Telefónica eyes Brazil options as clouds gather

César Alierta, chairman of Telefónica, would like to cure the malaise at the heart of the Spanish telecoms company’s Latin American empire.

Problems at its Brazilian operations are prompting Mr Alierta to weigh up a series of radical options that include Telefónica buying Telecom Italia or Portugal Telecom, the largest telecoms companies in their home countries.

No decisions have been taken, but the fact that Telefónica is exploring several ambitious solutions underlines the magnitude of its Brazilian problems. And, with Spain mired in recession, the company is also under pressure in its home market.

Telefónica declined to comment. But it has highlighted for years the importance of Latin America as its growth engine, and Brazil is its most significant profit generator.

Yet earnings at Telesp, Telefónica’s Sao Paulo-based fixed-line phone unit, fell 6 per cent on an underlying basis in the nine months to September 30 compared with the same period in 2008.

Last year regulators insisted Telesp temporarily stop selling broadband packages because customers had been left with no internet access during two network breakdowns.

Meanwhile, because most Brazilians now own a handset, growth at Telefónica’s Brazilian mobile phone joint venture with Portugal Telecom is slowing.

Revenue increased by 9 per cent in the nine months to September 30, compared with 21 per cent in the same period in 2008. Furthermore, Telefónica is facing rising competition in Brazil.

In 2009 the Brazilian government backed a merger between two local telecoms companies – Brasil Telecom and Telemar – in the hope the combined business would better challenge Telefónica.

Last November, Vivendi, the French media and telecoms conglomerate, saw off rival interest from Telefónica to take over GVT, a fast-growing Brazilian fixed-line business.

Vivendi, which declined to comment, is now looking at the case for owning a Brazilian mobile business.

Then in January Carlos Slim, the Mexican billionaire and Telefónica’s arch-rival in Latin America, announced plans to integrate his mobile and fixed line businesses.

The move should enable América Móvil, Mr Slim’s mobile company, to make big cost savings.

Telefónica would like to replicate América Móvil’s plans by merging Telefónica’s Brazilian fixed line and mobile assets, but the Spanish company is reluctant to share the synergies with Portugal Telecom.

Telefónica and Portugal Telecom jointly control Vivo, Brazil’s largest mobile operator.

Mr Alierta has repeatedly tried – unsuccessfully – to buy Portugal Telecom out of Vivo.

HSBC analysts estimate Telefónica would have to pay between €3.7bn ($5bn) and €4.8bn to buy Portugal Telecom’s stake.

But given Portugal Telecom seems determined to stay in Brazil, an alternative strategy for Telefónica would be to try and buy Portugal Telecom itself, which has a market capitalisation of €6.9bn.

However, Telefónica believes the Lisbon government could block a takeover of Portugal Telecom.

Telefónica has therefore also been exploring whether it could solve its Brazilian problems in Italy.

In 2007, Telefónica became the largest investor in Telecom Italia by joining a consortium that bought a controlling stake in the Italian company.

Telefónica made its move to stop Mr Slim making a similar investment in Telecom Italia.

The main reason that Mr Alierta was keen to thwart Mr Slim was the risk that América Móvil could emerge as the country’s largest mobile operator by combining its wireless unit with one owned by Telecom Italia.

Franco Bernabè, Telecom Italia’s chief executive, has insisted its Brazilian mobile business, the country’s third largest, is not for sale, and it is run entirely separately from Vivo.

Telefónica has instead been considering the case for buying Telecom Italia.

The Spanish company could then get control of TIM Brasil, Telecom Italia’s Brazilian mobile unit, and combine it with Telesp. Given regulators are unlikely to let Telefónica own TIM Brasil and half of Vivo, it could sell its stake in the latter to Portugal Telecom.

Without the Telecom Italia deal, Bernstein analysts say Telefónica will struggle to meet its target of a €1.75 dividend in 2012, although the Spanish company insists it can do so without any acquisition.

Telefónica knows that a takeover of Telecom Italia, which has a market capitalisation of €19.2bn, would be fraught with risk.

With net debt of €35.5bn, Telecom Italia is western Europe’s most leveraged former fixed-line phone monopoly, and is part way through a turnround. Moreover, the Italian government might not allow a takeover of a national asset like Telecom Italia.

Telefónica might, however, fix its Brazilian problems without making an offer for Telecom Italia.

HSBC analysts suggest that, for between €3.5bn and €4bn, Telefónica could buy out its fellow shareholders in Telco, the holding company through which the Italian-led consortium bought its controlling stake in Telecom Italia in 2007.

Telefónica could then take control of the Telecom Italia board, and decide whether to combine TIM Brasil with Telesp.

Telefónica is sceptical that the other Telco shareholders – Generali, Intesa and Mediobanca – want to sell, although they are reviewing their options.

For Mr Alierta, sorting out Telefónica’s Brazilian problems will not be easy. But he knows the status quo there for Telefónica is increasingly untenable.