portugal telecom - Nova School of Business and Economics

MASTERS IN FINANCE
EQUITY RESEARCH
PORTUGAL TELECOM
COMPANY REPORT
TELECOM
STUDENT: FRANCISCO MARTINS
7 JANUARY 2013
francisco.martins@novasbe.pt
It Keeps Holding On
Recommendation:
BUY
A History of Survival in a Hostile Environment
Price Target FY12:
4.87 €
price target of 4.87€ per share, corresponding to an overall upside
Price (as of 7-Feb-13)
3.87 €
potential of 21% compared to current price levels.
Reuters: Bloomberg

52-week range (€)

We recommend buying Portugal Telecom given our FY12
Despite a hazy economic climate (-3% GDP growth in
2012), domestic operations in the residential segment have shown
3.00-4.44
Market Cap (€m)
3,470,40
Outstanding Shares (m)
to be extremely resilient and we expect this to continue moving
896.51
Source: Bloomberg
forward, with PT being only moderately harmed. The massive
investment in fibber rollout, about 320M€, should not yield
4%
significant results in the short term, but once the economy is back
3%
on track, PT’s superior network should become an important
2%
differentiation factor, all the while the market continues to evolve to
a bundled-offer dominated market.

1%
0%
-1%
-2%
Domestic mobile will stop growing for now as a result of
the economic downturn, the rise of tribal plans and adverse
-3%
-4%
regulation. Domestic enterprise is the most affected segment, as a
PT Returns
PSI-20 Returns
natural result of the economic cycle and of austerity measures.
Source: Bloomberg

Oi’s turnaround plan, in a climate of economic growth (2%
(Values in € millions)
2011
2012E
GDP growth in 2012), will yield significant improvements in terms
Revenues
6.146
6.747
6.479
of efficiency, revenues and governance, despite stiff competition
EBITDA
2.188
2.335
2.2213
EBIT
744
811
709
Net Profit
423
405
446
EPS
0.47
0.45
0.50
0.50
and the required high levels of investment.

Leverage (80% D/EV in market values) will remain high,
2013E
EV/Sales
0.52
0.48
but will fall slightly through lower dividends, lower CAPEX, use of
EV/EBITDA
1.47
1.37
1.45
excess cash and divestment of international non-core assets.
Net Debt/EV
77%
64%
63%
9.2%
7.6%
Company description
Source: Analyst Estimates, Company Reports
ROIC
Portugal Telecom is the leading telecommunications operator in Portugal,
with presence in the fixed line, broadband, pay TV, mobile and corporate
segments. It is also present in the growing Brazilian market, through a
stake in Oi and a minor one in Contax, in addition to several other
countries in Africa and Asia.
THIS REPORT WAS PREPARED BY FRANCISCO MARTINS, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND
ECONOMICS, EXCLUSIVELY FOR ACADEMIC PURPOSES. THIS REPORT WAS SUPERVISED BY ROSÁRIO ANDRÉ WHO REVIEWED THE
VALUATION METHODOLOGY AND THE FINANCIAL MODEL. (SEE DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT)
See more information at WWW .NOVASBE.PT
Page 1/38
COMPANY REPORT
PORTUGAL TELECOM
Table of Contents
COMPANY OVERVIEW ........................................................................... 3
VALUATION METHODOLOGY ................................................................ 4
PORTUGAL BUSINESS ........................................................................... 5
THE RESIDENTIAL BUSINESS – A CASE OF RESILIENCE .....................................6
THE PERSONAL BUSINESS – UN AVOIDABLE DOWNTURN ................................ 14
ENTERPRISE – W HERE IT HURTS THE MOST..................................................... 17
COST MARGINS AND INVESTMENTS ................................................................... 18
OI BUSINESS ..........................................................................................20
OI TURNAROUND PLAN – A STEP IN THE RIGHT DIRECTION ............................. 20
THE RESIDENTIAL BUSINESS – A ROCK-BOTTOM START ................................. 22
PERSONAL BUSINESS: A SLOW MOVE............................................................... 24
ENTERPRISE ....................................................................................................... 25
FINANCIAL STRUCTURE AND COST OF CAPITAL .............................26
AN ATYPICAL CAPITAL STRUCTURE ................................................................... 26
THE COST OF CAPITAL ....................................................................................... 27
SCENARIO ANALYSIS ...........................................................................28
PORTUGAL LEAVES THE EURO ........................................................................... 28
M&A ACTIVITY IN PORTUGAL ............................................................................. 30
FINAL VALUATION CONSIDERATIONS ................................................31
APPENDIX I – FINANCIAL STATEMENTS .............................................33
APPENDIX II – MACROECONOMIC FORECASTS ................................36
APPENDIX III – INTERNATIONAL COMPARABLES .............................36
APPENDIX III – IMPACT OF LEVERAGE ON CREDIT RATING ............37
DISCLOSURES AND DISCLAIMER .......................................................38
RESEARCH RECOMMENDATIONS........................................................................ 38
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COMPANY REPORT
PORTUGAL TELECOM
Company Overview
Portugal Telecom (PT) is the largest Portuguese telecommunications company
currently operating. Although its main source of value creation is still its domestic
Graph 1 - Enterprise Value Per Geography
operations – PT Comunicações and TMN – through which the company provides
services in fixed phone, fixed broadband, Pay TV, mobile phone and mobile data,
11%
PT has been diversifying its operations, currently owing stakes in Brazil, as well
1
as various countries in Africa and Asia . This geographical dispersion comes as a
39%
51%
result of one of the key strategic milestones of the company, which is to have at
least 2/3 of its revenues coming from international assets. The Brazilian market,
in particular, has been paid great attention to. Up until 2010, PT held a 29.71%
Portugal
stake in Vivo, a Brazilian communications company, which has since then been
Brasil
sold to Telefonica. PT has however reinvested in the Brazilian market by
Other International Assets
acquiring a 25.6% stake in Oi, a communications company whose business
Source: Analyst Estimates
segments are very much in line with those of PT’s own domestic operations.
2
Once a Portuguese state-owned company (its last privatization was completed in
3
2000 ), the company is currently owned by a number of minority, mostly
4
institutional shareholders, the main ones being: RS Holding (10.05% of total
capital), Grupo Espírito Santo (10.04%), Grupo Telemar Norte Leste S.A.
(10.00%), Grupo Caixa Geral de Depósitos (6.42%), Grupo Norges Bank (4.96%)
Dispersed Ownership Structure
and UBS AG (4.69%). Moving forward, we do not forecast major changes in
these positions. As far as Ongoing Strategy Investments is concerned, it has
5
repeatedly stated their interest in remaining one of PT’s main shareholders ;
Telemar Norte Leste S.A. has just acquired it stake as part of the strategic
agreement between PT and Oi, and we find no reasons suggesting Norges Bank,
Grupo Espírito Santo and UBS AG to have intentions to divest. Doubts could
arise concerning the future intents of Caixa Geral de Depósitos since the group is
being pressured to divest; while so far there have been no movements in this
direction, we remain sceptical over the group’s ability to finance further capital
increases, should PT need them.
1
A summary of these international stakes is presented in the next section, “Valuation Methodology”.
PT has also acquired a 44.4% stake at Contax, a Brazilian corporate solutions company.
3
In July 2011, with the removal of the golden shares that effectively allowed the Portuguese government to still
intervene in the company by vetting its strategic decisions, all the direct influence of the Portuguese State was officially
terminated, despite the fact that an indirect stake (through Caixa Geral de Depósitos, a state-owned bank) is still present.
4
RS Holding is property of Ongoing Strategy Investments. This is a Portuguese company with investments in
communications, TMT, financial services, energy, infrastructures, real estate and services. On the communications side,
the company detains, beside its 10.05% stake in PT, a 3.29% stake in Zon, PT’s main competitor. This is not a unique
situation, seeing as how Grupo Espírito Santo also holds a stake in Zon.
5
“This was our strategy since the beginning. We wanted to become one of the largest shareholders from PT. This is a
company with a lot of liquidity and a very attractive balance sheet. It is the kind of company from which you want to be
an investor” – Nuno Vasconcelos, President of the Group, in a statement issued to Bloomberg at 03/06/2012.
2
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COMPANY REPORT
PORTUGAL TELECOM
Valuation Methodology
In order to value PT, we have employed a sum of parts (SOP) methodology, with
various valuation techniques being utilized to account for each segment, on a
SOP Methodology
relevance to availability of information basis. For the two main segments, which
are the domestic operations and the stake at Oi, we have used Discounted Cash
Flow (DCF) models; to value the interest in Contax, we took the company’s
Portugal and Oi evaluated
through DCFs
market value; for the company’s international assets in Africa and Asia, we have
6
used EV/EBITDA multiples of similar companies in those geographies ; for the
residual, non-operational assets of the company, the book value was used, with
adjustments made when deemed fit. We have reached a price target of 4.87€,
7
implying an upside potential of 21%. Below is a summary of our valuation :
Table 1 - Summary of Company Valuation
Method
Stake
Value to PT
Base
Scenario
p = 50%
7.526
5.084
292
1.023
152
91
8
218
58
Value to PT
Portugal
Leaves Euro
p = 5%
2.944
5.084
292
1.023
152
91
8
218
58
Value to PT Zon&Sonaecom
Merger
p = 45%
7.269
5.084
292
1.023
152
91
8
218
58
DCF
DCF
Market Cap
EV/EBITDA
EV/EBITDA
EV/EBITDA
EV/EBITDA
EV/EBITDA
EV/EBITDA
Book Value
100%
26%
44%
25%
34%
40%
51%
28%
41%
-
-990
48
-990
19
-990
48
Weighted
Value
Portuguese Operations
Oi
Contax
Unitel, Angola
MTC, Namíbia
CVT. Cabo Verde
CST., S. Tomé e Princípe
CTM, Macau
Timor Telecom, Timor-Leste
Net Unfunded Pension
Liabilities
Non Operational Assets
Book Value
Enterprise Value
Debt
Excess Cash
Market Value
Book Value
-
13.510
-12.768
3.843
8.899
-10.215
3.843
13.254
-12.768
3.843
Equity Value
# Outstanding Shares
(Million)
-
-
4.585
2.528
4.329
4.367
897
897
897
897
Price Target (end of 2012)
Current Price
Implied Upside Potential
-
5,11 €
3,87 €
24%
2,82 €
3,87 €
-37%
4,83 €
3,87 €
20%
4,87 €
3,87 €
21%
8
-
Unit: Million Euros, unless stated otherwise | Source: Analyst Estimates, Bloomberg, Company Reports
6
Although a case could be made for an evaluation of Unitel on the basis of a DCF model, both due to its relative
importance in PT’s portfolio and due to its long term growth potential, the lack of available information would make this
task excessively reliant on analysts’ assumptions, which is why we have decided to utilize a multiples’ approach.
7
This valuation includes scenario analysis, which will be explained later in this report.
8
The value of “Páginas Amarelas” business was not considered, as we believe the business is worth next to nothing
nowadays, making its book value a poor proxy for its actual worth.
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COMPANY REPORT
PORTUGAL TELECOM
Graph 2 - Domestic Business
Revenues Segmentation
Portugal Business
As stated, and despite its ever growing degree of international diversification,
16% 24%
34%
27%
PT’s major source of value is still coming from its Portuguese communications
operations, where its revenues are being generated essentially from four types of
clients (as seen in the graph): residential (wireline products), personal (mobile
products), enterprise (wireline and mobile) and wholesale (wireline and mobile).
Residential
Personal
Enteprise
Wholesale
Source: Company Reports
In the last few years, these markets have been shifting, to a larger or smaller
extent, due to a number of trends whose effects do not seem to have ceased yet.
Even though not all of these trends are connected to macroeconomic
Graph 3 - Unemployment Rate
developments, and despite the resilience that we believe the communications
sector has conquered throughout the years, some of what happens in the sector
18%
16%
14%
12%
10%
08%
06%
04%
02%
00%
is still inevitably connected, in some scale, with the Portuguese economy. As
such, it is important to understand what these foreseeable economic conditions
are, at least for the near future.
As known, the Euro Area is currently tacking what has become known as the
sovereign debt crisis. One of the most evident effects of this crisis are the
Source: OECD
Graph 4 - Private Consumption
recessionary measures that Governments have been implementing as a way to
reduce their sovereign debt – this holds true especially for problematic countries,
such as Greece, Ireland, Portugal and Spain. In Portugal, so far, these measures
have involved a higher tax rate, a lower budget for government-subsidized
44.000
43.500
43.000
42.500
42.000
41.500
41.000
40.500
40.000
institutions, and even a generalized cut in the public employees’ nominal wages.
