Description
Overview:
Telmex is the dominant wireline telecom operator in Mexico providing local, long-distance and data throughout the country. With over 90% market share Telmex has long enjoyed the benefits of its monopoly, but over the recent years has faced slowing growth given increasing competitive dynamics and wireless substitution. This continued slowdown has weighed on the valuation and growth opportunities presented in the Company’s international assets – a division which continues to enjoy growth in faster growing markets such as Brazil, Colombia & Peru. Much as Grupo Carso did with America Movil management is eager to unleash this growth potential and create two streamlined entities with focused management teams and boards. Management will conclude this long awaited spin-off with Telmex International trading as a separate Company – with Oscar Von Hauske Solis as CEO and Carlos Slim Domit as Chairman (also Chairman of Telmex).
The table below highlights the contrast of Telmex Mexico (‘Telmex’) versus Telmex International, which is not only expected to grow faster, but has a much cleaner balance sheet, allowing it to invest in its growth via acquisitions. Telmex, however, continues to see top-line declines as wireline and wireless pricing converges and wireline subs migrate to wireless use – a trend that will continue into the foreseeable future.
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Telmex |
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Telmex Intl |
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'07-'10 CAGR |
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Revenues |
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-2.9% |
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7.1% |
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EBITDA |
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-2.7% |
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12.0% |
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EPS |
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-3.9% |
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16.4% |
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2007 Financials |
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Revenues |
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$11,986 |
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$6,211 |
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EBITDA |
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$5,711 |
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$1,659 |
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% Margin |
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47.6% |
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26.7% |
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Balance Sheet |
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Cash |
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$436 |
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$1,583 |
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Debt |
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8,383 |
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1,465 |
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Net Debt |
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7,948 |
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-118 |
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Net Debt/EBITDA |
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1.4x |
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-0.1x |
Based on the current trading levels, Telmex Mexico is a Short. Continued wireless migration and subsequent ARPU pressure will continue to weigh on the margins & growth prospects for Telmex Mexico; any heightened regulatory concerns will only exacerbate the discount in valuation. Today’s share price offers over 20% upside as the market rerates the stand-alone risk to a Mexican wireline operator in secular decline.
Business Description:
Telmex is the incumbent wireline provider in Mexico with over 91% market share of the lines in service. As the dominant player in the market, Telmex is well positioned to win market share in broadband subscribers, however the Company is also susceptible to the continued migration of wireline subscribers to wireless. In Mexico, mobile subscribers represent over 70% of total telephone subscribers and 55% of voice revenues – this is up from only 30% in 2002, representing a CAGR of over 9% from 2002-2008. Given the convergence of wireless pricing to wireline the threat of substitution is even greater as pricing reaches parity. It is estimated that by 2010 this will be the case (from approx 15% pricing difference today and 70% 5 years ago) causing a serious threat to wireline growth and ARPU in voice service. In addition, Telmex continues to see competitive pressure from alternative carriers and cable companies such as Axtel, Maxcom, etc who have averaged 1-2pts of market share gains annually. Lastly, Mexican competition authorities (Cofeco) have expressed continued concern over the lack of competition and the high price of telecom service within the market and as a result have launched a series of investigations over the pricing & dominance of the major carriers. Any action on the part of Cofeco would further highlight the risk of Telmex.
Financial Summary:
Telmex Mexico will continue to see top-line pressure as line loss continues in the face of wireless substitution. In addition, while management has been aggressive in cost cutting to manage these losses, any slowdown or risk to such activity would magnify the top-line declines and pressure EBITDA margins making these projections conservative. Telmex will however continue to generate significant cash flow which will be used for dividends and continued share buybacks.
