) has around 13 million. In addition to that, TSP has 200,000 ADSL subscribers, and it is growing fast, but the region has a potential for at least 15% of the LIS. The company has an almost monopoly in the region, the competitor Vesper (owned by Velocom, Qualcomm and Bell Canada) was unable to dent its market share, because it offers WLL phones which does not allow access to Internet.

The Ebitda margins (2002E) of Telmex and TSP are very close, 52% vs. 51%, but last year TSP got 51,5% and the growth rate is almost the same in US$ dollars. However, TMX trades at higher EV/Ebitda ( 4,5x 2002E) multiples than TSP due to liquidity and country risk. Currency devaluation will impair TSP´s Ebitda growth in US$ for 2002, because the expected devaluation could be around 7%.

Investment Positives and Negatives:

Positives
- TSP has hedged its dollar denominated debt;
- The company met the penetration and quality targets established by the government, therefore it is allowed to offer inter-regional and international long-distance services. The state originates 50% of country’s international calls.
- Lower capex in the next years, in 2002E could reach US$ 1 billion, and thereafter 10% of revenues, this amount is close to US$ 450-500 million.
- The higher excess cash generation could be paid as dividends, besides that TEF´s troubles in its Argentinean subsidiary could estimulate them to improve even more the Brazilian operations in order to reduce the impact of Argentina on TEF´s bottom line.
- TSP has the lowest interconnection costs in the calls from Fixed to Mobile phones among the other wireline operators. Besides that, the biggest mobile operation in the country is owned by TCP (the local subsidiary of Portugal Telecom), and it operates in the same region, which has established a JV with Telefonica Moviles (TEM).

Negatives
- The company will have more competition next year from other wireline operators in the corporate segment, but in the household segment will be none.
- Lower liquidity, the ADRs trades an average amount of US$ 150,000.00 per day, but for individual investors this is not a problem.
- Currency devaluation could hurt earnings, however it is almost priced in.

Catalyst:

The best catalyst is the potential TEF´s tender offer. Besides that, there are the dividend yield and the low valuation.

Catalyst

The best catalyst is the potential TEF´s tender offer. Besides that, there are the dividend yield and the low valuation.