As a result, consumption has had a massive slowdown which, in turn, has had
negative implications on companies’ results, ultimately conducting to a sustained
increase in the unemployment rate, as seen in the graph. A snowball effect was
then in place and, eventually, the income available for families became lower and
the savings rate increased, meaning that consumption took yet another beating,
Source: OECD | Unit: Millions of Euros
as depicted in the graph. This is the effect that interests us, because when
consumption is affected, so are companies, including PT.
Graph 5 - GDP Growth
Looking at the GDP growth, shown on the left, we see that this contractionary
1,75%
behaviour is expect to last until at least 2013, with 2014 returning only to barely
0,75%
-0,25%
positive levels. This suggests that 2012-2014 will be the toughest ones for PT to
9
2010 2011 2012 2013 2014 2015 2016 2017
E
E
E
E
E
E
-1,25%
endure as far as its domestic revenues are concerned . For a more
comprehensive analysis of the impact of these macroeconomic conditions, as
well as other relevant trends on each of the company’s domestic businesses, we
-2,25%
will dwell into each of these markets individually in the next section.
-3,25%
Source: IMF
9
A more thorough macroeconomic picture for the next 5 years is presented in the Appendix, although the conclusions
taken from the observation of the GDP growth alone still hold.
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COMPANY REPORT
PORTUGAL TELECOM
The Residential Business – A Case of Resilience
Fixed Broadband and Pay TV – Some Impressive Wins
If there are markets whose perceived essentialness has changed drastically over
the last 15 years, they are certainly the Pay TV and the Fixed Broadband. Initially
perceived as high-end, luxurious products, the most recent behaviours of these
Graph 6 - Communications Weight on
Portuguese Available Income
markets, particularly in Portugal, suggest that these are now amongst the top
priority sectors for a typical consumer. One way to observe this is by looking at
3,4%
3,2%
3,0%
2,8%
2,6%
2,4%
2,2%
2,0%
the evolution of available income allocation during the last 15 years. As the table
below and the graph on the left both illustrate, not only were communications the
sector with the highest relative increase in terms of importance (32%), but it has
also had one of the most relevant increases in absolute terms (0.7%), only
behind housing and gas (likely related with the disproportionate increase in oil
prices in the last four years) and other goods and services (a very broad group).
Source: INE
Table 2 - Portuguese Available Income Distribution
1996
1998
2000
2002
2004
2006
2008
2010
Δ
% Change
Food and Non Alcoholic Drinks
18,2%
17,4%
16,6%
17,1%
16,9%
16,4%
16,6%
16,4%
-1,8%
-10%
Alchool, Tobaco and Narcotics
3,8%
3,7%
3,5%
3,6%
3,6%
3,5%
2,9%
3,3%
-0,6%
-15%
Clothing
6,8%
6,5%
6,3%
6,5%
6,2%
6,0%
5,7%
5,8%
-0,9%
-14%
Housing, water, electricity, gas and other fuels
13,5%
13,3%
13,0%
13,5%
14,3%
14,3%
14,5%
15,6%
2,1%
16%
Home accessories, household equipment and
routine household maintenance
7,1%
7,1%
7,0%
6,9%
6,5%
6,4%
6,2%
6,0%
-1,1%
-16%
25%
Health Care
4,6%
4,6%
4,6%
4,8%
5,0%
5,0%
5,4%
5,7%
1,1%
Transportation
14,8%
15,8%
16,4%
14,8%
14,3%
14,4%
14,0%
13,7%
-1,1%
-7%
Communications
2,3%
2,4%
2,6%
3,2%
3,3%
3,2%
3,0%
3,0%
0,7%
32%
Recreation and Culture
8,0%
8,1%
8,3%
7,9%
7,6%
7,5%
7,2%
7,0%
-1,0%
-12%
Education
1,0%
1,0%
1,0%
1,1%
1,1%
1,2%
1,2%
1,3%
0,3%
29%
Restaurants and Hotes
10,8%
10,7%
10,8%
11,1%
11,0%
11,0%
10,6%
11,1%
0,4%
3%
Other Goods and Services
9,1%
9,4%
9,7%
9,6%
10,2%
11,1%
12,7%
11,0%
1,9%
21%
Moreover, even though there has been a slight decrease in the last few years, we
Source: INE
believe this is due to declines in the voice sector (as will be developed later on),
Graph 7 - Sector Revenues
and GDP Growth
seeing as how, despite the fact that economic conditions have been worsening,
2%
1%
0%
-1%
-2%
-3%
-4%
1400
1200
1000
800
600
400
200
0
2008
2009
2010
2011
Fixed Broadband Revenues
the overall revenues in Portugal from fixed broadband and pay TV have actually
increased, as shown in the graph on the left.
We believe this developed resilience comes from a combination of two factors.
One is the ever-growing perception of usefulness and necessity associated with
these services that is related with the socio-cultural changes that have altered the
Pay TV Revenues
way we communicate with one another, both in a personal and professional
GDP Growth
context, and the way we seek entertainment in the technological world. The other
Units: Million Euros for Revenues and
Percentage for GDP Growth
Source: Analyst Estimates, Bloomberg
one is the tariff system in place, which does not make it easy to adjust the
amount on a monthly basis, as the billing is typically fixed, regardless of the
actual usage rate.
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COMPANY REPORT
PORTUGAL TELECOM
Graph 8 – 2010 Population Age
Going forward, we expect the same resilience pattern to hold for the most part,
meaning that even despite the negative economic outlook we are forecasting
80%
increases in the penetration rate for both services. Apart from the overall sector
70%
75%
resilience, we base this expectation on two important trends. The first one is the
30%
-20%
continued expected rise of bundled offers – we will dwell on this factor later on.
25%
30%
Portugal
OECD Countries
The second one is the evolving demographics of the Portuguese population.
Currently, Portugal is one of the oldest skewing OECD countries, as the first
% Population >30y
graph on the left shows. This is relevant because we are talking about a sector in
% Population <30y
Source: OECD
which young people have a higher usage of these services (as shown in the
Graph 9 – 2011 Broadband Penetration
second graph), which means that, in time, as these younger people become
households themselves, penetration will tend to go up.
64-74
55-64
Moreover, if we look at the Portuguese fixed broadband penetration rate
45-54
10
of 39%
as of 2011 in context, we see that there is still plenty of room to grow, as the rate
35-44
is considerably lower than the average OECD rate of 49%
25-34
16-24
11
- the third graph on
the left depicts a comparison with some of these countries. In fact, Portugal is
0
50
100
Source: INE, Anacom | Units:
#Broadband Users per 100 Inhabitants
th
only the 27 out of 34 OECD countries, which points towards a continued growth
in the near future. As such, we forecast a 3% CAGR until 2015 and a 6% from
2015 until 2017 when economic conditions start looking up (still below the 8%
Graph 10 – 2011 Fixed Broadband
Penetration Rate Across Countries
verified from 2007-2011). From there onwards, we assume Portugal to be more
or less aligned with its peers, so it should grow at a stable 1.5% per year, the rate
80%
70%
60%
50%
40%
30%
20%
10%
0%
at which the sector is expected to grow in OECD countries as a whole
1213
. As for
Pay TV, the gap with the remaining OECD countries is minimal (52% for Portugal
and 53% average and median for the OECD countries), and overall, we believe
the acceleration in growth that this sector has witnessed in the last five years
14
(around an 8% CAGR ) is slowing down. We assume the same growth rate
Source: OECD
expected for OECD moving forward, of 1%, meaning that Portugal should
Graph 10 - Fixed Broadband Penetration continue to be around the average OECD penetration rate
60%
40%
45% 48% 48%
39% 40% 41% 42%
1516
. These forecasts
can be seen in the last graph on the left and in the first graph on the next page.
Nevertheless, we expect some ARPU contraction in the next few years. This is
20%
because, despite our previous argument regarding the fixed nature of tariffs paid,
0%
2011 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
Portugal Fixed Broadband Penetration
OECD Fixed Broadband Penetration
Source: Analyst Estimates, OECD
we still believe that there is room for some flexibility, particularly in what concerns
the adoption of high-end products (premium pay TV channels, such as Sport TV,
or higher internet speeds), which can be cut down in periods of greater
recession. As such, although we expect customers to seek internet with higher
10
Penetration rate for wireline services defined as being # Users/ # Conventional Dwellings, unless stated otherwise.
Median is 49% and mode is 46%, also for 2011, for all OECD countries.
12
OECD Communications Outlook 2011 Report
13
Implicitly, we are thus assuming a penetration rate of about 60% in 20 years’ time.
14
We believe the analogue switch-off, a single occurrence factor in the past explains part of this peaks in growth.
15
OECD Communications Outlook 2011 Report
16
Implicitly, we are thus assuming a penetration rate of about 62% in 20 years’ time.
11
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COMPANY REPORT
PORTUGAL TELECOM
Graph 11 - Pay TV Penetration
60%
51% 52% 52% 52% 53% 53% 53%
speed and TV with better quality in the medium term, we believe macro
conditions will slow this down, leading to a downwards adjustment in the ARPU in
50%
the short-run for the whole sector. We do however expect to start seeing upticks
40%
in the ARPU in 2015, when economic conditions are better and consumers are
30%
ready to start taking advantage of the high-end products from PT. We also note
20%
that, as seen in the second graph on the left below, PT has generally followed
10%
0%
2011 2012 E2013 E2014 E2015 E2016 E2017 E
Europe’s pace when it comes to the behaviour of the ARPU: it fell the exact same
Portugal Pay TV Penetration
13% as the median of European countries, close to Italy (-15%) and France (-
OECD Pay TV Penetration
13%) and actually lower than Spain (-21%) although higher than countries like
Source: Analyst Estimates, OECD Statistics
17
the UK (-4%) or Germany (-8%) . We expect the same pattern to hold moving
forward. The table below summarizes our predictions:
Table 3 - Fixed Broadband and Pay TV ARPUs18
Fixed Broadband ARPU
Pay TV ARPU
Source: Analyst Estimates,
Company Reports
2011
38,7 €
29,7 €
2012 E
37,6 €
28,6 €
2013 E
36,5 €
27,5 €
2014 E
35,5 €
26,5 €
2015 E
36,5 €
27,9 €
2016 E
37,6 €
29,4 €
2017 E
38,7 €
31,0 €
Finally, one must look at competition, which we regard as the hardest aspect to
predict, due to the similar offers of the two main players, PT and Zon. Even
Graph 12 - ARPU Evolution
though PT’s service may have been superior in the past, Zon has made
20
18
16
14
12
10
8
6
4
2
0
significant progresses in the quality of its product, that is now quite similar to PT’s
in terms of TV experience (image and sound quality of software, content
available) and internet service (speed, number of failures per connections,
19
network reach). Furthermore, as depicted in the graph on the left , both
2010 2010 2010 2011 2011 2011 2011 2012 2012 2012
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
Portugal
European Median
Source: Bloomberg | Units: Euros
companies have reached similar levels of satisfaction: as of the end of 2011,
across the three wireline products, PT has a complaint rate of 0.14% whereas
20
Zon’s is 0.19%, a minimal difference . Additionally, there are no major price
Graph 13 - Complaints Rate Comparison differences between both: even though PT’s ARPU is 25% lower
21
than Zon’s,
this difference is mostly related with the discounts that PT gives to new clients
0,30%
0,25%
during their first years of usage and not so much with fundamentally different
0,20%
pricing strategies, which is why we believe that in the long-run, both ARPUs will
0,15%
0,10%
converge.
0,05%
0,00%
Fixed Line
Fixed
Broadband
PT
Pay TV
Zon
Source: Anacom, Analyst Estimates
17
These values refer to blended ARPUs from the wireline business, including fixed line. However, we are confident that
our conclusions still hold, seeing how all countries have experienced declines in the fixed line business. The percentages
presented refer to the change between the second quarter of 2010 and the third quarter of 2012.
18
ARPU defined as Yearly Revenues/#End of Year Users. In this case, it includes only single-play offers, meaning that
all users and revenues associated with bundled offers are not being considered.
19
Complaints Rate defined as being # Complains during the Year/ # Users during the Year
20
Although it is not possible to present data for the complaints rate for previous periods, Anacom mentions how Zon
used to have a substantially higher number of complaints, especially coming from its fixed broadband business.
21
Calculation based on the bundled offers ARPUs, as they are the most directly comparable ones.
