The battle for control of the Brazilian mobile telephone market is now well underway. It began on May 11, when Spain’s Telefónica decided to break its ties with Portugal Telecom (PT), with which it jointly owns Brasilcel, the holding company that operates Vivo, the leading mobile phone company in Brazil. Telefónica wants to launch a public share offering for PT’s 50% share of Brasilcell, which would give Telefónica total control of Vivo.
The struggle between Telefónica and Portugal Telecom for Vivo involves much more than a mere battle between companies. It has cast a spotlight on the vast potential of the Brazilian market, and the needs of European companies to strengthen their position there.
The US$6.9 billion that Telefónica offered for PT’s shares in Brasilcel was branded as insufficient by PT. Yet barely three weeks later, Telefónica returned to the attack, offering US$7.87 billion — a figure very close to the US$7.73 billion market capitalization for all of PT. Although many observers said Telefónica’s offer price was too high, PT’s board of directors once again said it was insufficient. For PT’s 50% of Brasilcel, the board is asking between US$9.08 billion and US$9.93 billion — a position which it will need to endorse on June 30, when the entire PT board discusses Telefónica’s offer.
Beyond the issue of whether Telefónica will move forward with its proposal, there is another concern: Why are both companies so interested in controlling Vivo? Mauro F. Guillén, director of the Lauder Institute at the Wharton School, notes that “Brazil is one of the larger, more dynamic emerging economies. In addition, forecasts call for the country to grow to the extent that it develops a middle class.” Esteban García-Canal, a professor of corporate management at the University of Oviedo in Spain, agrees. “You need to remember that Brazil is one of the four economies with the greatest growth potential — the famous BRIC countries: Brazil, Russia, India and China. Among them, Brazil is clearly the country where it is easiest for Telefónica to undertake a growth strategy all on its own,” he notes.
It’s hardly news that Telefónica CEO Cesar Alierta is interested in the Brazilian market. Six years ago, Alierta tried to acquire Embratel, the leading Brazilian phone operator, and last year, he battled for control of GVT, a [Brazilian] supplier of fixed line telephony and data transmission services. Alierta made some mistakes along the way. Now it seems that he is ready to fight to the finish for Vivo since he is already offering almost three times as much as the US$3.09 billion that he put on the table last October in his offer for GVT.
Germano Glufke Reis, professor of management and human resources at the Getulio Vargas Foundation in Brazil, explains that the difference between the prices of the two takeover offers reflects the relative importance of the companies. “Vivo is the largest mobile telephony company in Brazil, with almost 54 million customers. So the union of Vivo and Telesp, the fixed telephony subsidiary of Telefónica in Brazil — which would merge with the mobile operator — would create one of the country’s largest telecom players.”
An Offer that Would Save Millions
In addition to Vivo’s intrinsic importance – given its leadership in the Brazilian mobile telephony market – Vivo would offer another sweet prize for Telefónica: millions of dollars in cost savings as a result of synergies. Telefónica calculates that it would save some US$3.39 billion by integrating Vivo and Telesp, and it is using this argument to justify the high price of its offer for Brasilcel.
Nevertheless, the financial community is divided about whether Telefónica’s offer of US$7.87 billion is too high. According to Garcia-Canal, Telefónica is playing its cards right. “Given the reluctance of its board of directors, [Telefónica] has targeted its efforts at the non-Portuguese shareholders of [PT], who are the majority [of PT’s shareholders]. In addition, [Telefónica] has realized correctly that no one is in any condition to offer a higher price [than Telefónica]; only someone from a company that operates in fixed-line telephony could obtain these [sorts of] synergies” from such a takeover, he notes.
According to Guillén, “Telefónica has been accused of paying more [than it needs to]. But you have to remember that opportunities in this [government-] regulated sector present themselves only on occasion. In the past, Telefónica could not acquire other Brazilian assets, and it has to get this deal done. So I believe that the price [that Telefónica is offering] is justified. If the opposite were true, the market would be punishing its shares.”
Actually, between May 11 when Telefónica made its initial offer [for PT’s shares in Brasilcel], through June 11, shares of Telefónica lost barely 3.6%. Moreover, this happened at a time when the Spanish market was being severely punished by investors who had growing doubts about the performance of the country’s economy. Since June 1, when Telefónica raised its offer price for Brasilcel, shares of the Spanish company have risen by 2.3%. Shares of Portugal Telecom gained 21% on the market since the first offer, and have risen by 2.3% from June 1 through June 11.
