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Oi S.A. Company Report

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Oi S.A. Company Report MASTERS IN FINANCE EQUITY RESEARCH OI S.A. COMPANY REPORT TELECOMMUNICATION SERVICES JANUARY 7, 2015 STUDENT: RICARDO JORGE LUÍS GOMES [email protected] Future is all about uncertainty Recommendation: BUY Good business prospects, massive leverage Price Target FY15: R$ 19.51 Price (as of Jan. 6, 15) R$ 7.10 . We recommend buying Oi S.A.’s ordinary shares, provided our price target of R$ 19.51 as of December 31, 2015, which Reuters: OIBR3.SA, Bloomberg: OIBR3:BZ underlines an upside potential of 174.78% and represents a 5.78 52-week range (R$) 7.10-48.80 EV-to-EBITDA multiple. However, one should bear in mind the risk Market Cap (R$ mn) 5,984 Outstanding Shares 842,766,135 implied by the small expected participation of equity in the 52-week average daily volume 469,973 company’s enterprise value in 2015 (21.88%). Sources: Analyst estimates; Bloomberg . Selling PT Portugal – which will be decided by PT SGPS’s shareholders on January 12, 2015 – and consolidating in Brazil by acquiring a stake in TIM adds value to the company, as it would allow for a reduction of indebtedness while enjoying from operational synergies. Actually, the target price for this scenario is R$ 19.78, R$ 0.89 above the target price implied by the current scenario, on a standalone basis. We believe Oi S.A. will be able to leverage its wireline Source: Bloomberg footprint in Brazil in the coming years and capture market share in the pay TV segment. However, the debt burden and the possible (1) 2013 2014E 2015F focus on de-leveraging might impair its ability to explore growth Financials Revenues (R$ mn) 36,873 36,937 37,083 opportunities, particularly in a market within a wave of EBITDA (R$ mn) 13,049 10,066 10,272 consolidation. Net Income (R$ mn) 1,150 -1,066 -655 EPS (R$) 1.36 -1.27 -0.78 . The approval from CVM to proceed with the exchange of Ratios the investments in Rioforte by shares held by PT SGPS ROE (%) 6.63% -6.06% -4.29% Net Debt/EBITDA (x) 4.08 5.35 5.41 representing 16.58% of Oi S.A.’s share capital is still awaiting EV/Revenues (x) 2.45 1.95 2.01 approval, impairing the listing of CorpCo in the Novo Mercado EV/EBITDA (x) 6.91 7.14 7.25 (1) Consolidated Pro-forma segment of BM&FBOVESPA. Sources: Analyst estimates; Company fillings THIS REPORT WAS PREPARED BY RICARDO JORGE LUÍS GOMES, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND ECONOMICS, EXCLUSIVELY FOR ACADEMIC PURPOSES. THIS REPORT WAS SUPERVISED BY ROSÁRIO ANDRÉ WHO REVIEWED THE VALUATION METHODOLOGY AND THE FINANCIAL MODEL. (SEE DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT) See more information at WWW.NOVASBE.PT Page 1/40 OI S.A. COMPANY REPORT Table of Contents EXECUTIVE SUMMARY ...........................................................................3 VALUATION ..............................................................................................4 COMPANY OVERVIEW ............................................................................6 BRAZIL ............................................................................................................. 8 PORTUGAL ....................................................................................................... 9 EQUITY SECURITIES AND SHAREHOLDER STRUCTURE ..................................... 10 THE NEVER-ENDING BUSINESS COMBINATION ................................11 BACKGROUND AND RATIONALE ....................................................................... 11 PATHWAY TO CORPCO .................................................................................. 12 GONE WITH RIOFORTE ................................................................................... 13 BRAZILIAN OPERATIONS .....................................................................15 COMPETITION................................................................................................. 16 FINANCIAL PROJECTIONS ............................................................................... 18 PORTUGUESE OPERATIONS ...............................................................25 COMPETITION................................................................................................. 26 FINANCIAL PROJECTIONS ............................................................................... 27 SCENARIO ANALYSIS ...........................................................................32 SENSITIVITY ANALYSIS AND MULTIPLES VALUATION .....................34 APPENDIX ..............................................................................................36 RESEARCH RECOMMENDATIONS .................................................................... 