Description

I recommend to short UOLL4 due overvaluation, and the increasing competition in the online ads in the local market promoted by global companies and the powerful local media companies. We get a valuation range of R$ 8.27 to R$ 12.55. All data in local currency.

BACKGROUND

The company is the only listed player in the Brazilian Internet sector since the shutdown of AOL Latin America last June/2005. It is a leading web Portal aimed to Brazilian market, so its content is in Portuguese, besides that it has an ISP business with 1.44 million subscribers, the largest on-line subscriber base. It is the most popular Portal in Brazil with a total of 6.35 billion page views per month.

The company belongs to a leading newspaper group in Brazil – Folha de São Paulo, that provides a good chunk of its content, and the other big shareholder is Portugal Telecom.

UOL derives more than 80% of its revenues from subscription revenues related to Internet Access services, and the remaining is from online ads ( +/- 17%) and other services (VoIP).

The IPO structure was not ideal, since 77% of the proceeds went to the controlling shareholders (Folhapar and Portugal Telecom), and the remaining to the company. The IPO’s price was R$ 18.00 per share valuing the company at approximately R$ 2.1 billion or the equivalent to US$ 950 million on December 16th , 2005.

VALUATION

There is no comparables companies listed in Brazil, so the comparison has to be with other companies listed in USA. Besides that, UOL’s revenue growth is well below Internet companies that get most of its revenues from online ads such as Google and Yahoo.

The company posted results recently and together I included the First Call estimates in R$ (local currency) for the company:

2004A 2005A 2006E 2007E 2008E

Sales: 408 452 534 584 658
EBITDA 51 99 116 136 159
Margin 12.5% 21.9% 21.7% 23.3% 24.2%


The company has 117.6 million shares and all have tag-along rights of 100%. The company has no debt but cash of R$ 334 million (US$ 152 million), after redeemed shares owned by controlling shareholders.

USA ISPs such as: United Online and Earthlink, are selling according Bloomberg to an average EV/Ebitda of 5.5x, applying this multiple on 2006’s EBITDA of R$ 116 million we get a value of R$ 638 million plus cash on hand of R$ 334 million, that results in a value per share of R$ 8.27 per share.

However if we balance a little bit the valuation assuming that the content/Portal side of the business is where most of its EBITDA is generated, lets say 20% of Sales are ads, and the margin is 50% so we get an EBITDA of R$ 53 million. The multiple to be applied has to be lower than Google and Yahoo, because these are the leading companies in the business and have a global reach and much more brand awareness than UOL even in the local market. So a discount of around 40% is warranted, therefore a 15x multiple is reasonable, however this multiple is high for the Brazilian market, UOL’s growth has to be very high in order to compensate the high multiple attached.

Based on this multiple we get a value for the Portal of R$ 6.76 per share, for the ISP business of R$ 2.95 per share and R$ 2.84 per share for the cash on hand, therefore the total value is R$ 12.55 per share.


POSITIVE ASPECTS FOR SHORTING

The ISP business is under pressure from broadband access providers that belong to incumbent telcos (Terra – owned by Telefonica and linked to its local subsidiary (ticker: TSP); BRTurbo which is owned by Brasil Telecom (ticker: BTM) and Oi Internet owned by Telemar (ticker: TNE)). Besides that, there are many free dial ISP, which are backed by strong companies, such as: Yahoo Free, Click 21 (Telmex/Embratel), and IG owned by Brasil Telecom (ticker: BTM), which is the biggest in Brazil.

Google is increasing its investments in order to attend better the Brazilian market, so it has acquired a local company that developed a search engine aimed to Brazilian market, this will help them to cater local companies for online ads.

Yahoo has also a local operation and owns the leading search engine aimed to online shoppers in Brazil called www.buscape.com.br , that allows price comparison, and they get a lot of ads and receive a fee from online shops every time that a buyer view pages.

Despite the strong partners AOL Latin America did not survive in Brazil. It had as one of its partners, Banco Itau (ticker - NYSE: ITU) which is the second largest private bank in the country, and a leading online banking provider with millions of customers.

More than a year ago, UOL does not have anymore the exclusive content produced by the leading media company in Brazil – Abril Group, which is a kind of a local Time Inc. in terms of magazines offered. Abril Group has its own portal that competes with UOL for online ads.

Another big competitor for online ads is www.globo.com which is owned by TV Globo (the leading Brazilian TV with more than 50% market share) and TIM – Telecom Italia Mobile. Besides that, Globo Group has newspapers in the main cities and has also magazines; it is associated with Telmex in the company Net Serviços, which is the leading cable TV in Brazil.

UOL has an agreement with its main shareholder in order to provide content, this agreement is valid until 2009, if Folhapar sells its stake, and the renewal can not be guaranteed.

UOL’s value is highly dependent on grabbing market share of the growing online ads market, but the sector is plenty of powerful competitors which also have good brand awareness in the local market.

The company is discussing some tax matters in court, therefore no provisions are reflected in its financial statements and we don’t have any estimate on that.

Catalyst

- Market disappointment with its ads revenue growth;
- Change in legislation, actually all users has to have an ISP provider; however some companies that provide broadband connection are skipping that.
- Reduction in global liquidity will hurt this kind of company due its business model.