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Telmex ($US mm) |
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2005 |
2006 |
2007 |
2008 |
2009 |
2010 |
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Revenue |
$12,697 |
$11,893 |
$11,986 |
$11,366 |
$11,237 |
$11,007 |
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% Growth |
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-6.3% |
0.8% |
-5.2% |
-1.1% |
-2.0% |
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EBITDA |
$6,429 |
$5,956 |
$5,711 |
$5,458 |
$5,397 |
$5,279 |
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% Margin |
50.6% |
50.1% |
47.6% |
48.0% |
48.0% |
48.0% |
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% Growth |
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-7.4% |
-4.1% |
-4.4% |
-1.1% |
-2.2% |
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Capex |
$1,399 |
$1,166 |
$1,279 |
$577 |
$1,245 |
$1,194 |
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FCF |
$2,772 |
$2,918 |
$2,503 |
$3,097 |
$2,952 |
$2,799 |
Valuation:
Telmex Mexico currently trades at 5.7x 2008 EV/EBITDA, nearly a 20% premium to peers
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Telmex Mexico ($US mm) |
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Price ($US ADR) |
$20.00 |
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$21.00 |
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$22.00 |
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$23.00 |
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$24.00 |
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$24.57 |
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$25.00 |
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$26.00 |
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Shares out |
950 |
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950 |
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950 |
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950 |
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950 |
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950 |
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950 |
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950 |
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Market Cap |
$19,000 |
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$19,950 |
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$20,900 |
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$21,850 |
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$22,800 |
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$23,342 |
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$23,750 |
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$24,700 |
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Net Debt |
4,851 |
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4,851 |
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4,851 |
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4,851 |
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4,851 |
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4,851 |
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4,851 |
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4,851 |
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Enterprise Value |
$23,851 |
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$24,801 |
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$25,751 |
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$26,701 |
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$27,651 |
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$28,193 |
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$28,601 |
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$29,551 |
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EV/Revenue: |
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2007 |
2.0x |
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2.1x |
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2.1x |
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2.2x |
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2.3x |
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2.4x |
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2.4x |
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2.5x |
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2008 |
2.1x |
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2.2x |
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2.3x |
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2.3x |
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2.4x |
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2.5x |
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2.5x |
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2.6x |
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2009 |
2.1x |
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2.2x |
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2.3x |
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2.4x |
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2.5x |
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2.5x |
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2.5x |
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2.6x |
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EV/EBITDA: |
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2007 |
4.2x |
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4.3x |
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4.5x |
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4.7x |
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4.8x |
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4.9x |
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5.0x |
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5.2x |
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2008 |
4.4x |
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4.5x |
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4.7x |
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4.9x |
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5.1x |
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5.2x |
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5.2x |
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5.4x |
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2009 |
4.4x |
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4.6x |
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4.8x |
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4.9x |
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5.1x |
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5.2x |
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5.3x |
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5.5x |
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EV/EBIT: |
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2007 |
5.9x |
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6.2x |
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6.4x |
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6.6x |
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6.9x |
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7.0x |
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7.1x |
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7.3x |
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2008 |
6.2x |
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6.5x |
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6.7x |
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7.0x |
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7.2x |
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7.4x |
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7.5x |
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7.7x |
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2009 |
6.5x |
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6.8x |
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7.0x |
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7.3x |
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7.5x |
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7.7x |
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7.8x |
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8.1x |
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P/E: |
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2007 |
6.0x |
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6.3x |
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6.5x |
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6.8x |
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7.1x |
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7.3x |
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7.4x |
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7.7x |
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2008 |
8.2x |
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8.6x |
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9.0x |
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9.4x |
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9.8x |
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10.0x |
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10.2x |
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10.6x |
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2009 |
8.1x |
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8.5x |
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8.9x |
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9.3x |
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9.7x |
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9.9x |
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10.1x |
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10.5x |
Comps:
LatAm integrated/wireline comps trade at approximately 4.8x EV/EBITDA
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Integrated/Wireline Comps |
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EV/EBITDA |
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P/E |
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Company |
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Price |
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Market Cap |
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2008 |
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2009 |
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2010 |
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2008 |
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2009 |
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2010 |
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LatAm: |
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Tele Norte |
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$24.76 |
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$10,129 |
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4.1x |
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3.8x |
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3.5x |
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8.2x |
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9.5x |
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9.1x |
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Brasil Telecom |
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$84.42 |
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$8,126 |
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5.8x |
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5.8x |
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5.5x |
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19.0x |
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17.2x |
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17.4x |
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Telecomunicacoes de SP |
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$27.64 |
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$13,981 |
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4.4x |
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4.3x |
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4.3x |
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11.6x |
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11.5x |
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11.3x |
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Average |
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4.8x |
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4.6x |
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4.4x |
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12.9x |
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12.7x |
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12.6x |
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Risks to Short Thesis:
· Strong Free Cash allows for Dividend & Strong Payback: Telmex’s relatively solid balance sheet and strong cash flow puts the Company in an attractive position to continue to pay dividends and buyback shares. Telmex has consistently purchased its shares on average of 3-4m a day over the past 18 months (10-20% of daily volume)
· Strong management: In the face of adverse conditions, management has proven their ability to keep margins relatively flat via cost cutting and have a history of execution (e.g. America Movil) via Grupo Carso; this support should provide encouragement to investors who are concerned with management’s execution amidst the secular/structural issues
· Potential growth into Pay TV: Telmex has been attempting to launch an IPTV product, but has been delayed several times due to regulatory requirement/constraints; any movement on this front could provide potential growth and mitigate wireline loss
Catalyst
• Wireline replacement: Telmex’s greatest risk lies in the continued wireless substitution which has caused a 25% absolute drop in wireline revenue in the telecom industry over the past 7 years; this trend will clearly continue as pricing converges and parity is met; significant line loss and ARPU pressure could be seen once this occurs
• Regulatory Risks: Cofeco is currently conducting five separate investigations into TMX’s dominance and monopolistic practices with a preliminary ruling excepted by early June; any negative outcome to any one of these investigations could further pressure pricing or relative competitive strength
• Number Portability: Portability begins in Q3:08 and could further pressure competitive dynamics and increase revenue and line loss to CLEC’s such as Axtel and Maxcom