40 PAGE 2/40 OI S.A. COMPANY REPORT Executive summary Oi S.A. is one of the main integrated telecom service providers in Brazil (which are conveyed under the trademark Oi) and Portugal (through PT Portugal and its brands, MEO and PT Empresas), having in its portfolio more than 100 million customers in seven different countries and forecasted to generate an EBITDA amounting to R$ 10,066 in 2014. It is the leading provider of fixed line telephony services in both countries – responsible for 36.50% and 54.80% of the total number of accesses in Brazil and Portugal, respectively – as well as the market leader in what concerns bundled offers in Portugal, with a market share of 44.30%. The relationship between both sides of the Atlantic dates back to July 2010, despite the on-going merger was only announced in October 2013. However, ever since Rioforte defaulted and Oi S.A. did not recover the short-term investments that had been made by PT SGPS, the whole process came to a halt, with the terms that had been signed being revised, including a downsize of the share of CorpCo to which PT SGPS’s shareholders will be entitled to (from 32.22% to 15.65%). As for the Brazilian and Portuguese telecom markets, both are at different stages of maturity. Whereas in Brazil penetration rates are quite below those experienced in developed markets – except for mobile devices – and its population and demand for such services are still increasing, in Portugal, on average, penetration rates are in line with the ones recorded in Europe and the market has reached a stabilization of demand. Such framework led PT Portugal to be amongst the worldwide pioneers providing convergent offers – allowing for lower churn rates and higher ARPUs – which have been replicated across the world, including in Brazil. However, the truth is that it seems that the intention to create a multinational telecom giant has dissipated itself from the summer of 2014 onwards. On top of the default of Rioforte have increased the indebtedness level of Oi S.A. – we estimate its Net Debt-to-EBITDA to be 5.35 by the end of 2014 –, the acquisition of GVT by Telefónica in September 2014 left TIM as a clear non-integrated target for takeovers, within a country that stands amongst those that spend the most in CAPEX per access. Such events triggered the interest of international entities in PT Portugal and Oi S.A. is currently awaiting the approval of PT SGPS’s shareholders to divest PT Portugal’s assets to Altice, by a total consideration of € 7,400 million (including earn-outs). Thus, we have incorporated into our price target – R$ 19.51 – the scenario under which Oi S.A. sells PT Portugal to Altice and acquires a one-third stake in TIM by R$ 14,304, which we believe might entail synergies up to R$ 14,263 on an NPV-basis, as of December 31, 2014. PAGE 3/40 OI S.A. COMPANY REPORT Valuation The methodology used throughout this note relies on the sum of parts (SoP) technic, combined with Discounted Cash Flow (DCF) models and market multiples, according to the relevance of each operating segment. The Brazilian and Portuguese telecommunications segments were valued through DCF models, whereas the interests held in Africa and East Timor were valued through market-based Enterprise Value-to-EBITDA (EV-to-EBITDA) multiples1, because either their relevance is not material or there is lack of information available which would make a DCF valuation too much dependent on analysts’ assumptions. Regarding the DCF-based valuations, both segments were analyzed centered on an explicit forecast period of 5 years (2015 through 2019) and a perpetuity thereafter, with annual nominal growth rates equal to 4.70%2 for Brazil and 0.50%3 for Portugal. Moreover, all estimates were made in local currencies (Brazilian Real and Euros) and then consolidated into the Brazilian currency, using the following projected exchange rates4: Table 1 – Forecasted exchange rates (Brazilian Real per Euro) 2014 2015F 2016F 2017F 2018F 2019F Year-average 3.11 3.27 3.41 3.53 3.64 3.75 Year-end 3.22 3.37 3.52 3.65 3.76 3.87 Source s: IMF, Bloomberg, Analyst estimates In order to discount the projected cash-flows, it was decided to use the WACC5, which is summarized in Table 2. 1 A 6.70x EV-to-EBITDA was used. This figure was computed as the average EV-to-EBITDA multiple for the following list of comparable companies: MTN Group, Vodacom Group, Maroc Telecom, Safaricom, and Telecom Egypt. 2 We believe the combination of a low installed base of pay TV and fixed broadband services, the still-increasing Brazilian population, and the recent roll-out of multiple play offers create considerable room for growth within the country’s telecom industry. Moreover, comparable businesses (refer to Footnote 7) traded at 5.48x EV-to-EBITDA as of December 31, 2014. Thus, we predict that the operations held by Oi S.A. in Brazil will grow at 4.70% per year from 2020 onwards, corresponding
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