Oi CEO Bava Says Investment Plan Will Convert Skeptics

Oi SA Chief Executive Officer Zeinal Bava, saddled with the lowest analyst ratings in Brazil’s phone industry, said he’ll win over skeptics by improving quality and cutting investments at the same time.

The company’s surprise loss in the most recent quarter led Bradesco BBI to drop its outperform rating, leaving the number of analysts advising buying Oi shares at 3 out of 16, according to data compiled by Bloomberg. Fitch Ratings downgraded Oi’s debt, citing “weak operating results and higher net leverage.”

Bava, with two months on the job, is preserving cash by reducing the industry’s best annual dividend by 75 percent, a move that sent shares down 10 percent last week. His next step is to cut Oi’s yearly budget for capital expenses below 6 billion reais ($2.52 billion), going against the advice of analysts who say the company needs more network investment to keep up with deep-pocketed competitors Telefonica SA and America Movil SAB.

“A capex of 6 billion reais alone will not solve quality problems,” Bava, 47, said in a telephone interview. “We are going to do more with less money, and thus capex next year will be lower. It’s not just about how much we invest but how we invest, where we invest and improvements from better bottom-up processes.”

Deeper Pockets

The move to reduce spending on network investments surprised analysts, since telecommunications companies are capital-intensive and need to continually invest to keep up with technology. Telefonica, based in Madrid, is spending 5.7 billion reais in Brazil capital expenditures this year. Mexico City-based America Movil, which doesn’t provide budgets for individual countries, is spending $10 billion across Latin America. Brazil is its largest market after Mexico.

“Oi has to enter into this rhythm to compete with others,” said Gustavo Serra, an analyst at Planner Corretora de Valores SA. If it doesn’t match competitors, it will fall further behind in terms of quality of service, network expansion and the ability to attract clients, said the analyst, whose rating on Oi is under review.

Since it serves 4,500 municipalities as the largest provider of telephone landlines in Brazil, Oi’s network requires more attention and maintenance than competitors that cover only portions of the country with fixed connections. Its current investment of about 3 billion reais in landlines is the same as in 2010, “suggesting significant historical underspending,” HSBC Holdings Plc analysts led by Richard Dineen wrote in a report on July 17.

Spending Trails

The company is also spending about 2.4 billion reais on mobile, less than its peers, they wrote.

Reducing investment spending, along with paying about 500 million reais in dividends a year from an earlier annual budget of 2 billion reais, will help strengthen Oi’s balance sheet, Bava said.

“We have a team that is committed to executing the operational turnaround of Oi,” Bava said in the telephone interview from Rio de Janeiro. “Our plan is to change the cash-flow profile of the company, consolidate our business model and improve the efficiency of operations and grow revenues.”

He told analysts on a conference call last week that Oi could wring better terms from suppliers and better prioritize investments, such as spending more on third-generation, or 3G, technology and less on expanding older 2G coverage.

Inherited Problems

Oi was down 50 percent through last week since Francisco Valim was ousted as CEO in January, compared with the 16 percent decline of the benchmark Ibovespa index. The shares fell 3.7 percent to 3.87 reais at 2:28 p.m. in Sao Paulo. Bava inherited a company whose problems are deep and will take years to unwind, said Andres Medina-Mora, an analyst at Corporativo GBM SAB.

“Like any major turnaround story with such a hefty debt situation, it’s going to be difficult to get there,” said Medina-Mora, who decreased his target price last week from 6.63 reais to 6 reais while maintaining his buy recommendation.

The company will have to slow down after indiscriminately adding customers who now aren’t paying their bills, Medina-Mora said. Oi’s second-quarter loss included a 97 percent increase from a year earlier in bad-debt provisions, which cover customers who don’t pay their bills.

‘Enormous’ Costs

Revenue grew 2.4 percent in the second quarter to 7.1 billion reais, according to data compiled by Bloomberg. Costs rose 10 percent to 5.3 billion reais because of personnel, marketing and provisions for bad debt, which were “enormous,” said Alex Pardellas, a Rio de Janeiro-based analyst at CGD Securities, in a telephone interview. He has a buy recommendation on Oi with a target price of 8 reais.

“The increase in bad debt provisions was related to a difficult macroeconomic scenario,” Pardellas said.

While the industry as a whole saw an increase in bad debt last quarter -- Telefonica Brasil SA’s provision for deadbeat customers rose by 26 percent -- “the case of Oi was much more aggressive,” Medina-Mora said.

“This is a priority for the new team and for Mr. Bava,” Medina-Mora said. “I’m much more comfortable with the way he’s doing things.”

Telefonica Brasil said this year’s budget is part of 24.3 billion reais of investments planned from 2011 to 2014.

“The funding is dedicated principally to the expansion and modernization of networks and systems, continuous quality improvement for our services and customer service, in addition to innovative solutions,” the company said in a statement.

Long-Term Changes

While Oi has sold an undersea cable business and phone towers to net 4 billion reais since December, those were insufficient, one-time measures, Serra said. Bava had to make more long-term changes to assure Oi could grow, he said.

“If you consider the policy of dividends with investments, this was incompatible with the cash generation of the company,” Serra said in a telephone interview from Sao Paulo. “The impact of the dividend cut on the stock will be negative in the short term, but for the company it’s a measure that goes along with more sustainable growth.”

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