Description

SUMMARY: UOLL4 is like a Graham play that is full of cash (80% of Market Cap) and offers a free option on growth. The company is trading at EV/EBITDA of 0.9x (2009), well below other alternatives in the sector. The shares were sold off amid the rush for the exits in Emerging Markets. Besides that, the market is tired of them due to the high amount of cash. Right now having cash is a huge competitive advantage for purchasing businesses that are cash strapped.

BACKGROUND

 I had submitted this idea before to VIC on December 11, 2007. Therefore please refer to my previous wtite up for more information. Below I will present brief comments on UOL.

The Company’s flagship portal in Brazil is organized into 42 thematic stations with more than 1,000 channels of news, information, entertainment, and services, representing a total of more than 7 (seven) million pages. UOL’s extensive interactive platform offers communications products, VoIP, Internet communities, security and search engine, among others. The company has 24 categories that have more than 1 million Unique Visitors/month, and the closest competitor – Terra (Telefonica Group) has only 15 categories.

It is a leading web Portal aimed to Brazilian market and Portuguese speaking people around the world. Besides that it has an ISP business with 1.8 million subscribers, the largest on-line subscriber base. UOL provides local Internet access in more than 3,000 cities throughout Brazil and 14,000 cities abroad. Besides that, the average time spent on UOL’s sites by the users is 1:09 hours (Set/08).

The company belongs to a leading newspaper group in Brazil – Folha de São Paulo, that provides some of its content, and the other big shareholder is Portugal Telecom. Folhapar, the group holding company, bought more than 10 million shares (8,3% of total shares) in the last two months amid market turbulence without moving the price.

UOL derives 66% (last year was 75%) of its revenues from subscription revenues related to Internet Access services (ISP), and the remaining is from online ads and other products. The company develops internally 80% of the portal’s content. A key point is that most of the investors view UOL as a simple ISP business, and additionally don’t believe that UOL can leverage its content and brand popularity to get more online ads. The company does not disclose its ads revenue in P&L line alone, and barter transactions. According to company, they have around 25%-30% market share of internet advertising in Brazil. I would like to enphasize that the Brazilian Telecommunications Law requires that everybody has to have an ISP subscription.

The company was voted as the preferred portal by InfoExame’s readers, a leading PC magazine in Brazil, with 44% of the votes. Terra (Telefonica) got 38% and IG (owned by Brasil Telecom) 18%.

The company’s management is careful on asset allocation; despite its huge cash pile is not doing any silly acquisition. They choose to develop inside company the new products instead of buying existing competitors, because the acquisition premiums used to be very high, because successful Mercado Libre’s IPO (ticker: MELI) and other related technology oriented companies in Brazil, such as: Totovs and Datasul. I spoke to Private Equity people and they told me that sellers are now more humble on price because there are not any other options to raise capital, if you need it to grow.

UOL has established a commercial partnership with Google, sharing revenues from traffic to Google’s search engine through UOL’s portal. It has also launched new products to attract more viewers/traffic, such as:

a)Shopping UOL: Online price comparison tool, which competes with BuscaPé/Bondfaro. It is the 2^nd largest in the country.

b)PagSeguro: Online payment website, which is similar to PayPal and competes with MercadoPago offered by Mercado Libre (Ticker: MELI), and this has synergies with the UOL’s auction site TodaOferta.

c)UOL Megastore: Online music store, with the aim of generating traffic.

d)TodaOferta: Auction site, whichhas a different business model than Mercado Livre, a subsidiary of Mercado Libre (ticker: MELI). At TodaOferta, the sellers pay a fee for showing the merchandise and there is not a "success fee" as Mercado Libre.

e) UOL Host: At end of 2007, the company bought two small internet companies that offer hosting services, with that came 18 thousand customers. This service got high marks from “Info Exame” the leading internet/technology magazine in Brazil. Right now, UOL’s has close to 35 thousand customers, and with this got the 2^nd largest market share. The leading company in the segment is LocalWeb with almost 180 thousand customers. UOL’s has almost 250 thousand e-mails that are used by small-businesses, which don’t have a website, so there is a huge untapped opportunity. The lowest cost for having a website is R$ 15,00 /month (around US$ 7,00/month). There are operational and business sinergies with this new business, because it uses the capacity of the datacenter that handles ISP’s e-mails and hosts portal’s content.