Esteban Garcia-Canal explains why investors have been backing Telefónica during this period. “The current growth strategy of telecom companies is based on the so-called ‘quadruple play.’ That is to say, an integrated package of services that includes fixed telephony, cellular [mobile telephony], Internet access, and TV. In addition to being attractive for consumers, this optimizes the use of these companies’ investments in infrastructure and reduces their operating costs. For Telefónica, the possibilities derived from offering this package in Brazil go beyond just taking total control of Vivo. Even if the cost of the deal seems excessive, you have to realize that this time around, the [dollar value of the] synergies associated with the deal are easier to estimate than on other occasions. In this case, there is [also Telefónica’s] direct knowledge of the local market and the impact that an integrated supply of services can have on the growth of the company and on its operating costs.”
International Strategy
As experts note, Telefónica’s interest in Vivo can be seen from two points of view. First, there is the potential that Vivo has for the Spanish phone operator [Telefónica], permitting it to integrate its entire supply of telecom [products and services] and to strengthen itself as the leader in its mobile business, which has the largest [growth] potential in the country. Second, there is a more international consideration, related to the global strategy of the company. If its offer wins, Telefónica will consider its geographic expansion plans to be complete, at least for the moment.
That is just Alierta told reporters recently in New York. He said that once the battle for the Brazilian market concludes, it will signal the end of the current chapter in the company’s history, which has involved large-scale investments. This sort of reasoning can be explained by the fact that, on the one hand, Telefónica is already the biggest company in the Latin American telecom sector, and it is also one of the main players in Europe – thanks to its purchase of Britain’s O2 and its partial ownership of Telecom Italia and PT. And it is an emerging player in China, thanks to its agreement with China Unicom, in which it controls 8.4% of the capital and will soon own 10%, thanks to a strategic alliance agreement with that company. To bring this expansionary cycle to an end, however, the company needs to move forward with this major deal in Brazil.
Why is there so much interest in Brazil, when Telefónica is already the leader in the Latin American market? Professor Reis notes: “Although the mobile telephony market has expanded in [Brazil], growing by 30% in 2009 [alone], fixed telephony has shown clear indications of stagnation. Some analysts forecast that the largest operators will lose customers since the industry believes it is threatened by the expansion of mobile telephony and the introduction of new technologies [such as Voice over IP] in the country. Estimates call for an annual decline of 2% to 3% in the number of conventional phones in service by the main providers. So the acquisition of Vivo expands Telefónica’s room for action in the mobile telephony industry, and creates new prospects.”
PT would suffer if were to lose Vivo, which has been a real financial gold mine, according to Guillermo Escribano, investment manager of Metagestion, a financial service boutique, in an article in the Spanish investment magazine Estrategias de Inversion. Escribano noted that Vivo “represents 80% of PT’s business,” which explains why it has been “worth the pain” for both PT and Telefónica “to strengthen their positions in the company and in the Brazil.”
Nevertheless, when it comes to size, leadership and buying potential, Telefónica seems to have a greater chance to win this war. It can also make an offer that includes better conditions than an offer made by its competitor.
On June 11, PT acknowledged that it could not guarantee that it would offer its shareholders a similar price for their shares of Vivo if they rejected Telefónica’s offer for those shares. This show of weakness has not prevented PT’s board of directors from once again denouncing the Spanish company’s offer of 6.5 billion euros (currently US$7.95 billion) as too low.
“From a financial point of view, there is a fluctuating margin between the current value of the profits that PT would obtain from its shares of Vivo, and the current value of the synergies that Telefónica would obtain [from owning all of Vivo],” notes Garcia Canal. “None of the extreme figures [in this fluctuation] makes sense because PT is not interested in selling at the first value [the lower price], and Telefónica is not interested in buying at the second [higher price]. Also, [neither extreme makes sense] because it is hard for anyone to derive the same synergies as Telefónica would, and because PT’s financial situation is not very healthy. So the price should be closer to the first [lower] value than to the second [higher] value.”
Telefónica’s advantage is even greater if you consider the details of the profits that it will be able to derive from taking control of Vivo. “The mobile broadband market has expanded in Brazil,” says Reis. “Fixed broadband is already a very profitable business for Telefónica today. With full ownership of Vivo, it will have greater autonomy when it comes to investing in mobile broadband. On the other hand, Vivo has one of the largest market shares for 3G technology in Brazil, compared with other companies,” he adds.
Observers predict that Telefónica is going to fight this war to the finish. If PT manages to block its offer for Brasilcel, Telefónica could go directly after PT. Guillén notes that Telefónica is not prepared to allow itself another failure in the Brazilian market, following its failed attempts for Embratel and GVT. “That’s precisely the reason why Telefónica wants to prevail, and it even seems prepared to acquire PT [itself],” he notes.
It is not a question of the price involved. Telefónica’s latest offer for Brasilcel is nearly US$1.21 billion above the market capitalization of PT itself. And many people are certain that if this offer does not get results, Alierta will directly attempt to acquire PT.