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COMPANY REPORT
PORTUGAL TELECOM
Yet, in regards to Pay TV, we still think there is some differentiation. We expect
22
PT to keep up the strong commercial awareness from the Meo brand , thus
leading to positive growth in its market share. Moreover, with the launch of Video
Graph 14 - Technhology Comparison
on Demand (VoD) channels and special interactivity features tied with popular TV
programs (Secret Story, Biggest Looser, Idols), as well as exclusive channels
100.000
90.000
80.000
70.000
60.000
50.000
40.000
30.000
20.000
10.000
0
23
(Benfica TV), Meo has achieved some differentiation . We also expect a longterm boost coming from the massive investment PT has made in fibber rollout, a
superior technology than the cable technology used by Zon, as seen in the graph
on the left, but we believe that the macro environment will put off the adoption of
24
these , leading to low impact in the short term. We thus expect market shares to
Average
Average upload
download speed
speed
25
remain relatively flat , with fluctuations explained mostly by the rise of bundled
26
DSL
Cable
offers , which will favour Zon and PT at the expense of smaller players, such as
FTTH
Source: OECD | Units: Kbits/ second
Cabovisão, who lack these developed bundled offers. We will explain this later.
All in all, we expect a slowdown in PT’s intense increase in fixed broadband and,
especially, Pay TV market share, the latter of which during the last two years
27
grew by more than 15% per year . We thus forecast an average increase in Pay
TV market share of about 3.5% per year and of about 0.65% in fixed broadband.
This would mean PT would eventually reach 44% and 51% in pay TV and fixed
broadband respectively, by 2016. From then onwards, we believe further
increases will have to come almost exclusively from new additions to the market,
so we do not expect further major changes in the market distribution
Graph 15 - Fixed Broadband and Pay TV Market Shares
100%
100%
80%
80%
60%
60%
40%
40%
20%
20%
0%
0%
2007
2008
2009
2010
2011 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
PT Comunicações
Cabovisão
Optimus/Sonaecom
Grupo Zon/TV Cabo
Vodafone
Others
2007
2008
2009
2010
2011 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
PT Comunicações
Grupo Zon/TV Cabo
Cabovisão
Vodafone
Optimus/Sonaecom
Others
Source: Anacom, Analyst Estimates
22
Meo is one of the most well promoted brands in Portugal. It has won multiple “Media Effectiveness Awards” (results
based awards that look at recall, sales or other types of return that meet a previously set goal) on various years.
Additionally, the most watched ever advertising in TV in Portugal, with 3.2 million viewers and 85% share is from Meo.
23
Zon is also investing heavily on these interactive features so there is a risk that this small differentiation is soon gone.
24
According to a study carried out by Anacom, the higher the social class and the level of income, the higher the
probability of adopting the FTTH technology. This shows that FTTH is, indeed, regarded as a high-end product.
25
Even though these were not constant in the past (especially in Pay TV), we believe this was due to major differences
in the products, which do not exist nowadays, at least on a low-to-medium end products.
26
We also believe that, given the fact that PT’s market share in fixed broadband is now almost half of the market, there
is a chance regulation will make it more difficult for PT to achieve further increases.
27
When looking at this number, we have to consider that 70% of this increase (55% for fixed broadband) came from
clients that were already in the market (smaller operators mostly), an effect that cannot be maintained forever.
PAGE 9/38
COMPANY REPORT
PORTUGAL TELECOM
Graph 16 - Portugal Fixed Line Revenues
Fixed Line – A Slowdown in Decline
1.200
1.000
The third component of the residential business is the fixed line. Unlike the
800
previous two segments, which have been in unmistakable expansion, the fixed
600
400
line segment has been contracting, as the graph on the left displays, mostly due
200
to the fixed-mobile substitution effect. One way to observe this effect is by looking
0
at the evolution of the number of calls made each quarter in Portugal, as depicted
2007 2008 2009 2010 2011
Units: Million Euros| Source: Anacom
in the second graph on the left. In addition, unlike the previous two segments,
this is a segment in which consumers can also easily control the amount that is
Graph 17 - # Calls in Portugal
spent, which means that the ARPU is, by definition, less resilient to economic
40.000
35.000
30.000
25.000
20.000
15.000
10.000
5.000
0
downturns. Perhaps the most blatant illustration of this decline is the fact that,
from 2010 to 2011 alone, sector revenues have fallen by a hefty 22%.
Nevertheless, there are positive trends in this market, making us expect a
deceleration in the sector decline. Despite the enormous revenue declines, the
3T11
4T10
1T10
2T09
3T08
4T07
1T07
2T06
3T05
4T04
1T04
number of users on the market has remained remarkably flat (4% decrease) even
when economic conditions worsened, between 2010 and 2011, all the while
28
Fixed Line # Calls
Mobile # Calls
Units: Thousands of Calls| Source: Anacom
Europe fell, in average terms, by an immense 24.4% .
This unforeseen
resilience makes us confident that the number of users has found its ceiling for
now and that continued decreases in the sector will come almost exclusively from
Graph 18 – PT’s Fixed Line ARPU
25
losses on the ARPU level, which we expect to continue bleeding heavily until
2015, with some deceleration and even a slight recovery afterwards, as depicted
22,2
19,1
16,3
20
16,2 17,5
14,0 15,1
in the third graph on the left. Ironically, we believe it is the aforementioned
15
flexibility in the amount spent that is responsible both for bringing down the
10
ARPU and, at the same time, for retaining a stable number of users, as it enables
5
consumers to adjust their expenditures. However, even accounting for this, we
0
2011 2012 2013 2014 2015 2016 2017
E
E
E
E
E
E
Units: Euros | Source: Analyst Estimates
would expect a steeper decline in penetration were it not for the expected rise of
bundled offers, which we believe to be part of the reason why the number of
29
users has remained so steady .
As for competition dynamics, we believe Zon will make significant progresses on
the fixed line business, precisely due to the rise of the bundled type of clients, so
30
we are forecasting a decrease, albeit a soft one, in PT’s market share.
In short, we expect a slowdown in the decline that fixed line revenues have
experienced, even if most of the positive effects will come from bundled
packages and not so much from single play offers anymore.
28
Anacom
PRINCE, Jeffrey, The Dynamic Effects of Triple Play Bundling in Telecommunications, Research Program on Digital
Telecommunications. According to this study, bundling the prior year increases the likelihood of continuing to subscribe
fixed line services from that company by 3.5%. We will dwell on the bundled offers effects in greater depth later.
30
We expect Zon’s rise to be done mostly at the expense of smaller players, who lack sophisticated bundled offers.
29
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COMPANY REPORT
PORTUGAL TELECOM
The Rise of Bundled Offers
Bundled offers, the importance of which we have been mentioning throughout the
report, is, in our opinion, the most important trend currently in play in the
31
residential market. As explained by BEREC , bundled offers have been
increasing in popularity due to its attractiveness for both consumers and
Bundled Offers present a number
companies. The former, in addition to the usual perception of paying an amount
of advantages both for
consumers and corporations
32
that is smaller than the sum of parts they would pay otherwise , also benefits
33
from the receipt of a single bill from a single provider . Companies, on the other
hand, reduce their churn rate
34
and have the chance to develop a stable,
constant customer base, the services of whom they can attempt to gradually
35
upgrade to more expensive products through a better marketing focus . At the
same time, costs (e.g. marketing and distribution) are diminished – economies of
Graph 19 - Sector Residential Revenues scale are created36 – and firms have the opportunity to engage in price
differentiation strategies among different categories of customers, as offers tend
5
4,90
4
to become personalized to each customer.
4,92
As of the end of 2011, there were 630 thousand and 1.5 million residential
4,75
3
subscribers of, respectively, double play and triple play offers in Portugal;
together, these amount to over one third of the total residential market in
2
Portugal. Even more relevant, this is a number that has been on an exponential
2,17
1
1,12
1,58
advantages stated above for both consumers and corporations, we firmly believe
0
2009
rise in the last few years, as showcased by the graph on the left. Due to the
2010
2011
Single-Play Revenes
Multiple-Play Revenues
Unit: Million Euros | Source: Anacom,
Analyst Estimates
this is a tendency that will be continued, albeit with two caveats. The first caveat
is that we expect some degree of natural bundled offer “cannibalization”, in the
sense that double play offers will tend to be upgraded to triple play offers, which
might distort the overall number we look at. The second caveat, and in our
opinion the most important one, is that we believe this shift in the offer mix will
31
Body of European Regulators for Electronic Communications
According to a study presented by Anacom and conducted by E-Communications Household Survey, as of the first
quarter of 2011, the perception of Portuguese households is that save about 34% by subscribing to multiple play offers
(33% European Average). This value is higher than the year before value, which was 20%, suggesting an increase in the
perceived advantages of bundled offers.
33
2010 E-Communications Household Survey indicates that 34% of Portuguese customers (41% European average) has
decided to engage in buddle offers due to the advantages related with the payment of a single bill, thus suggesting that
multiple play offers would create value for some customers even if the prices offered were not perceived as lower.
34
PRINCE, Jeffrey, The Dynamic Effects of Triple Play Bundling in Telecommunications, Research Program on Digital
Telecommunications. This study shows that triple play bundling on communications indeed reduces churn rate across
all three services. According to this study, bundling the prior year increases the likelihood of continuing to subscribe the
services by 3.5%, 1.8% and 2.2%, for fixed line, fixed broadband and Pay TV, respectively.
35
According to a study presented by Anacom and conducted by E-Communications Household Survey, as of the first
quarter of 2011, 16% of individual services contracted through bundles (the same as the European average) would not
have been contracted otherwise, thus showing once again the added strength of bundled offers and why we expect these
to continue to be a driving force in increasing the penetration rates of the various products.
36
BEREC, BEREC Report on Impact of Bundled Offers in Retail and Wholesale Market Definition. According to this
study, cost advantages for companies engaging in multiple play offers may vary between 12% and 20%.
32
PAGE 11/38
COMPANY REPORT
PORTUGAL TELECOM
be, to some significant extent, put off at least for the next 3 years, due to the
adverse economic conditions. Even though it is true that churn rates are lower
once a client signs on a bundled offer since the willingness to quit is significantly
smaller, we believe that the prognosis of yet another large fixed bill during times
Graph 20 - Percentage of Bundled Offer
Clients as of the end of 2011
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
of economic duress is likely to increase the perception of bundled offers as being
a high-end product (regardless of whether that is true or not), thus shifting the
adoption of these offers to after the worse years of recession.
77%
65%
65%
47%
Focusing now on PT’s own client base, as we can see in the graphs below, there
74%81%
is an overwhelming percentage of clients on the internet and pay TV business
that are coming from triple play and multiple play as a whole. As explained, it is
Fixed Line
Fixed
Broadband
Sector
Pay TV
our belief that these are numbers that will only tend to move upwards. As for the
fixed line, in which single play is still the major type of client for PT (unlike the
PT
remaining industry, as showcased in the graph on the left), we are also expecting
Source: Anacom, Company Reports,
Analyst Estimates
a major increase in the percentage of multiple play clients, especially because we
believe this will be the main factor in stopping the bleeding that the fixed line
business had been suffering ever since the fixed-to-mobile substitution effect
started, as discussed before.
Graph 23 – PT’s Fixed Line Client Mix
Graph 23 - PT’s Fixed Broadband Client Mix
100%
90%
80%
37%
38%
39%
40%
100%
100%
90%
90%
80%
80%
70%
70%
60%
60%
11%
11%
50%
12%
12%
40%
30%
53%
20%
51%
48%
Double-Play
9%
20%
23%
67%
70%
74%
30%
10%
10%
10%
20%
18%
16%
13%
12%
20%
17%
15%
10%
19%
17%
16%
15%
2011
2013 E
2015 E
2017 E
0%
2017 E
Triple-Play
63%
60%
40%
0%
Single-Play
75%
50%
0%
2015 E
72%
40%
10%
2013 E
70%
70%
50%
10%
2011
67%
30%
50%
Graph 23 - PT’s Pay TV Client Mix
2011
Single-Play
2013 E
2015 E
Double-Play
2017 E
Triple-Play
Single-Play
Double-Play
Triple-Play
Source: Anacom, Company Reports, Analyst Estimates
As for the ARPUs of these bundled offers when paralleled with those from single
offers, the comparison is not clear at the moment, meaning that in some cases
PT has an ARPU higher than the sum of parts (most double play offers) whereas
ARPUs to rise in the long run
in others the ARPU is actually lower than the sum of parts (tripe play offers
essentially). On this matter, our conviction is that, long-term, companies will be
able to profit from bundled offers on an ARPU level, meaning that the tendency
will be for them to go upwards. We believe PT’s present situation, with the ARPU
being lower than the sum of parts in the case of triple pay offers, is a result of
marketing campaigns that have been aiming to increase the number of users by
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COMPANY REPORT
PORTUGAL TELECOM
providing discounts to new clients during the first year of usage
3738
. Once again,
however, we believe the unfavourable economic outlook will keep ARPUs down
and may even exert some further downward pressure in the next few years, but
once passed that period, PT will be able to increase the multiple play offers’
ARPU, especially considering that it currently 25% below Zon’s, as previously
39
mentioned .
