10/16/07


Oi alternatives

Oi (Telemar) is the biggest fixed telephony operator of Brazil with 14.3 million accesses in service (Aug/07). Fixed telephony business is decreasing. In 2004 Oi had 15.2 million accesses in service. The gross revenue of Oi's fixed telephony (except data communication) decreased from R$ 18.9 billion in 2005 to R$ 18.2 billion in 2006.

 

Oi needs to invest in cellular and broad band to increase the participation of these services in its gross revenue. In the 2nd quarter of 2007 (Q207), cellular and communication data represented 14.4% and 11.5%.

 

In the Q207, Oi had 1.3 million broad band accesses (ADSL), lesser than Brt (1.5 million) and Telefonica (1.8 million). With cellular, even being market leader in its region, Oi has been having difficulties to keep leadership. To compete as equal with Vivo, Claro and Tim, will have to become an operator with national coverage and invest in 3G. The recent acquisition of frequencies in São Paulo shows the desire of national coverage.

 

The shareholders that control Oi will have different moments. According to market informations, some want to sell its participation and others want to keep in the business. No doubt, this situation difficult decisions on new investments that the company needs .

 

New shares issuance would result in losing control, only left debt in which have limits.

 

This situation gets worse because of the low value of the market, when measured by shares traded on the stock exchange (more details), Oi (TNL): R$ 18.8 billion in Sept/07, lesser than Telefonica (R$ 29.8 billion) and Tim (R$ 20.3 billion).

 

Still there's a possibility of Oi and BrT joint venture and some other alternatives to Oi.

 

 

 

Corporate Reorganization Proposal

 

This situation motivated Oi's shareholders to launch in Apr/06 a corporate reorganization proposal to increase market cap of the company.

 

By the proposal, the corporate structure would be simplified, trading all the existing shares in ON shares (ordinary) of Telemar Participações, which would be negotiated in the São Paulo Stock Exchange - Bovespa (“New Market”) and in the New York Stock Exchange (“NYSE”).

 

Telemar Participações would have an independent board, a policy of distributing dividends attractive and controlling shareholders would make a public offer of shares spraying the capital of the company if the company's stock reach the expected recovery.

 

In case of success, this proposal would solve most of the problems of Oi. The controlling shareholders who wanted to sell out its participation in the public offer of shares, those who wanted to stay would stay, and with the increase in the value of the company Oi would be prepared to face new investments and a possible joint venture with BrT. BrT with corporate structure similar to Oi, should follow the steps if the operation had been successful.

 

This operation, which seemed to be good for all, was rejected by holders of PN shares (preferential) in Dec/06, who did not agree with the exchange relation proposed by its shares.

 

To solve this situation Oi announced in Apr/07 public offer for the purchase of PN shares, subject to the acquisition at least two thirds of the shares. The initial price of R$ 35 proposed by PN shares of Tele Norte Leste (TNL) was subsequently increased to R$ 45. The proposal received, however, the accession of 50% of the PN shares and was canceled on October 11, 2007.

 

According to this situation, what'll Oi's controlling shareholders do ?

 

To answer the question it's necessary to understand the reasons that took Oi's minority shareholders to reject the operation.

 

Why the proposal failed

 

Oi (Telemar) present the following corporate structure.

 

 

Telemar Participações is the company that gathers the group of investors which acquired the control of TNL in 1998 per R$ 3.4 Billion.

 

The following table presents the economic impact to each group of shareholders with the reorganization proposed in Apr/06.

 

R$ Thousands
Market Cap
Recovery
Apr/06
after * reorganization
ON shares of TNL belonging to Telemar Part sahreholders.
3,823
9,732
155%
Others ON shares of TNL
3,285
6,929
111%
PN shares of TNL
8,921
11,403
28%
ON shares of Telemar Norte Leste
241
502
108%
PN shares of Telemar Norte Leste
2,152
2,853
33%
Total
18,422
31,420
71%

* shares of Telemar Participações R$ 2,835, average values R$ 2.69 and R$ 2.98 considered in Oi's proposal. Source Telemar.

 

As you can see the holders of PN shares of TNL wouldn't make a lot with the operation with a recovery of just 28%.

 

In Apr/06 the price per share of TNL PN was R$ 35.02. A recovery of 28% would increase the price of these shares to R$ 45.00, value proposed by Oi in the public offer of Oct/07. The offer of PN shares purchase of TNL kept the same structure of distribution of earnings of the reorganization proposal rejected in 2006. Taking off only from TNL PN shareholders the risk of achieving the projected recovery.

 

An analysis of the evolution price of TNL shares helps to understand why 50% of PN TNL shareholders consider $ 45.00 low price for their actions.

 

 

Alternatives to shareholders

 

Left the following alternatives to Oi's controlling shareholders:

  • Insisting on reorganization proposal increasing the value proposed to the PN shares acquisition. This alternative would reduce share value of the controlling shareholders which can prevent their sale in stock exchange and capital spraying.
  • Betting on the joint venture of Oi with BrT, through the joint venture of Telemar Participations with Solpart (BrT controller) and in this process allow the sale of the controllers participation who want to leave the business.
  • Sell Telemar Particiações to a new group controller. Portugal Telecom has shown interest in the acquisition and would be willing to pay around 3.5 billion euros ($ 8.9 billion) for Oi's control (more details)

 

You could ask :

  • Which alternative will Oi's controlers choose? Is there any other option?
  • These shoreholding questions could impact the growth of Telemar and the investments to its operation in São Paulo?
  • And what about B rT? What will it do?

 

Comment.

 

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