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.

AUDIENCE

UOL maintained leadership in page views and time spent online among content portals in Brazil with 1,789 (1,608 Sep/2007) million page views, which means an increase of 11,3% Y-o-Y; and an average time spent online of 1h:09min:13sec – Sep/2008 (1h:05min:22sec in September 2007), according to IBOPE//NetRatings. Additionally the Unique Visitors figures reached 16, 2 million.

UOL Busca (UOL Search) ended September/2008 with 5,1 million Unique Visitors, mantaining the 2^nd position behind Google, and last year in the same month achieved 4.9 million unique domestic search visitors, putting them  in second place in the IBOPE//NetRatings search rankings.

AUDIENCE Data
Metrics	Sep-06	Sep-07	Var. %	Sep-08	Var. %
Page views (million)	1.293	1.608	24%	1.789	11,3%
Unique visitors (000)	8.898	13.019	46%	16.225	24,6%
Unique visitors - search (000)	3.451	4.936	43%	5.106	3,4%
Reach (% of Brazilian Internet users)	65%	65%	n.a.	67%	2,0%
Time spent online (hours:min:sec)	1:14:56	1:05:22	-13%	1:09:13	6,0%
Source: Ibope//NetRatings (portal audience, home panel, brand, excluding Internet applications).

UOL continues to maintain its leadership in audience amongst Brazilian portals (Globo, iG, Terra (Telefonica), YahooBrasil). This leadership is the foundation for advertising of sponsored links, banners and its advertising revenues are having a healthy growth.

GROWTH PROSPECTS

Growth of Internet Users. According to a report by Internetworldstats.com, the number of Internet users in Brazil reached 50 million in June/2008. This includes people that uses internet from all access places (home, work, schools, cyber cafes etc.).  Having grown at a compound annual rate of 15 % since 2002.

The Internet penetration (= Internet Users by total population) in Brazil is 26,1% (according to Internetworldstats.com – June 2008), which is still below Argentina 39,3% and Chile with 44,9%, however is higher than Mexico with 21,6%. Brazil’s internet market is bigger than the sum of Argentina+Chile+Mexico. Brazil is the 6^th largest internet market in the world.

Looking at the internet market in Brazil, with more than 50 million users, and all these users with a 21-hour usage per month, we believe that these two factors, size of the market and number of users and the time they are spending on the web represent a high growth potential for portals with good content, therefore high traffic and brand recognition by advertisers, as UOL, going forward.

 Increased adoption of e-commerce among Internet users. We believe that the relatively high penetration of online banking and the large number of income tax returns filed online, as well as the popularity of online communities (e.g. Orkut) illustrate the willingness of Brazilians to adopt new technologies. E-commerce in Brazil is continue to grow, as we can attest based on data from ComScore Media Metrix that shows a growth of 24% (Y-o-Y).

BRAZIL RETAIL - ComScore Media Metrix	Type	Total unique visitors (000s)	March 2008 - Reach %	Total unique visitors (000s)	March 2007 - Reach %	Unique Visitors - Y-o-Y %
Total Internet Audience	all	18.939	100%	15.307	100%	24%
1 B2W (*)	e-retailer	9.014	47,6%	7.735	50,3%	17%
2 MercadoLibre	auctions	7.952	42,0%	7.440	48,6%	7%
3 BuscaPe + Bondfaro	price comparison	5.722	30,2%	4.767	31,1%	20%
4 UOL Shopping	price comparison	4.083	21,6%	1.205	7,9%	239%
5 Saraiva	e-retailer	1.246	6,6%	975	6,4%	28%
6 eBay	auctions	1.237	6,5%	1.165	7,6%	6%
7 Apple	e-retailer	1.152	6,1%	n.a.	n.a.	n.a.
Source: Com Score Media Metrix
(*) Includes Submarino + Americanas + Shoptime websites.