On this matter, it is also important to mention that, once again, there is little room
for differentiation. Out of the three wireline products that are part of multiple play
offers, the one that still has the most room for differentiation is the Pay TV
service, due to the different channels that can always be offered and to the
possibilities for innovation and interactivity that the nature of the business
40
creates . This is extremely important because when thinking about bundles, this
Pay TV to become the deciding means that Pay TV will be the deciding factor when households decide with
factor when picking the bundled which company they want to sign their entire monthly bill with; as such, the player
operator
with the upper hand in TV is likely to gain an important advantage on the
multiple-play market – we believe this is something that has not failed to be
understood by companies, which have been putting a considerable effort on their
pay TV businesses, likely anticipating these trends. Nowadays, Zon has the
highest market share in Pay TV as a whole (54% vs. 35% from PT) and it also
has the highest market share in bundled offers as a whole (42% vs. 38% from
PT). However, as we have described in detail above, mostly because of its wellreceived initiatives and continued innovation in interactivity features and in
41
developing exclusive channels , PT has been gaining market share in Pay TV at
a very steep pace, and we believe it has positioned itself to possibly have the
upper hand on this market moving forward, thus enabling PT to soar in capturing
new bundled clients.
37
A price comparison, rather than ARPU comparison, indeed makes it look like the triple play offers are more profitable
for companies, even on a strictly revenues generation level (i.e. not accounting for cost synergies or other bundled offers
advantages).
38
We were not able to find the exact number of clients on these conditions, but this is widely visible if one looks at PT’s
marketing campaigns.
39
As explained before, we do not believe that there will be sustained long-term differences in pricing in the offers from
Zon and PT.
40
We do not exclude the possibility that, on the long term, the superior technological capabilities provided by the fiber
rollout and thus the fixed broadband service become also deciding factors. However, it is always possible to imagine a
scenario in which Zon upgrades its network as well or in which PT is forced to engage in wholesale agreements of its
network, which is why we believe it is more likely that Pay TV becomes the deciding factor.
41
Mr Bava has already stated that the Pay TV segment is the top priority for the domestic operations of PT.
PAGE 13/38
COMPANY REPORT
PORTUGAL TELECOM
The Personal Business – Un Avoidable Downturn
Graph 24 - Portugal
Personal Mobile Revnues
-5,0%
3
-5,5%
If the story of the residential business is one of resilience and long-term positive
trends, the one from personal business is of sustained decline over the years and
of a simultaneous convergence of negative trends and little long term good news.
2
-6,0%
1
-6,5%
0
-7,0%
2008
2009
2010
2011
For starters, and perhaps most importantly, spending patterns on the mobile
sector are far different from what we find on wireline. While the socio-cultural
argument concerning the way communications are made today and the sense of
essentialness that we made for the wireline is still present (perhaps even
Sector Revenues
strongly) on the mobile market, the tariffing system of the sector, and of Portugal
Growth of Sector Revenues
in particular, does not do the sector any favours. The fact that, unlike the Pay TV
Units: Million Euros| Source: Anacom
or the fixed broadband, there is a direct relationship between what is paid for and
what is being used (usually in terms of minutes), means that we are dealing with
Graph 25 - Mobile ARPU
a business that suffers, from the get-go, from a much smaller capacity to withhold
negative economic cycles, as consumers will simply be able to adjust their usage
50
45
and, therefore, their expenditures. This is clearly visible in the different ARPUs
40
35
from both plans, as depicted in the graph on the left: in Portugal, post-paid has
30
been on average 313% higher than pre-paid, a value in line with the European
25
median, 298%. On top of this, Portugal has an overwhelming percentage of pre-
20
15
42
paid plans (74% vs. an European Average of 52% ), which allows consumers to
10
monitor and decide on a more rational way their expenditures, thus adjusting
5
0
patterns to worse economic environments on an ex-ante root, as opposed to
what happens in a post-paid plan, in which the control of the level of expenditures
Median Europe Pre-Paid
is made on an ex-post basis, as these involve signing contracts that stipulate a
Median Europe Post-Paid
minimum monthly bill for a certain amount of time. As one can imagine, given the
Portugal Pre-Paid
economic conditions that we are currently facing and that we will be facing during
Portugal Post-Paid
Units: Euros| Source: Bloomberg
the next few years, this is an extremely important factor, capable of undermining
the financial health of the whole sector.
The second trend that we believe to be negatively affecting this market is the rise
43
of tribal plans . These are pre-paid pricing plans targeted, but not limited, at
The rise of tribal plans has been
bringing down the ARPU
young consumers, which offer free communications between members of the
same plan, thus significantly cannibalizing the ARPU from the mobile segment.
These tribal plans were originally launched by Optimus (the “Tag” program), the
third Portuguese mobile operator, as a way to try to increase its market share
among the youth; when Vodafone, the second operator and the most serious
threat to TMN’s long running leadership, ended up responding with the launch of
42
Anacom
Although we could not find any concrete numbers to back up this statement, it is widely reported by all three operators
that the percentage of revenues arising from tribal plans has been rising each year since its launch.
43
PAGE 14/38
COMPANY REPORT
PORTUGAL TELECOM
“Extreme”, PT (TMN) had no choice but to launch a similar offer, which was the
“Moche” program. By definition, these programs suffer from structurally lower
ARPUs and the similar offers in the market makes pricing upswings hard to
sustain in the long run. This means that as tribal plans keep on gaining
Graph 27 - Portugal On-Net and Off-Net popularity, a downward pressure on ARPUs is expected to continue.
Prices Comparison (end of 2011)
The third trend we would like to bring to the discussion is related with regulation,
15
particularly with the decrease in mobile termination rates (MTRs). In Portugal, as
13
11
a result of an enormous gap between on-net and off-net prices (as seen in the
09
graph on the left), people tend to prefer to belong to the same network as their
07
13,6
05
friends and family, which creates significant barriers for consumers to change
network – network effect. However, in May 2009, the European Commission
9,2
03
adopted a recommendation on the termination rates
01
44
decrease as a way to
boost competition (as seen in the graph on the left), thus bringing down the
-01
On-Net
Off-Net
Source: Analyst Estimates, Diário
Económico Research, Anacom |
Units: Eurocents per Minute
companies’ ARPUs as a result. Although the target for this decrease was the end
45
of 2012 , Anacom has already made announcements that would suggest further
decreases in the MTRs. In addition to this, another regulatory measure, aimed at
reducing the roaming fees, is also in play, which is also expected to have some
Graph 26 - Portugal MTR Evolution
impact, albeit on a lower scale. There are two implications of these regulatory
exactly to the high barriers that consumers faced to change networks and then
0
be forced to pay substantially more to communicate with their normal contacts.
4Q2012
1
3Q2012
remarkably stable, as the graph below illustrates, a situation that we attribute
2Q2012
share distribution. Historically, Portuguese market shares have remained
2
Q12012
3
4Q2011
able to charge less per each call. The second effect is related with the market
3Q2011
4
2Q2011
most straightforward, is a continued decrease in the ARPU, as companies are
1Q2011
changes for the communications sector and PT in particular. The first, and the
5
4Q2010
6
Source: Anacom | Units: Eurocents
However, with the decrease of mobile termination rates, this stability of the
market is likely to have a shakedown, and one whose effects are quite
unforeseeable. We believe that some minor players will be able to benefit from
the situation as they offer more competitive packages (although they are not
likely to become a factor in the long run) and we also believe that Optimus,
whose pricing is actually, in general terms, more attractive than the one offered
by TMN, might rise at the expense of the PT brand. We acknowledge the
possibility of TMN adjusting its pricing in order to counteract this effect, but we do
anticipate this to be very significant given the already low ARPUs which will not
leave much room for companies to engage in price wars.
44
The termination rates are the fees that operators charge to one another for terminating calls on its network, which
means, for routing calls from one company to another. These rates are the most important element in explaining the
difference between the on-net and off-net prices (on-net prices o do not include termination rates, whereas off-net do).
45
OECD reports that from 2006 to 2011 these rates fell by a hefty 53% average on OECD countries.
PAGE 15/38
COMPANY REPORT
PORTUGAL TELECOM
Graph 28 - Personal Mobile Market Shares
100%
80%
Others
60%
Optimus
40%
20%
44%
44%
43%
43%
43%
42%
42%
42%
0%
2009
Graph 29 - Mobile Data Traffic in
Western Europe
400000
2010
2011
2012 E
2013 E
2014 E
2015 E
2016 E
Vodafone
TMN
Source: Anacom, Analyst
Estimates
The last factor we would like to mention is the fact that, unlike wireline, it is
improbable that an ARPU contraction will be counterbalanced by an increase in
350000
the number of users, as Portugal already has one of the highest penetration rates
300000
in Europe in mobile. Although not a trend per se, the fact that the market has
250000
200000
pretty much ceiled up will certainly not do PT or its competitors any favours, as
150000
this means new users will forcefully have to be conquered from the competition.
100000
Amidst all these negative dynamics, the only positive trend seems to be coming
50000
0
2010
20011
2012
Source: Bloomberg | Units: TB/Month
from the increase in the mobile data consumption, as signalled by the increase in
data traffic worldwide, as seen by the first graph on the left. In fact, as shown in
th
the second graph on the left, Portugal is, as of the end of 2011, the 16 country
Graph 30 - Smartphone Penetration
in the world with the highest penetration rate of smart-phones (35%) suggesting
South Korea
indeed a rise in mobile data consumption. Even more importantly, it is still way
USA
behind countries which usually exhibit the same adoption patterns as Portugal,
Portugal
such as Spain (46%) and Italy (38%), suggesting further growth potential. As
Ireland
Greece
such, the challenge for Portuguese mobile operators seems to be finding a way
Taiwan
to monetize this revenue, which is shaping more and more to be the primary
Austria
source of revenues in the segment in the future . PT has positioned itself in a
46
The Netherlands
privileged position to do so, as it possesses an impressive LTE network, with a
Italy
47
UK
superior speed and quality and over 90% coverage . We believe this will prove
New Zealand
to be critical for the company’s continued dominance on this market in the long
Norway
term, even though similarly to what happens with the fibber rollout investment,
Finland
Israel
this is an investment whose return we do not expect the company to get back in
Denmark
the next years, due to the adverse economic conditions, which will continue to
Spain
postpone the adoption of these superior technologies.
Australia
Sweden
48
Bottom line, we believe that despite long-term positive impact from data , there
Hong Kong
are just too many negative factors in play, so we expect revenues to fall,
Singapore
0% 20% 40% 60% 80%
especially in the next three years, after which we trust things will start looking up.
Source: Wired Magazine
46
Another important source of revenues are the mobile pen-drives that provide internet access which have been gaining
popularity within the last years, although neither companies nor regulators provide individual information about this.
47
Although we could not quantify Vodafone and Optimus’ coverage of this technology, the consensus is that it is still
considerably below the 90% held by TMN. The biggest cause for this appears to be the implementation gap: while TMN
started its investment in early 2009, it was not until late 2010 that the other competitors got serious about it (Anacom).
48
The positive impact of mobile data is weakened by the low ARPU that it has, 3.6€, when compared with the mobile
voice ARPU, 7.4€, of PT (as of the end of 2011).
PAGE 16/38
COMPANY REPORT
PORTUGAL TELECOM
Enterprise – Where It Hurts the Most
The enterprise segment is, in our opinion, the one that in the next years will truly
Graph 31 - PT Enterprise
Users Segmentation
harm PT’s revenues and overall results, as we expect a continued decline on its
revenues. The thing with this segment is that it is a sector that will always follow
18%
very closely the economic cycles. As such, in a recessionary time such as the
present one and the ones we will be going through the next years, not only are
the net additions of clients negative (there are more companies going bankrupt
157
%
and closing than new companies opening) but ARPUs are also falling at a
downright scary pace (-10% in the last year, to 32.3€), as a result of expenditure
cut programs all across the corporate world. PT in particular is widely exposed to
Fixed Broadband + Pay TV Users
Fixed Line + Mobile Users
Source: Company Reports
these expenditure cuts due to the fact that its product mix in the enterprise
segment is, as showcased in the chart on the left, heavily skewed towards voice
(826K users from fixed line and 1445K users from mobile, against 193K from
broadband and 68K from Pay TV), which, as discussed before, is the product in
which consumers have less trouble adjusting their spending patterns.
