Oi Buys Time for Turnaround With Portugal Telecom Deal

Oi SA’s merger with Portugal Telecom SGPS SA is likely to bolster Brazil’s largest landline phone carrier as it battles better-equipped rivals in the world’s fifth-biggest wireless market. The shares fell on concern it won’t be enough.

The transaction provides a cushion for Rio de Janeiro-based Oi, which had already lost almost half its value in the past year, by shoring up its balance sheet, reducing expenses and giving it more buying power with suppliers, Corporativo GBM SAB said. The merged company will compete with Telefonica SA, America Movil SAB and Telecom Italia SpA, and may play a role in future mergers, JPMorgan Chase & Co. said.

Still, assuming he closes the deal as planned in the first half of next year, Oi Chief Executive Officer Zeinal Bava will have a company with a lower-quality network and fewer wireless subscribers than his competitors and higher leverage, with net debt at 3.3 times earnings. To succeed, he’s counting on better cash flow while not ruling out other mergers, he said.

“This buys them time and gives Oi more capacity to do better and allow the company to invest,” said Andres Medina-Mora, an analyst at GBM. “It is in a better position to compete.”

Oi fell 11 percent to 3.94 reais at 3:24 p.m. in Sao Paulo, erasing its gains from yesterday, when the transaction was announced. Portugal Telecom dropped 3.8 percent to 3.48 euros in Lisbon, retreating after surging 6.5 percent yesterday.

Standard & Poor’s said it’s reviewing the transaction and may downgrade Oi’s debt rating to junk. Moody’s Investors Service reiterated that it may do the same.

Rio Headquarters

The transaction cements a relationship that began three years ago, when Lisbon-based Portugal Telecom said it would acquire a 22.4 percent stake in Oi for $4.8 billion. Both companies now hold minority stakes in each other. The combined carrier, which will include Portugal Telecom’s assets in Europe and Africa, will be based in Rio de Janeiro, with Bava as CEO.

Brazil Communications Minister Paulo Bernardo said the transaction was unlikely to meet resistance from regulators. Sergio Monteiro, Portugal’s secretary of state for public works, transport and communications, said the government won’t interfere with the deal.

By keeping the new company’s headquarters in Brazil, the government can continue to support what Barclays Plc described in 2010 as the “national champion” in the phone business. Oi’s controlling ownership group includes Brazil’s Jereissati and Andrade Gutierrez families, along with development bank BNDES and pension funds for state-run companies such as Banco do Brasil SA.

‘Better Position’

Oi is making its move while rival Tim Participacoes SA awaits word of its future. Tim, Brazil’s second-biggest wireless carrier, is owned by Telecom Italia, which may have to sell the asset to cut debt, analysts at Barclays Plc and BTIG LLC have said.

Brazil’s government wouldn’t allow a single competitor to buy all of Tim, Bernardo said last month. As an alternative, the company could be broken up into parts, allowing its assets to be divvied up by rivals -- including Oi, if it has the money to do so.

“This puts Oi in a better position to bid for a stake in Tim,” said Andre Baggio, an analyst at JPMorgan, in a note to clients yesterday. He said he kept a neutral rating on Oi because the new stock issuance will dilute the shares.

After the transaction, the new company will trade under a single class of shares, eliminating Oi’s multitiered ownership structure. That simplified approach gives the company more options, Bava said today.

Opening Options

“As we are today it is impossible for us to actually play any kind of consolidation game, so I think this is the first step that we need to put in place,” he said in an interview on Bloomberg Television’s “The Pulse.” The union “will certainly open up options for the company for the future.”

With more than 100 million mobile-phone subscribers across three continents, the Oi-Portugal Telecom combination -- known for now as CorpCo -- would still lag far behind America Movil, which now has 262 million wireless users and Telefonica, with 249 million. It wouldn’t even catch up with Telecom Italia, which has 123 million across Italy, Brazil and Argentina.

That means CorpCo remains at a disadvantage to the bigger companies in bartering for lower prices from suppliers of smartphones, network routers and other bulk purchases needed to operate a telecommunications network.

More Leveraged

CorpCo’s net-debt-to-earnings ratio, at 3.3 times, would be an improvement from Oi’s 3.7 times. It would still be more burdened by debt compared with Telecom Italia’s 2.8 times, Telefonica’s 2.6 times and America Movil’s 1.7 times, according to data compiled by Bloomberg.

By eliminating overlaps in technology, personnel, network investments and other expenses, CorpCo will save 5.5 billion reais ($2.5 billion), Bava said yesterday.

“This better cash flow should lower debt,” said Thomas Chang, an analyst at UM Investimentos, which manages about 150 million reais. “But in the short term, this question of debt will still worry investors.”

CorpCo’s shares will be listed on Brazil’s Novo Mercado, which has a stricter set of corporate-governance regulations than the broader market. By moving to a single share class, instead of Oi’s voting and non-voting shares,the company becomes more beholden to all shareholders instead of a select group.

“We don’t like Oi the way it is today because of reasons of governance,” said Flavio Clemente, an analyst at Jardim Botanico Investimentos, which manages 850 million reais. The transaction is prompting the group to take another look, he said.

Bava and his team should now start focusing on operations, having addressed the ownership structure, said Susana Salaru, an analyst at Banco Itau BBA, in a research note yesterday.

“We see this as a potential turning point in Oi’s investment story,” she said.

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