ADVERTISING SPENDING by MEDIA (BRL million)
Brazil	Acum.	Acum.	Acum.
MEDIA	Set/06	Set/07	Change %	Share %	Set/08	Change %	Share %
TV	7.482	7.855	5,0%	59,3%	8.968	14,20%	58,50%
Newspaper	1.988	2.191	10,1%	16,5%	2531	15,60%	16,60%
Magazines	1.018	1.057	3,8%	8,0%	1279	21,00%	8,40%
Radio	530	528	-0,4%	4,0%	648,7	22,80%	4,20%
Pay-TV	368	427	16,1%	3,2%	556,6	30,30%	3,60%
Billboard etc.	467	391	-16,2%	3,0%	415,8	6,30%	2,70%
Guides/Phone Lists	443	383	-13,6%	2,9%	343	-10,30%	2,20%
>>INTERNET	253	353	39,7%	2,7%	519,5	47,20%	3,40%
Movie Theaters	40	49	24,3%	0,4%	61,5	25%	0,40%
Total	12.589	13.234	5,1%	100,0%	15323	15,80%	100,00%
Source: Inter-Meios - Nov 26, 2008.

Internet share in Brazilian’s advertising pie is well below world averages, 2.7% against 7.4% in 2007, so there is a huge growth ahead. Besides that, Brazil spends comparatively a good chunk of its GDP in advertising.

FINANCIALS / VALUATION

 The company is profitable: Net Earnings for 9 Months 2008 is BRL$ 75,6 million and for all 2007 reached BRL$ 109,4 million.

We calculated an adjusted P/E where we simulatedthat the company distributes all of the cash (BRL $ 567 million), so we can show how low is UOL’s P/E ratio on the table below.

 

Estimated P/E - 2008	BRL Million
EBIT (9 months-2008)	57,0
(-) Income Tax	(10,5)
Adjusted Net Earnings (*)	47
Annualized Net Earnings	62
(*) Eliminated all interest income
from cash balance.
Market Capitalization	817
(-) Cash Distribution	(567)
Adjusted Mkt Capitalization	250
Adjusted P/E Ratio	4,0
Earnings Yield	25%

 

EV/Ebitda Calculation	BRL Million
Number of Shares (million)	120,1
Price BRL$	6,8
Mkt Cap	817
(-) Excess Cash	-567
(-) Tax Credit	-112
(+) Swaps Payments Due	11
(+)Tax Debts Renegotiated	6
Enterprise Value	155
2008e	2009e
Enterprise Value	155	155
Ebitda	143	169
EV/Ebitda Multiple	1,1	0,9

UOL    P & L (BRL Million)	2005	2006	2007	2008e	2009e
Gross Revenues	564	634	716	791	883
Subscription	457	485	525	510	517
Advertising+Other	107	150	192	281	366
(-) Sales Deductions	(120)	(154)	(191)	(216)	(221)
Net Revenues	444	481	525	576	662
Net Revenues Growth	8,8%	8,2%	9,2%	9,7%	15,0%
(-) Cost Services Sold	(215)	(215)	(217)	(234)	(291)
Gross Profit	229	265	309	342	371
Gross Margin	52%	55%	59%	59%	56%
(-) S, G &A	(154)	(150)	(172)	(199)	(202)
(-) Depreciation	(22)	(33)	(44)	(43)	(63)
Other Oper (Exp.) Revenues	24	20	17	0	0
EBIT before Non-Recur.	78	102	109	100	106
(-) Non Recurring	(24)	(20)	(17)	0	0
EBIT Recurring	54	82	92	100	106
(+) Depreciation & Amort.	22	33	44	43	63
EBITDA	75	115	136	143	169
Ebitda Growth	36%	53%	19%	5%	18%
Ebitda Margin	17%	24%	26%	25%	25%

We think that brand recognition as UOL enjoys (mainly for companies running sites or a community of sites) is an essential intangible asset and that today it is difficult to build this up from scratch. Brand (and image) takes on a strategic dimension since it provides audience figures or “natural traffic” that can be used by advertisers.

Catalyst

1) Uses his excess cash of BRL$ 567 million (US$ 243 million) to make accretive acquisitions. CFO told us that they have around 8 potential acquisitions in the pipeline.
2) Advertising revenues continue to growth despite the competition due its portal content, popularity among internet users and brand recognition by advertisers.
3) The company could be acquired by another media company due its preeminence among the Brazilian portals.