Additionally, PT is also more exposed to the enterprise sector as a whole than its
peers: whereas 21% of total PT users come from the enterprise sector, on a
49
Portuguese sector basis, this number is only about 7% .
Graph 32 - Fixed Broadband Penetration Nevertheless, on a long term basis, we believe PT, through its impressive
on Enterprises Across Countries
investments both in fibber rollout and LTE, has positioned itself to counterbalance
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
00%
most of these short term losses and that it will remain the company of choice for
most corporations due to its superior technology and complete offer, considering
corporations are usually interested in hiring services in a bundled fashion,
including also mobile services. Moreover, as seen in the graph on the left,
Spain
France
Sweden
Netherlands
Germany
UK
Ireland
Denmark
Portugal
Italy
Austria
Greece
Poland
Portugal is still far from having a very high penetration rate in the enterprise
Source: OECD
sector when compared to its peers when it comes, for instance, to broadband,
which means that there is still a lot of room to grow. Standing between the
materialisation of this potential and PT is, of course, the Portuguese macro
environment, which despite these positive trends, we still believe will be, by far,
the dominant effect on this market.
We are therefore forecasting massive declines on this sector, both on the number
of users and on the ARPU in the short to medium term, with recovery starting,
albeit on a slow pace, around 2016.
49
Looking at fixed broadband only, 17% of PT customers are enterprise, whereas these are only 5% from the sector as a
whole, again reflecting the higher exposure from PT. These numbers, as well as the 7% aforementioned, were estimated
through data provided by Anacom as well as company reports.
PAGE 17/38
COMPANY REPORT
PORTUGAL TELECOM
Graph 33 - EBITDA Margin
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Cost Margins and Investments
Despite the recent hits that PT’s domestic revenues took, the operational
performance has actually been very healthy, as the company was able to cut its
costs and achieve more favourable EBITDA margins, even amidst a recessionary
climate. In fact, operational expenditures fell 14.2% in 2010 while revenues fell by
just 7.4% thus allowing for an impressive expansion of the EBITDA margin of
5.2%. Nevertheless, we believe that PT is already at the limit of cost reductions,
particularly those concerned with personnel and commercial costs, so it is not in
EBITDA Margin
a position to keep cutting down costs. For this reason, we are expecting some
Comparables Margin as of 2011
Source: Company Reports, Analyst
Estimates, Bloomberg
contraction of the EBITDA margin in the short term. On the long term though, we
expect this margin to start swinging upwards, eventually stabilizing around the
40-45% range once again. As shown in the graph, this range is actually higher
Graph 35 - ARPU Across Countries
80
than the average European EBITDA margin from its peers. In order to assess
whether this was mostly due to efficiency gains or due to higher ARPUs (due to
70
60
lower competition or due to more collusion), we have looked at the ARPUs from
50
other countries . As shown in the second graph on the left, Portugal’s ARPU is
50
40
actually one of the lowest analysed, supporting to the idea of a higher operational
30
51
As such, we are counting on PT’s ability to keep this operational
20
efficiency .
10
efficiency in the long run. Nevertheless, the long term margins we are forecasting
00
are slightly below today’s margins, reflecting on the one hand the fact today PT is
having margins that are already diminished to adjust for negative economic
Source: OECD, Analyst Estimates |
Units: Euros
conditions and also the fact that the expected product mix, skewed towards fixed
52
broadband and pay TV is associated with lower margins than voice .
Graph 34 - FTTH Users from PT
On the other hand, in what concerns CAPEX, the outlook seems to be far more
200.000
favourable. In the last years, PT has had an abnormally high CAPEX, especially
150.000
53
due to its fibber rollout investment. . Recently, Mr Bava has stated that PT had
100.000
an approximate cost of 200€ with each household passed with fibber, which
50.000
would mean an approximate 320M€ of total investment from 2009 until 2012. To
1T09
2T09
3T09
4T09
1T10
2T10
3T10
4T10
1T11
2T11
3T11
4T11
0
analyse the impact of this investment, we have looked at the number of clients
54
Fixed Broadband
Pay TV
PT has in FTTH , as summarized in the graph, and assumed an increase in the
55
Source: Anacom, Company Reports
Analyst Estimates | Units: # Users
ARPU of about 27% . This would mean that from 2009 until the end of 2011,
50
The ARPUs presented are estimates of averages (considering the purchasing power parity differences) across fixed
line, fixed broadband and Pay TV that do not take into account the distribution of users across these three services.
51
Although the average EBITDA margin presented includes a few more countries than the 7 here presented, we do not
think the conclusions would be altered in a significant way.
52
Although PT does not disclose these margins separately, this is the typical situation, as we will show when dwelling
into Oi’s business, where this is also an important factor.
53
The LTE investment has also contributed to this high level of CAPEX.
54
PT is leader in both areas with a market share in FTTH fixed broadband of 80% and of 83.4% in FTTH Pay TV.
55
This value is not disclosed, so we have used as proxies international companies (Nippon Telephone Corporation,
Telekom Austria Group and Swisscom). The results presented are thus estimates only.
PAGE 18/38
COMPANY REPORT
PORTUGAL TELECOM
PT’s incremental revenues from FTTH would have been about 200M€ - the
Graph 36 - PT Revenues Split
company should have then broken-even in 2012. There are, however, two
900
800
700
600
500
400
300
200
100
0
caveats. The first is that FTTH also reduces OPEX due to the higher quality of
the technology, although we could not infer exactly by how much. The second is
that some of these clients would likely not be PT’s clients were it not for the FTTH
– in such cases, the added value of the investment would be the entire revenue
generated by these users rather than the incremental portion. As such, it is likely
1T09
2T09
3T09
4T09
1T10
2T10
3T10
4T10
1T11
2T11
3T11
4T11
that we are underestimating the positive impact of the FTTH investment and that
FTTH Revenues
Other Revenues
Source: Anacom, Company Reports
Analyst Estimates | Units: Million Euros
the break-even might have occurred as early as in 2011. In any case, we believe
the investment has already paid off and will continue to do so in the future, as
FTTH revenues continue to grow, as seen by the first graph on the left.
Coming back to the impact on CAPEX, this FTTH investment is ceasing in 2012
as company is reaching the 1.6M households passed with fibber, thus achieving
about 40% coverage. Mr Bava has already confirmed that further investments on
this technology are not on PT’s plans for the foreseeable future, not only because
56
Portugal’s penetration rate in FTTH is already extremely high , but also due to
the possible adverse regulations effects. In fact, the EC has been pressuring
Anacom to force PT to engage in wholesale agreements with its competitors and
open its fibber rollout lines (as a way to save the duplication of infrastructures) –
Graph 37 - CAPEX
1000
900
800
700
600
500
400
300
200
100
0
30%
25%
remuneration but it would also lose its differentiation factor. So far, Anacom has
not pursued this recommendation, on the grounds that the coverage that PT has
15%
is still not large enough for this (this is why we do not believe PT will keep on
10%
investing), although the threat still stands. Regardless, this CAPEX reduction
5%
offers PT a CF advantage over most of its competitors, which are now struggling
0%
to upgrade their own networks in spite of the adverse market trends. As for the
2017 E
2016 E
2015 E
2014 E
2013 E
2011
2012 E
2010
20%
this would obviously alter PT’s return on its investment, as it would receive
Capex
intangible assets, PT has announced that it will not need to renew its licenses
until 2025, so there are no major investments in this area expected either.
Capex as % Sales
This lower CAPEX needs give PT a great flexibility to postpone its investments,
Comparables Margin (as of 2011)
which become mostly related with revamping activities, the timing of which could
Source: Company Reports,
Analyst Estimates, Bloomberg |
Units: Million Euros or %
be easily adjusted. Overall, we expect a decrease of the CAPEX/Sales Ratio
from the current 22% to about 18% in the long term, still above the sector
average of 13%, bearing in mind PT’s continued focus on innovation and the
need to create differentiated products, particularly on Pay TV, as discussed.
57
56
Portugal’s penetration rate in FTTH was, as of the end of 2011, 1.60% (per inhabitant), a value that was more than
double the European average of 0.6%, according to data from Anacom. This suggests that Portugal is already advanced
for its time, so a similar amount of investment in this in the near future is unlikely.
57
The higher-than-the-sector expectation comes from PT’s commitment to innovation and ahead of its time investments,
which we believe will continue to impact the company’s direction moving forward.
PAGE 19/38
COMPANY REPORT
PORTUGAL TELECOM
Oi Business
The other significant source of value creation for PT is Oi. As with the domestic
operations, the major segments are residential, personal and enterprise. There
Graph 38 - Brazil GDP Growth
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
are, however, striking differences in the trends currently affecting the two
markets, in terms of the state of the company itself, of the economic conditions of
8,0%
both countries. We will be dwelling into the two former points as we describe
4,5% 4,7% 4,7% 4,6% 4,6%
3,2%
each market. As for the economic conditions, as illustrated by the graph on the
left, Brazil is currently undergoing a clear expansion phase that still has no clear
58
end in sight, considering speed of GDP growth . An economic boom such as this
2,0%
is reflected, to a higher or smaller extent, in the various sectors of the economy,
such as communications, thus meaning that positive trends are expected.
20102011201220132014201520162017
E
E
E
E
E
E
Moreover, Brazil has two big sporting events approaching, which are the
Source: IMF
Worldwide Football Championship in 2014 and the Olympics in 2016, both of
which are also expected to boost, albeit on a very short term basis, consumption.
This means that, if the story of the Portuguese business was one of survival and
resilience to a tremendous economic downturn, the one from the Brazilian
business is one of being able to ride with the wave of economic growth and
expand the company position within a budding market.
Oi Turnaround Plan – A Step in the Right Direction
In spite of the growth potential that the Brazilian market entails, during the last
years, Oi’s results have been far from spectacular. On the one hand, as we will
be analysing later on, this is explained by the stiff competition in Brazil. There is,
however, another important factor which is the fact that, in our view, Oi has been
poorly managed up until recently. A very clear evidence of this is the lack of
efficiency, as can be observed by comparing its margins both with those from its
peers and with PT itself, as showcased in Graph 43, on page 22. Another issue is
that we could not find any specific activity in which the company was focusing its
Graph 39 - Depreciation Rate
investments – although the CAPEX levels were normal, there were no long-term
16%
investments that felt like a priority in the company’s strategy (for instance, as the
14%
12%
LTE and FTTH technologies of PT in Portugal) – in a sector that is centred on
10%
8%
innovation, we believe this is a weakness. There is also the poor state of its fairly
6%
4%
old network, which drives high maintenance costs. One way to view this is by
2%
looking at the depreciation rate of Oi, which is far superior to that from its
0%
2010 Q1
2011 Q4
2012 Q3
competitors, as depicted in the graph on the left. Another indicator of the poor
Telecom Itália
Telefónica
Oi
performance of the company is the complaints rate, which was amongst the
Source: Bloomberg, Company Reports|
Units: % (Depreciation over Net Fixed
and Intangible Assets)
highest in the sector, but has been falling ever since the turnaround started to
58
Once again, a more thorough macroeconomic picture for the next 5 years is presented in the Appendix, although the
conclusions taken from the observation of the GDP growth alone still hold.
PAGE 20/38
COMPANY REPORT
PORTUGAL TELECOM
take effect, as seen in the graph on the left. The company suffered also from a
Graph 41 - Complaints Rate
fragmented and complex corporate organization, which often troubled decision
120%
59
making . In short, we believe the company was performing below its true
100%
80%
60
potential when PT acquired its stake in it at the beginning of 2011 .
60%
40%
20%
Ever since then, the company has announced a turnaround plan which appears
0%
1T11
2T11
3T11
4T11
1T12
2T12
to be a major step in the right direction. For starters, the company underwent a
Teleónica
Embratel
major corporate reorganization which vastly simplified its processes and allowed
Oi
Telecom Américas
for an improvement of its decision making processes, while favouring the
TIM
company visibility. Secondly, we believe PT’s active’s entrance in the
Source: Teleco
management team
61
will yield positive results soon, particularly in terms of
62
efficiency, since PT is, as we have discussed, a cost-efficient company . For this
reason, and as showcased in the graph below, we forecast major margin
Graph 40 - Oi's EBIT Margin (2011)
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
improvements within the next 5 years even accounting for the shift towards a
more unfavourable product mix (more Pay TV and fixed broadband instead of
voice, where margins are structurally higher, as seen in the graph on the left). We
further note that we would expect even higher margins in the short run were it not
47%
31%
for the fact that, as part of exactly this turnaround plan, Oi is increasing its brand
exposure thus rising up commercial costs, at least in the short run.
