The Great Telephone Operators of Brazil: Which Ones to Buy?

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Brazil is fifth-largest mobile market in the world. As wireless penetration in Brazil is over 130%, it is important for companies to focus on efficiency rather than growth. Also, wireless revenue faces added pressure after Anatel mandated industry-wide fee cuts.

There is a fixed-to-mobile services substitution, but internet penetration is still rather low and is expected to surge over the next few years along with economic growth. Pay television also offers an opportunity over the longer term, as penetration rate is still less than 30%.

Top choice -- Leading position

Based in Sao Paulo, Telefonica Brasil (NYSE: VIV) is the Brazilian subsidiary of Spanish Telefonica. With the acquisition of Vivo, Telefonica now enjoys the position of being the leading telephone operator in Brazil.

Its fixed-line arm, Telecomunicacoes de Sao Paulo (Telesp), dominates the state of Sao Paulo with nearly 95% of market share, which gives it a sustainable competitive advantage over peers. The fixed-line business is lagging, but Telefonica is expected to benefit from the expansion of video, broadband Internet, and Pay TV services.  

On the mobile business front, given the fact that the penetration rate is reaching 140% in Brazil, Vivo’s incremental subscriber is less profitable than before. While subscriber growth was up 6.4% year-over-year in 2012, average revenue per user (ARPU) has fallen on a year-over-year basis for five consecutive years.

However, its sector leading postpaid market share allowed the company to generate ARPU growth of 3.4% year-over-year in the first-quarter of 2013. Postpaid customers are typically smartphone users who consume more data. Vivo's share of these higher-end subscribers increased from 32.2% in 2009 to almost 37% in 2012.

Telefonica is also progressing well in expanding its 3G network based on CDMA EV-DO and HSPA technologies that provide significant advantage over its peers.  

First-quarter revenue rose 2.9% year-over-year to $4.3 billion. Its mobile service operation grew 7%, offsetting a drop of 8.9% in the fixed-line segment.

Second choice -- Mobile market 

TIM Participacoes (NYSE: TSU), which stands for Telecom Italia Mobile, is Brazil’s second-largest mobile operator.

TIM’s first-quarter results showed solid postpaid subscriber growth which was offset by soft ARPU. Revenue rose 5.4% year-over-year to $2.35 billion, but mobile termination rate cuts continue to pressure ARPU, which fell 3.6%. However, subscriber mix continued to improve as TIM’s postpaid base increased 13.2%, three times as fast as its prepaid segment.

TIM was severely hurt a few years ago when it lost significant market share after number portability was introduced. At the time, it lost four customers for each one it added. Since 2009, the new management team has re-positioned the brand toward high-value/postpaid clients, improving overall market share from 23% to 27%.

The growing smartphone market is pressuring TIM’s margins downwards, but this is something to expect in the near-term.

Not promising -- Dominant in fixed line operations

Oi S.A. (NYSE: OIBR) is the fourth-largest mobile carrier in Brazil. However, while revenue growth is driven by its mobile segment, most of its revenue comes from fixed-line operations. The firm has 53% fixed-line market share in Brazil, and dominates all of the major regions in the country with the exception of Sao Paulo.

Oi’s first-quarter revenue grew 3.5% year-over-year to $3.5 billion. However, wireless ARPU was down 3.8% year-over-year, its lowest level in years, due to lower interconnection revenue after fees were cut. However, in its residential segment, strong customer demand for triple-play and quadruple-play services drove ARPU up 9%. Oi’s pay TV penetration rate has more than doubled in the past year.

CFO Alex Zornig declared recently that Oi will continue to pay the highest dividend yield among telecommunications providers, totaling 4 billion reais ($2 billion) through 2014, as long as earnings keep pace with debt. First-quarter EBITDA was up 6.6% year-over-year, but the cash balance dropped 67% and net debt surged 63%.

Bottom line

Telefonica is my first choice as an attractive defensive stock. Merging with Vivo helped it return to profitability and become more economically efficient, something that Oi is still lacking. In addition, with the mobile market maturing, Telefonica managed to increase ARPU by 3.4% in the first-quarter, while TIM’s dropped 3.6% and Oi’s fell 3.8%.

TIM is my second choice. Its ability to enhance profitability and efficiency without having to make a major acquisition is encouraging.

Telefonica and TIM have robust dividends and strong balance sheets. In contrast, one of Oi’s most appealing attribute, its dividend, is now in question. 

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