Oi Portugal Deal Hits Snag as Investors Get Bargaining Chip

Oi SA’s merger with Portugal Telecom SGPS SA, the biggest Brazilian deal announced last year, hit a snag after minority shareholders won an early victory in their fight for more favorable terms.

In a preliminary decision obtained by Bloomberg News, Brazilian securities regulator CVM said Oi’s controlling ownership group can’t participate in calculating the price of some assets involved in the transaction. Oi and Portugal Telecom had planned to use asset prices approved by their biggest investors to help determine the distribution of shares in the new company.

The decision means Oi may have to buy out non-controlling investors, who argued the transaction favored Oi’s biggest owners. The CVM technical staff’s ruling, if it’s upheld, would let some minority shareholders demand that Oi purchase their stock, which could cost the debt-laden company about 950 million reais ($403 million), according to Exane BNP Paribas.

“This is a fundamental step in the merger, and they’re going to have to convince minority shareholders of the advantages of the operation, or it won’t happen,” said Raphael Martins, a lawyer representing Oi investor Tempo Capital. “If the base-case scenario for the merger is maintained, there won’t be an accord among shareholders for a capital increase.”

Oi Chief Executive Officer Zeinal Bava is pushing for the merger to help the phone carrier compete with America Movil SAB and Telefonica SA in Brazil.

Diluting Stock

The company, based in Rio de Janeiro, had planned to raise at least 7 billion reais by selling new shares -- diluting its stock -- and to pay off $2 billion in debt for controlling shareholder Telemar Participacoes SA, a holding company whose owners include the Andrade-Gutierrez and Jereissati families.

An Oi press official declined to comment.

Under the deal, Portugal Telecom was to participate in the capital increase by contributing all of its assets, allowing itself to be absorbed in the new company. In October, the Lisbon-based phone carrier said its assets were worth 1.9 billion to 2.1 billion euros ($2.6 billion to $2.9 billion). Bava told investors that same month that the companies would hire an independent appraiser to make a publicly available estimate of the assets’ value “in due course.”

While controlling holders will have their debts paid off through the merger transaction, minority shareholders -- who are getting diluted by the new shares being issued -- receive no payout. On top of that, smaller investors saw their shares fall 50 percent in 2013. Now they’ve gained a way to negotiate the terms of the deal, said Martins, a partner at law firm Faoro & Fucci Advogados, by phone from Rio de Janeiro.

Stock Gain

Oi surged 5 percent on Jan. 10 on speculation that the regulator’s initial finding would give minority investors an edge. The details of the merger are still on the drawing board, said Pedro Galdi, the head strategist at brokerage firm SLW Corretora in Sao Paulo.

“There is a risk this operation won’t happen,” he said by telephone.

Oi rose 1.4 percent to 4.28 reais at the close today in Sao Paulo, its highest price in almost three months. Portugal Telecom fell less than 1 percent to 3.53 euros in Lisbon.

Bava has said the transaction aids all shareholders by strengthening Oi and simplifying its ownership structure, partly by eliminating the debt of controlling shareholders in exchange for them giving up special voting powers.

High Stakes

If Oi is forced by the CVM to make an offer to repurchase shares from minority investors, the amount won’t affect the company’s liquidity much, Mathieu Robilliard, an analyst at Exane BNP Paribas, said in a research note.

“Whilst a deal failure cannot be ruled out, we believe that stakes for Oi and PT are very high,” said Robilliard, who has the equivalent of a sell rating on Portugal Telecom. “If the CVM goes along with this initial recommendation (not guaranteed), the companies will be ready to make some concessions.”

Even if Oi can complete its merger with Portugal Telecom, it still needs to upgrade its network to fight Telefonica, America Movil and Telecom Italia SpA for the most lucrative customers in a market where new user growth is slowing. Bava has said the merger would allow the new company to spend less by becoming more efficient.

‘Highly Levered’

Investors might be more in favor of the Portugal Telecom deal if one of Oi’s competitors vanished, giving the carrier more room to grow, said Walt Piecyk, an analyst at BTIG LLC in New York. That could happen if Milan-based Telecom Italia, struggling under its own debt pile, breaks up its Brazilian mobile-phone unit, Tim Participacoes SA, and sells the parts to its rivals, he said.

“Oi’s a highly levered company, and you need money at this stage because you’re investing in 3G and 4G networks to try and benefit from wireless data growth,” Piecyk said in a phone interview last week. “Without consolidation, it may be very difficult for Oi to raise the capital that they need to complete the transaction and invest money in Brazil.”

A spokeswoman for Tim referred to a Jan. 3 regulatory filing in which the company and its parent deny knowledge of any offer for the sale of Tim.

Right now, Oi couldn’t afford to buy part of Tim if it became available, said Alex Pardellas, an analyst at CGD Securities in Rio de Janeiro. Its ratio of net debt to earnings before interest, taxes, depreciation and amortization was 3.4 at the end of June, and Bava has said it will be 3.3 once the merger is completed. America Movil’s was less than 2, and Telefonica’s Brazilian unit was less than 1.

“Oi would have to raise another round of capital” to buy part of Tim, Pardellas said by telephone. “There is a lot of competition, and the need for capex is very high. The sector isn’t going through good times.”

(Updates with closing share price in 12th paragraph.)
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