Finally, Oi is more focused on how it wants to grow and in taking advantage of
Fixed Line
Pay TV & Fixed
Broadband
Source: Company Reports
the booming market where it is inserted. Indeed, recent news indicate that the
company is focusing on its still much undeveloped Pay TV business as well as in
capturing broadband customers, a strategy that, as we will explain, we believe to
be adequate given the current market trends. CAPEX is now expected to rise
significantly, as a result of three big factors. The first is the aforementioned focus
on the Pay TV business, in which Oi’s presence is still minimal. The second is the
replacement of infrastructures which as we have described, are older and in
poorer state than normal. Finally, Oi has signed an agreement with Anatel
63
regarding the development of fixed broadband in Brazil , according to which “Oi
must guarantee that the quality of the offer provided is not inferior the quality of
remaining offers with the same features provided in the same markets”, which will
force Oi to further invest to assure such standards of quality. Bearing all this in
59
It is the actual company that recognizes the previous governance and organizational problems by stating that one of
the key goals of the reorganization was precisely “the alignment of shareholders’ interests”.
60
This is probably what actually led PT to invest in the company in the first place.
61
Mr. Bava is said to spend at least a week per month in Brazil.
62
Oi recognizes the importance of PT’s involvement by stating their “important know-how in terms of technology,
operations, quality of services and product offer”, highlighting that it has “large experience in the markets of mobile
voice, TV, fixed and mobile broadband, in Portugal and in the remaining countries where it is present”
63
“Termo de ompromisso ao Plano Nacional de Banda Larga no Brasil”
PAGE 21/38
COMPANY REPORT
PORTUGAL TELECOM
mind, we forecast significant CAPEX increases in the short term, with some
64
stabilization in 5 years, albeit at level still higher than the current one .
Graph 43 - EBITDA Margin
Graph 43 - CAPEX
50%
8.000
40%
25%
6.000
30%
20%
30%
7.000
20%
5.000
34%
31%
30%
33%
35%
37%
39%
41%
4.000
7.083
3.000
10%
2.000
0%
7.006
6.751
7.123
7.388
6.949
10%
4.422
5%
1.000
2010
2011
2012 E
2013 E
EBITDA Margin
2014 E
2015 E
2016 E
2017 E
Comparables Margin (2011)
PT Domestic EBITDA Margin
0
0%
2011
2012 E
Capex
2013 E
2014 E
Capex as % Sales
2015 E
2016 E
2017 E
Comparables Margin (2011)
Source: Company Reports, Analyst Estimates, Bloomberg | Units: Million Brazilian Reals, unless %
The Residential Business – A Rock-Bottom Start
The main thing about the residential business from Oi is that, although this is a
Graph 44 - 2011 Residential
Revenues Breakdown
sector that is clearly booming, Oi is currently in a position that does not seem to
give it much of a competitive advantage, thus making its future on this segment
4%
shaky at best. In other words, it is as if the remaining competitors have an
important head-start over Oi on this market. This is due to three factors.
32%
The first is Oi’s product mix. Although it has businesses in all three wireline
64%
products, an overwhelming portion of its revenues, 64%, are coming from fixed
line, as seen in the graph on the left. When we take into account the pace at
which the fixed line segment has been losing relevance, mostly due to the fixedFixed Line
Fixed Broadband
Pay TV
Source: Company Reports
to-mobile substitution effect – in world terms, 90% of telecom revenues were
coming from fixed line in 2000, compared with the 36% from today – this
revenues distribution becomes downright scary. In our opinion, this trend
represents a sort of “make it or break it” opportunity/threat for the company. On
the one hand, the continued bleeding suggests that the fixed line business will
Unfavourable Product Mix
15%
keep on deteriorating, which would mean a massive bleeding on the company’s
largest source of revenues. On the other hand, the fact is that Oi still has a
massively big customer base on this segment, which could prove to be a
valuable asset at a time when bundled offers are just starting to be launched in
the market. For this reason, we believe timing is a key determinant of the future
of the company: if Oi manages to leverage its fixed line customer base and
increase its revenues generated per user before this base shrinks too much,
there are great things lying ahead for the company; if, however, there is too much
64
The oscillations in the absolute numbers of CAPEX shown in the graph have to do with 1)The high amount of
depreciations coming from previous years, which we predict to decrease from 2015 onwards; 2)The oscillations in
revenues, which obviously have an impact in terms of CAPEX needed.
PAGE 22/38
COMPANY REPORT
PORTUGAL TELECOM
of an erosion of this customer base before there is a significant upgrade to
bundled offers, the future of the company becomes all the much more blurred.
This is where the aforementioned operational turnaround, particularly the
entrance of PT in the management group, as well as the definition of a long term
strategy that passes through a massive investment and commercial campaign to
raise its pay TV users (Oi currently offers its TV services at entrance pries that
are approximately half of the competitors’) and capture customers that are using
Strategy focused on the rise of
multiple-play offers to hedge
Oi’s current client base
65
fixed broadband for the first time , becomes crucial. As we have mentioned, we
believe that this long-term plan is very much adequate to the expected rise of
bundled offers because, similarly to what happens in Portugal, Pay TV and, to a
lesser extent, fixed broadband, will be the key determinant of what operator
consumers will prefer to sign their bundled contract with. As such, we believe that
despite the unfavourable product mix, Oi will be able to timely retain these
customers just long enough to allow for an upgrade to multiple-play offers, thus
shifting its product mix while capturing new users that will enter these broadband
and TV markets for the first time – we predict penetrations to increase.
The second factor that we believe will complicate Oi’s progression to a higher-
Graph 45 - Brazil Regions Distribution
end product mix is the fact that it currently has a very low-income subscriber
base. In Brazil, the fixed line market operates through the attribution of
concessions by regions; under this, Oi has been attributed the concession of
regions I and II. On a GDP per capita basis though, region II happens to be the
poorest region whereas region III, which Oi is missing out, to be the wealthiest.
We reflect this factor in our model by forecasting a longer period for Oi to
increase its bundled-offers clients and also by forecasting ARPUs that ultimately
will always tend to be slightly lower than those from its competitors. We still
believe that even the poorest regions will benefit, long term from Brazil’s
exceptional growth – we simply trust that will take them longer to get there and
66
that a gap with the wealthiest regions will still persist .
Finally, there is the stiff competition on the market. The Brazilian boom seems to
Source: Teleco (Altered)
have caught the attention from a number of international, experienced players, as
there are currently market players from Portugal (Oi), Spain (Vivo), Italy (Telecom
Italia) and USA (Telecom Americas), among others. Obviously, Oi is not the only
one realizing the long term potential of trends such as the rise of bundled offers,
meaning that we expect all these companies to increase its investment levels in
65
Brazil’s penetration rate for fixed broadband and pay TV is still very low, being 30% and 20%, respectively, which
means there is a lot of room for future growth.
66
In a way, this factor is related to the first one that we mentioned: because Oi operates in the some of the poorest
regions in Brazil, the fixed broadband and the pay TV products are still very much “high-end” products, which tends to
skew its product mix towards voice, an already “lower-end” product. In any case, our argument that Oi has an
unfavorable product mix still stands.
PAGE 23/38
COMPANY REPORT
PORTUGAL TELECOM
the near future as well. We believe there is some likelihood of price wars,
motivated essentially by an attempt to capture those users who are still not part
of the broadband or Pay TV markets, which will obviously maintain the current
downwards pressure on the ARPUs. An effect on market shares is also
expected, as seen in the graph below, even if we do not expect this to differ
significantly from last years’ trend, except in the Pay TV market, where we expect
Oi to surge significantly, mostly at the expense of smaller players that do not
have any sophisticated multiple play offer in the market. We do not forecast
significant changes on the fixed line market distribution.
Graph 47 - Market Shares Fixed Broadband
Graph 48 - Market Shares Pay TV
100%
100%
80%
80%
60%
60%
40%
40%
20%
37%
32%
30%
2009
2010
2011
30%
30%
31%
31%
0%
31%
20%
32%
0%
2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
Oi
Telecom Americas
Source: Teleco, Analyst Estimates
Telefónica
Others
3%
3%
3%
2009
2010
2011
3%
4%
4%
5%
6%
2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
Oi
Telecom Américas
Source: Teleco, Analyst Estimates
Telefônica
Others
Overall, we believe that despite a number of challenges ahead, Oi has positioned
itself to adequately thrive in a market that is becoming more and more
competitive, so we forecast positive behaviour from the segment revenues, albeit
at a slower pace than one would expect when looking at the GDP growth.
Personal Business: A Slow Move
The most striking aspect that one finds when looking at the mobile market in
Graph 49 – Top 15 Countries
Mobile Penetration Rate
Brazil is that, even though this is an emerging market that is expected to grow at
an astonishing pace in the next five years, its mobile penetration rates are
Denmark
Israel
Iran
Germany
Brazil
Portgal
Arab Emirantes
Bulgaria
Sigapore
Italy
Estonia
Lithuania
Russia
Saudi Arabia
Hong-Kong
th
already impressively high, being, as of the end of 2011, the 11 country with the
highest penetration rate. In fact, during the last 5 years, this penetration rate
increased on average 18% per year, an abysmal number that clearly illustrates
the boom the sector was undergoing. Moving forward however, we do not expect
this behaviour to be replicated. We believe Brazil to have reached, for the most
part, its “stable” point as far as penetration rates are concerned especially
because excluding some very extreme cases such as Russia, Saudi Arabia and
Hong-Kong, the current penetration rate, of about 125%, appears to be pretty
0%
Source: Teleco
50%
100%
150%
200%
7%
much the ceiling for all countries. As such, we forecast only minor increases in
this number each year, with the 150% of penetration eventually being reached by
2017 (3.3% CAGR). However, as Brazilian population is expected to keep on
rising at least by about 1% per year as seen in the graph on the left on the next
page, this apparent minor increase in penetration rates will still end up being
reflected in a somehow higher amount of new sector users.
PAGE 24/38
COMPANY REPORT
PORTUGAL TELECOM
In fact, we expect the rise in the Brazilian population to become the main driver of
Graph 49 - Brazilian Population
growth in Oi’s mobile revenues, since we anticipate the stiff competition in the
210
market to undermine any other form of growth. As of the end of 2011, Oi holds
205
18.8% of the market and we do not expect this value to be altered significantly,
200
as the market has been pretty stable during the last years, so we would expect it
195
to continue to be so, meaning that we do not expect Oi to be able to grow
190
significantly at the expense of its competitors, although some progress should
180
still be possible as the company is currently updating its network, which is certain
175
to increase the quality of its service. Nevertheless, the same type of directives
2007
2008
2009
2010
2011
2012 E
2013 E
2014 E
2015 E
2016 E
2017 E
185
Source: IBGE | Units: Millions of People
that were adopted in Portugal concerning the decrease of MTRs are also being
applied, albeit at a lower extent, in Brazil, so more drastic changes in the market
share distribution could be an unforeseen possibility. As for the ARPU, this
appears bound to keep on declining, both due to the aforementioned decrease of
the MTRs and also due to the competition dynamics, which are likely to keep on
pressuring them downwards. The exception to this trend would be the
aforementioned sports events in 2014 and 2016, in which we expect some ARPU
surges, mostly due to higher roaming revenues. Finally, in what concerns the
potential rise of revenues coming from data, we believe Brazil is still behind on
this trend (smartphones penetration rate is just 14%), so we do not expect it to be
very significant in the short-term, especially in Oi’s case, since, as explained
before, its client base is very low-income skewed, which would tend to delay the
adoption of these higher-end products even further.
All in all, we believe this is a sector that will remain stable, with some revenue
growth, but way below the spectacular growth number it has brought in the past.
Enterprise
Graph 50 - Enterprise Users
The enterprise segment has been trending positively during the last few years
and we expect this to be maintained over the next years. We believe this is the
11
sector that will benefit in a more clear way from Brazil’s growth, as new
9
companies continue to open up and as current companies continue to expand its
7
business. In the mobile business particularly, we are forecasting a 7% increase
5
per year in the number of users of Oi. We believe that, unlike the personal market
3
in which penetration has pretty much ceiled up, the potential to capture new
1
users here is considerable and that Oi’s soon to be upgraded network will prove
-1
2010 2011 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
Source: Company Reports, Analyst
Estimates | Units: Millions of Users
to be a competitive advantage in this setting, thus allowing it to grow. We believe,
however, that competition dynamics will continue to push down the segments’
ARPU, currently about 90 BRL, although we expect the gap with the remaining
segments (currently 285% higher, on average), to be sustained.
