Telefonica Latin America Luster Fades on Brazil Slowdown

Telefonica CEO Cesar Alierta
Cesar Alierta, chief executive officer of Telefonica SA. Photographer: Angel Navarrete/Bloomberg

Telefonica SA’s days of guaranteed earnings expansion in Latin America may be over, leaving Chief Executive Officer Cesar Alierta with few growth markets as he tries to sell a stake in the assets to repay debt.

Revenue growth from the 15 countries including Brazil and Peru is poised to slow to 2.7 percent in 2013 from 12 percent last year, according to an estimate by Sanford C. Bernstein. Telefonica Brasil SA, which made almost half of Telefonica’s 29 billion euros ($35 billion) in Latin American sales last year, may see its 2012 profit margins drop to the lowest level since at least 2004, Banco de Sabadell analysts predict.

Alierta’s reliance on the region to offset a decline in earnings at its debt-battered Spanish home market may prove risky as the region’s economy slows and competition with Carlos Slim’s America Movil intensifies. Telefonica is discussing ways to sell shares in the regional business worth at least 40 billion euros, with one option being the creation of a holding company excluding Brazil and list it in the U.S., people familiar with the matter said this week.

“If Brazil starts to show weakening growth, I’d be very concerned because there would be massive consequences on both debt and equity markets,” said Roger Appleyard, head of global credit research at RBC Capital Markets in London. “As the other countries aren’t fantastic, Brazil is key in order to create a great story and convince any potential investors.”

Vivo Deal

Shares of Telefonica fell 3.2 percent to 9.76 euros at the close in Madrid, extending their decline this year to 27 percent. America Movil was little changed at 17.53 pesos in Mexico City.

Telefonica entered Latin America in 1990 through Chile and Argentina. Four years later the Madrid-based company added Peru and in 1998 it won a tender for Telecomunicacoes de Sao Paulo SA, which became the fixed-line unit known as Telesp in Brazil.

About $42 billion in acquisitions over two decades in the region, which culminated in the $10 billion takeover of Brazilian mobile operator Vivo Participacoes SA in 2010, made Telefonica the most acquisitive Spanish company in the region.

Latin America is helping Spain’s largest phone company offset a profit decline at its domestic market amid the debt crisis. Brazil accounted for 23 percent of Telefonica’s revenue and 25 percent of operating income before depreciation and amortization in the first quarter. That period also marked the first time for Telefonica, which was founded in 1924, when earnings from Latin America surpassed those from Europe.

Brazil Growth

Still, the growth is slowing. Macquarie estimates revenue from Latin America will climb 5.5 percent next year, while Banco de Sabadell projects an increase of 3.4 percent. Telefonica’s Oibda margin in Brazil, a country with more mobile-phone accounts than people, is poised to shrink to 36.4 percent this year from 37 percent in 2011, according to the bank.

Economic growth in Brazil, the world’s second-largest emerging economy, is forecast by analysts in a central bank survey to slow to 2 percent this year. Gross domestic product grew 2.7 percent in 2011, after 7.5 percent expansion in 2010.

Latin America is “an attractive market, but it’s a very competitive market, so you have to be careful with that,” said Will Landers, who helps manage more than $6 billion in Latin American equities including America Movil at New York-based BlackRock Inc. “All the good postpaid customers already have a phone or two, so the consumers you’re adding now are not going to be very high-quality customers.”

Cash Restriction

Other options under consideration by Telefonica, with 57 billion euros in net debt at the end of March, include incorporating all its Latin America units into Telefonica Brasil and hold a secondary share sale, the people said, adding that no decision has been made.

Telefonica hasn’t made much progress in Mexico and Colombia, where America Movil dominates with 70 percent and 62 percent of subscribers, respectively, compared with the Spanish company’s 20 percent and 25 percent.

In some Latin American countries, Telefonica, as a foreign investor, has had turbulent encounters with local governments. Venezuela has limited the amount of cash Telefonica can move out of the country. Moody’s Investors Service said in April that Argentina’s takeover of Repsol YPF SA’s unit would have negative implications for investors like Telefonica.

Even in Chile, where Telefonica leads with 39 percent of the wireless market, and Peru, where it dominates with a 61 percent share, profit margins are shrinking as competition gets tougher.

Chile Churn

Chile introduced regulations in January allowing users to switch providers without changing their phone numbers, causing Telefonica’s churn, a measure of customer turnover, to surge 70 percent from a year earlier to 2.2 percent. At the end of last year, Peru’s phone regulator cut the fees mobile carriers are allowed to charge to connect calls from land lines, hurting Telefonica’s sales.

Shares of Telefonica Brasil have dropped 4.6 percent this year, lagging gains of 11 percent by America Movil and 6.1 percent by Tim Participacoes SA, the Brazilian division of Telecom Italia SpA.

To be sure, America Movil’s profit margins have also been shrinking, falling to 38 percent last year from 40.6 percent in 2010, excluding interest, taxes, depreciation and amortization. The pressure has been most pronounced in the operator’s biggest markets, including Mexico, Brazil and the U.S., due to competition, regulatory changes and more aggressive prices. Profitability improved last year in Colombia, Chile, Peru and Ecuador.

German IPO

“When we went to Brazil, many of these analysts told us that we were wrong but now the reality shows we were actually right,” Alierta told shareholders on May 14. “We’ll continue to grow in Brazil, which is evidently a priority, and revenues and profits from that country will overtake those from Spain.”

A Latin America share sale may not happen until 2013 because of regulatory issues, the people said, adding that Telefonica will focus first on the IPO of its German wireless unit 02. The operator is considering a sale of a 20 percent stake in the O2 Germany business, people familiar with the matter have said.

Separately, Telefonica said yesterday it received several offers for the call-center unit Atento, without identifying the bidders. The operator was seeking about 1 billion euros for the asset, people familiar with the matter have said.

Telefonica needs Latin America to continue to grow as a recovery in Spain is unlikely any time soon with the country mired in its worst economic crisis in decades. With a 52 percent unemployment rate among people under 25 years old, Telefonica is losing market share to competitors including Jazztel Plc.

“Telefonica is being forced to launch the IPO in Latin America now and that’s not ideal,” Andres Bolumburu, a Madrid-based analyst at Banco de Sabadell said by phone. “The tough current market environment could imply low prices, though next year could be even worse.”

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