PAGE 25/38
COMPANY REPORT
PORTUGAL TELECOM
Graph 51 - Capital Structure
(Market Values)
Financial Structure and Cost of Capital
100%
90%
20%
An Atypical Capital Structure
34%
80%
51%
70%
As the graph on the left shows, PT is highly leveraged, with about 80% of debt, a
60%
67
value way higher than the comparables’ average, which is nearly 50% . This
50%
40%
80%
66%
30%
49%
20%
high leverage comes from various investment decisions, both organic (high
68
CAPEX from the FTTH and LTE investments ) and inorganic (Vivo investment
10%
69
70
and Oi investment ), as well as higher dividends in 2010 (as seen in the graph
0%
Current PT
Average
Comparables
Target
on the left, PT has paid 0.65€ in 2011 and 2010 and 0.575€ in the 3 years before
71
Debt
that, but in 2010 it paid extraordinary dividends of 1€ following Vivo’ sale ).
Equity
Source: Bloomberg, Analyst Estimates,
Company Reports
In any case, we do not regard this capital structure as being an occasional hip
Graph 52 – Ordinary Dividends per Shareand we do believe that PT has evolved in a direction that makes its current
70
capital structure the one it will tend to have, even if this is somehow atypical to its
60
sector. Yet, we still consider that the current structure is a bit exaggerated and
50
40
that in the near future, PT will reduce its leverage. Our main motivation for this is
30
20
the fact that with the Portuguese government, currently rated BB by S&P, PT,
10
currently ranked BB+ by the same agency, in risk of a further downgrade, will try
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
0
Source: Company Reports| Units Eurocents
72
to prevent a further downgrade by paying up its debt . We see several
possibilities for PT to achieve this, such as the usage of the excess of cash the
Graph 53 – 2011 Dividends Payout Ratio company gathered after the sale of its stake at Vivo, the disposal of non-core
international assets in Africa and Asia or a lower dividend policy, as PT has
25%
20%
15%
10%
5%
0%
73
already announced , which as we can see by the graph on the left will still leave
74
the company with an attractive payout ratio . Meanwhile, we believe the
slowdown in domestic CAPEX will also bring down needs for further debt in the
near future. All in all, we expect PT to move closer to the average capital
structure from its sector, but not fully reach it, since it has already differentiated
itself in a large way. As such, we will proceed using a long-term target of 66%
Comparables
Source: Bloomberg
Median Comparables
75
D/EV .
67
Even if we consider net debt instead (i.e., after accounting for the excess of cash), the D/E is still a very high 73%.
As discussed above, we estimate that the fiber rollout alone has required an investment of about 320M€.
69
PT received 7.500M€ for selling its stake at Vivo to Telefónica in 2010. Vivo was a joint venture formed in 2003with
Telefonica, for which PT contributed with two assets, Telesp Celular (for which it paid 1.381M€ in 1998) and Global
Telecom (for which it paid 1.280M€ in 2001). Looking strictly at what it paid for the investment and what it got from the
investment, the net result would be a positive 975M€, but we do not believe this value to be very meaningful in itself.
70
PT paid 8.320 million of reals (about 3.573M€) for its stake at Oi.
71
In 2007, there were also extraordinary dividends, of 1.62, following the spin-off of PT Multimedia.
72
The same course of action applies for the argument that PT will try to achieve an investment graded rating as soon as
possible due to all the restriction associated with being non-investment graded. In the Appendix III, we provide a brief
analysis of the impact of the amount of leverage on the credit rating of a company of the communications sector.
73
PT has announced that, from 2012 until 2014, dividends per share will be reduced to 0.35€. This will be accompanied
by a buyback shares programs of 200 million Euros for these three years, equivalent to an additional 0.225€ per share.
74
In a group of 21 European peers, the ratio from 2011 was 7%, 6% and 6%, respectively for average, median and mode.
75
This value was obtained by giving a 1/3 weight to the sector average and a 2/3 weight to the current company’s ratio.
68
PAGE 26/38
COMPANY REPORT
PORTUGAL TELECOM
Table 4 - Portugal WACC
The Cost of Capital
In what concerns the cost of capital, considering the different opportunity costs
present to investors in Portugal and Brazil, even in spite of markets globalisation,
we have computed separate costs of capital for both segments.
Starting with Portugal, we have taken the CAPM model to obtain a proxy for the
cost of equity. For the risk-free rate, we have decided to use an average of the
yield from 10y German Government Bonds and the 10y Euro Swap Rate, in order
to minimize for current distortions within the market, reaching a value of 2.28%.
We have used an unlevered sector beta
76
77
of 0.76 , which considering the 69%
D/EV yields a beta of 1.16. We have also considered a country beta of 1.2 in our
78
calculations . We believe that, despite the fact that investors can nowadays
invest on a mostly global scale and should thus be able to diversify these risks,
the geography of the investment is still not indifferent in terms of the risk-return
Source: Bloomberg, Analyst Estimates
Table 5 - Brazil WACC
trade-off demanded, thus suggesting the existence of a perceived nondiversifiable risk. Finally, considering a market premium of 5.5%, we reached a
cost of equity of 9.9%. For Brazil, the rationale was the same, but we have used
79
a higher risk-free rate, of 5.3% , to account for the higher opportunity cost, and
80
we have used also a higher country Beta, of 1.6 , accounting for the higher risk
of this emerging economy. We have reached a cost of equity of 15.8%.
For the cost of debt, we took SP’s probability of default, 2%, and the historical
recovery rate for similar-rated companies, 70%, and then took the sum of the risk
free rate with the CDS on the company’s 10 year bonds (proxy for the default
spread) as a proxy for what the company is paying on the market for its debt. The
cost of debt for Portugal and Brazil were then, respectively, 8.3% and 11.2%.
Taking into account the statutory tax rates in both countries as well as the
aforementioned target capital structure, we then reached a cost of capital of 7.5%
and 10.3%, respectively.
Source: Bloomberg, Analyst Estimates
76
This value was obtained by averaging the unlevered betas of 17 foreign communication companies (median was a
similar 0.70). To obtain the raw betas of these companies, we have regressed their returns on the MSCI World Index
returns using monthly data for the last three years. The unleveraging was then done using each company’s capital
structure in market values.
77
The fact that we obtain a Beta that is lower than 1 further supports our initial argument concerning the resilience and
“basic” nature that communications industry have attained.
78
This Beta was computed by regressing the returns of the PSI-20 Index over the MSCI World Index using 3 years of
monthly data. Despite eventual issues concerning the liquidity of the PSI-20 Index, we still believe this is a reasonable
proxy to be used. The resulting regression exhibited an R-Square of 49% (suggesting that about half of the country risk
is diversifiable) and a regression error of about 6%.
79
We have computed this risk-free through an inflation differential, following the following expression:
(
)
80
This Beta was computed by regressing the returns of the IBOV Index over the MSCI World Index using 3 years of
monthly data. The resulting regression exhibited an R-Square of 69% (suggesting that about 30% of the country risk is
diversifiable) and a regression error of about 5%.
PAGE 27/38
COMPANY REPORT
PORTUGAL TELECOM
Scenario Analysis
As stated in our valuation summary, we have included in our model a scenario
analysis in order to account for two potential game-changers for the future of PT.
The first one we have performed concerns what would to happen to the company
were Portugal to leave the Euro Area, because even though this is a lowprobability scenario, its impact on PT would be considerable. On the contrary, the
other one we have looked at, a merger between Sonaecom and Zon, is an event
with a relatively low impact to the company, yet one with a respectable probability
of taking place.
81
Portugal Leaves the Euro
The Situation
As described before, the Euro Area is currently tackling the sovereign debt crisis,
resultant from the high levels of deficit and public sovereign debt displayed by
some EU members, which has put the very own sustainability of the euro in
jeopardy. While it is possible to think of a scenario in which the Euro disappears,
we believe a scenario involving a unilateral exit by troubled countries, particularly
Greece and Portugal, is far more likely than a full end of the Euro Area,
considering the significantly lower level of distress it would cause – this is the
scenario in which we focus on here, thereby assuming that Portugal would leave
the Euro Area in 2014, after failing to meet the necessary reduction in its deficit.
Graph 54 - GDP Growth
Evolution Comparison
If Portugal were to leave the Euro area, its currency, Escudos, would steeply
4%
foresee. Looking at the little precedent that is available, we see that Argentina
2%
devaluated about 75% when it decided to leave the dollar and reintroduce the
0%
-2%
2013 E 2014 E 2015 E 2016 E 2017 E
devaluate, although the exact extent of this devaluation is extremely hard to
peso as its currency. Although we are not insensitive to the different economic
characteristics of both countries and to the overall differences between both
-4%
-6%
situations, we have used this number as the best available proxy for the
-8%
-10%
devaluation of the escudo.
-12%
followed by a dramatic reduction in the overall spending, thus reducing economic
-14%
This currency devaluation would most likely be
activity. Sooner rather than later, this would impact companies in a massive way,
Basis Scenario GDP Growth
which by 2015 would be facing bankruptcy or enormous downsizings. Again, we
Portugal Leaves Euro GDP Growth
use the Argentinian’s numbers to infer what the impact over our GDP would be,
Source: IMF
as seen in the graph on the left. As showcased in the graph, we believe the major
impact would be felt in 2015 and 2016 and that, by 2017 (three years after the
81
We did not perform a scenario analysis for the case of Brazil long-term growth being higher than expected, but we
incorporate that possibility in the growth rate that we have used for the terminal value and we have done a sensitivity
analysis to this value, as will be explained in the next section.
PAGE 28/38
COMPANY REPORT
PORTUGAL TELECOM
currency change, as in the Argentinian’s case), Portugal would be able to come
back to its expected GDP growth rates, assuming a smoother fiscal policy in the
82
meantime, particularly a reduction in taxation .
The Impact to PT
As described, the deflation spiral that the Portuguese Escudo would face in the
short term would have a major impact on domestic spending, thus eventually
affecting companies as well, including PT. In fact, in spite our standing argument
regarding the resilience of the sector for the most part, we believe the overall
communications market would suffer a major shrinkage. We use the relationship
between the expected GDP in both cases to alter our forecasts for the
penetration rates in order to account for this in our model. Similarly, we believe
the ARPUs would go down massively, reflecting the reduction in the disposable
income for most agents. At the same time, we would expect margins to shrink,
Penetration Rates, ARPUs and
EBITDA Margins to fall sharply
as a result of the overall
decrease in economic activity
due to some incapability to adjust fixed costs at least in the short run. Overall, we
forecast an EBITDA that would be on average about 60% lower than the one
forecasted in the basis scenario from 2013-2017. At the same time, and perhaps
even more worrisome for PT, there would also be a considerable impact on the
amount of debt outstanding. It is not clear whether or not the company would be
able to convert most of its debt to escudos or if it would be forced to repay it in
Euros. In our scenario, we assume that the debt associated with the Brazilian
segment remains unchanged but that PT would have to pay about 80% of its
83
debt in Euros . This would have a tremendous impact on the company’s equity
value, which coming from an already lower enterprise value, would yield a price
Diversification to somehow
mitigate the negative impact
that this would have to the
company
per share equal to 2.82€, thus implying a downside of about 37% relative to the
price PT has today and of about 70% relative to our valuation. The downside,
which we think would be unavoidable for most Portuguese companies should
Portugal actually leave the Euro is not however excessively bad, reflecting the
diversification of PT’s portfolio, particularly the OI business, which should, for the
most part, remain unaffected by these changes.
82
We are ignoring in our analysis further contagious effects after Portugal and Greece leaving the Euro in 2014, as we
believe this would be enough to allow the Euro Area to come back to a positive path. If contagion were to occur,
Portugal’s exports would be negatively affected, which could halt GDP’s growth even further.
83
The 80% is a rough estimation of the % of debt that PT has contracted with foreign institutions, which should require
it to still pay back in Euros.
PAGE 29/38
COMPANY REPORT
PORTUGAL TELECOM
M&A Activity in Portugal
The Situation
Ever since Zon has spined-off from PT, the Portuguese communications market
Graph 55 - Impact on
Mobile's Market Share
has remained reasonably stable. However, in the light of the rise of bundled-
17%
17%
16%
16%
15%
15%
14%
14%
13%
offers, there is some likelihood that M&A activity occurs, as to create a more
sophisticated multiple-play offer and leverage two different customers base. Zon
and Sonaecom would be the most likely companies to pursue this
84
and, in fact,
the main shareholders from both companies (Sonae and Mrs Isabel dos Santos)
have already moved forward with public agreements supporting the merger, with
the impeding result now depending on the result of the general assembly vote.
The biggest obstacle to the deal has long been believed to be the resulting
2013 E
Basis Scenario
2015 E
2017 E
Merger Scenario
shareholder structure. However, we think there is a high likelihood that an
agreement is reached, especially seeing as how several shareholders have
already manifested their interest in a possible negotiation and exit, due to liquidity
Source: Analyst Estimates
needs (such as CGD), which might facilitate the deal. There is an obvious
rationale behind the deal, as the two companies operate for the most part in
different, yet complementary sectors, thus not sharing the same customer base.
However, we believe the deal’s biggest strength, at least in a short-run basis
would be cost savings (even accounting for eventual integration costs). We would
expect the biggest percentual increase to occur in mobile, as shown in the graph
on the left, as we perceive a higher relative strength from Zon than from
Sonaecom, meaning that there will be higher increase in the sectors in which Zon
is not already very strong and in which it can leverage Sonaecom’s position.
The Impact to PT
The biggest impact the merger would have for PT would be a decrease in its
market share. However, we would not expect this effect to be huge, as we do not
foresee a significant increase in the market share of the merged entity way
beyond the mere sum of parts. We anticipate PT to suffer most of the wireline
damages (90% of the increase of the merged entity), as the increases on this
Moderate-to-Low Impact on
PT’s Market Share and ARPU
area should come from bundled offers, which is something in which only PT and
Zon are realistically competing. In addition, we expect some impact on ARPU, as
Zon/Sonaecom would have higher market power, although we would not expect
this to take place before the macro conditions brighten up, due to the already
existent downwards pressure on the ARPUs until then. Overall, PT’s price would
fall to a 4.83€, a value which although 6% below our basis scenario, still yields a
respectable 20% upside potential, again emphasising PT’s resilience.
84
Recent declarations from Vodafone’s new CEO indicate that Vodafone would be willing take part in the merger
instead of Sonaecom, but this is far less likely. In any case, the impact for PT would not change significantly.
PAGE 30/38
COMPANY REPORT
PORTUGAL TELECOM
Final Valuation Considerations
Having explained our valuation, we will now assess the reasonability behind our
projections. To do so, we have performed several analyses.
Graph 56 - Portugal ROIC/WACC
The first thing we believe is worth looking at is the implicit returns on invested
15%
capital (ROICs) as well as its relative relationship with the cost of capital (WACC)
10%
to understand if value is being created or not. As we can see in the graphs on the
5%
left, we find radically different situations in both Portugal and Brazil. In Portugal,
we see that PT, while still creating value, will soon slide into three straight years
0%
2012 2013 2014 2015 2016 2017
E
E
E
E
E
E
ROIC
of value destruction, before hitting a positive stride again back in 2017, from
which we forecast no further declines. As inelegant as it may appear, we do
WACC
believe this is a realistic scenario when compared with the macroeconomic
Source: Analyst Estimates
conditions that the country will be facing during the next three to four years. On
the other hand, the Brazilian case is quite different. We anticipate two years of
Graph 58 - Brazil
ROIC/WACC
value destruction, 2012 and 2013, with value starting to be created in 2014.
20%
Again, we believe the two years of value destruction make sense bearing in mind
15%
the long term growth strategy of the company, which will require it to have higher
10%
than average investment and commercial costs during the next two years to
5%
boost its competitive position in the market. As such, we believe that this analysis
0%
2012 2013 2014 2015 2016 2017
E
E
E
E
E
E
ROIC
shows a model that is consistent with our main assumptions for the future of the
market and the company.
WACC
85
Another item we considered was the growth rate used for the terminal value. We
Source: Analyst Estimates
86
have used in our basis scenario the real GDP growth rates from both countries ,
thus assuming that the weight of the communications sector on each country’s
Graph 57 - Communications/Information
87
GDP (about 3.30% for Portugal and about 3.70% for Brazil l) will not change
Weight on Portuguese GDP
4,0%
significantly in the future – the graph on the left shows the stable evolution of the
3,0%
weight of the communications and information sector on the Portuguese GDP
2,0%
3,3%
3,3%
3,3%
3,4%
3,3%
during the last 6 years, thus supporting our assumption. In any case, we have
3,3%
performed a sensitivity analysis, as presented below, to guarantee that our
1,0%
assumption would not have a major implication in our model. As we can see,
0,0%
2006 2007 2008 2009 2010 2011
Sector Weight
Average Sector Weight
even if we were to have growth rates that were significantly inferior to the one
assumed (and even negative in the case of Portugal), our valuation would still
yield an upside relative to the current price per share, albeit one that is much
Source: OECD Statistics
lower than the one we present (price would be 16% lower). Again, this analysis
gives us an idea that the valuation is within a reasonable range.
85
This analysis was performed with our base case scenario only – scenario analysis is not incorporated here.
These were calculated by computing the difference between the long-term GDP growth and the long-term inflation
rate, as presented in the Appendix.
87
OECD Statistics and IBGE Statistics, respectively
86
PAGE 31/38
COMPANY REPORT
PORTUGAL TELECOM
Brazilian Growth
Rate
Table 6 - Terminal Growth Rates Sensitivity Analysis
4,822308701
0%
0,50%
0,75%
1,00%
1,25%
1,50%
1,75%
-0,50%
4,19 €
4,30 €
4,42 €
4,55 €
4,68 €
4,82 €
4,97 €
Source: Analyst Estimates
-0,25%
4,28 €
4,40 €
4,52 €
4,64 €
4,78 €
4,92 €
5,07 €
Portuguese Growth Rate
0%
0,28%
0,50%
4,39 €
4,51 €
4,61 €
4,50 €
4,62 €
4,73 €
4,62 €
4,74 €
4,85 €
4,75 €
4,87 €
4,98 €
4,88 €
5,01 €
5,11 €
5,02 €
5,15 €
5,25 €
5,17 €
5,30 €
5,40 €
0,75%
4,74 €
4,85 €
4,97 €
5,10 €
5,24 €
5,38 €
5,53 €
1%
4,88 €
4,99 €
5,11 €
5,24 €
5,37 €
5,51 €
5,66 €
We have also performed a sensitivity analysis concerning the multiple used to
value PT’s stakes in its international assets in Africa and Asia. The multiple we
have used in our valuation was an EV/EBITDA of 5.45, computed as an average
Table 7 - International Assets
EV/EBITDA Multiple
Sensitivity Analysis
of a number of comparable communication companies from these geographies
(Appendix III). As seen on the table on the left, a change in this multiple would
not yield significantly different results, with our more extreme scenarios
representing a variation of only about 7%, which point towards a reasonable
assumption in our main valuation. We highlight, however, the uncertainty related
with Unitel, not only because PT’s stake in it is considerable, but also because
due to the potential the company might have in the future. As any company in
Angola though, we believe this potential is hard to quantify, as it is very
dependent on a number of factors not directly related with communications,
particularly the oil prices (which determine the overall strength of this economy)
and the country’s political situation, dependent on Mr José Eduardo dos Santos.
In any case, we believe our analysis shows that, unless some completely
Source: Analyst Estimates
unforeseen variations were to occur, the overall value of PT will not change
dramatically.
Finally, we have also triangulated our valuation with a multiples valuation
performed based on a peer group. We have computed the average EV/EBITDA
Table 8 - Multiples Valuation Comparison
multiple, 5.19, and the average P/E multiple, 11.78. These compare with the 5.74
and 10.66 respectively implicit in our valuation. As we can see, the values are
EV/EBITDA
5,74
5,19
12.108 €
-10%
P/E
Transactions
10,66
5,74
11,78
7,06
13.648 €
16.487 €
2%
23%
within the same range. Additionally, we have also looked at the average
Source: Bloomberg, Zephyr Database,
Analyst Estimates
value of companies on M&A deals. Considering the existence of this premium,
Own
Average
Implicit EV
Difference
88
transaction multiple in terms of EBITDA from sector , which we found out to be
7.06. Unsurprisingly, this value is higher than the comparables multiple and
higher than our own implicit multiple, reflecting the premium paid over the actual
we believe this value still makes our valuations seem reasonable. The table on
the left summarizes this triangulation through multiples, which we conclude to
point out towards a sensible valuation from our part.
88
Zephyr Database. We have limited the analysis to complete transactions that took place within the last 2 years in
European Union countries (about 1,300 transactions).
PAGE 32/38
COMPANY REPORT
PORTUGAL TELECOM
Appendix I – Financial Statements
Table 9 - Consolidated Balance Sheet
2011
2012 E
2013 E
2014 E
2015 E
2016 E
2017 E
Current Assets
Cash and Short-Term Investments
Receivables, Deferred Costs and Others
Inventories
Taxes Receivable
Judicial Deposits
8.339
5.668
1.959
134
349
229
4.281
1.829
1.769
131
284
267
4.128
1.768
1.697
125
279
259
3.923
1.670
1.619
119
269
245
4.271
1.796
1.778
128
302
267
4.332
1.763
1.860
135
310
264
4.302
1.674
1.922
141
313
253
Non Current Assets
Receivables and Others
Taxes Receivable
Financial Investments
Intangible Assets
Fixed Assets
Pension Plans
Deferred Taxes
Judicial Deposits
14.605
225
82
556
5.424
6.229
14
1.221
855
14.348
203
67
561
5.462
6.052
8
999
996
14.000
195
66
572
5.493
5.756
8
946
965
13.473
186
64
598
5.483
5.357
8
864
914
13.888
204
71
661
5.728
5.396
9
824
996
13.877
213
73
808
5.792
5.165
9
834
984
13.790
220
74
1.149
5.789
4.766
9
840
942
Total Assets
22.944
18.629
18.128
17.396
18.158
18.210
18.092
LIABILITIES
Current Liabilities
Short Term Debt
Payables, Accruals, Deferrals and Others
Current Taxes Payable
Provisions
6.812
3.292
2.826
412
282
4.747
1.161
2.631
440
516
4.597
1.212
2.526
350
509
4.299
1.146
2.411
248
493
4.580
1.111
2.638
277
555
4.625
1.017
2.759
284
566
4.582
875
2.851
287
568
Non Current Liabilities
Medium and Long Term Debt
Payables and Others
Taxes Payable
Provisions
Pension Plans
Defered Taxes
12.389
8.989
449
314
579
1.004
1.052
9.832
6.244
406
125
558
1.678
822
9.143
6.520
390
99
551
1.085
498
8.414
6.166
372
70
534
1.043
229
8.417
5.975
407
78
601
1.138
218
7.846
5.469
426
80
613
1.063
196
7.020
4.707
440
81
615
994
182
Total Liabilities
19.201
14.580
13.740
12.713
12.997
12.472
11.602
Capital
Own Shares
Legal Reserves
Own Shares Reserves
Revaluation Reserves
Other Reserves and Retained Earnings
Non-Controlling Interests
Total Equity
27
-326
7
7
557
2.557
915
3.743
27
-326
7
7
557
2.864
915
4.049
27
-326
7
7
557
3.203
915
4.389
27
-326
7
7
557
3.497
915
4.683
27
-326
7
7
557
3.976
915
5.162
27
-326
7
7
557
4.552
915
5.738
27
-326
7
7
557
5.304
915
6.490
Total Equity+Liabilities
22.944
18.629
18.128
17.396
18.158
18.210
18.092
ASSETS
EQUITY
Source: Company Reports, Analyst Estimates | Unit: Millions of Euros
PAGE 33/38
COMPANY REPORT
PORTUGAL TELECOM
Table 10 - Consolidated Income Statement
Revenues
Portugal
Brazil - Oi
Brazil - Contax
Other International Assets
Non-Core Assets & Eliminations
2011
6.147
2.892
2.414
469
114
258
2012 E
6.754
2.739
3.066
589
115
245
2013 E
6.492
2.529
3.033
589
115
226
2014 E
6.183
2.345
2.939
573
117
209
2015 E
6.878
2.550
3.333
649
118
228
2016 E
7.195
2.773
3.395
661
119
248
2017 E
7.410
2.980
3.397
646
120
266
Operational Costs
Portugal
Brazil - Oi
Brazil - Contax
Other International Assets
Non-Core Assets & Eliminations
3.959
1.587
1.694
430
58
190
4.414
1.549
2.108
515
57
185
4.269
1.492
2.026
515
58
178
4.088
1.451
1.904
501
58
174
4.356
1.463
2.092
567
59
175
4.499
1.605
2.066
577
59
192
4.566
1.740
1.993
565
60
208
EBITDA
Portugal
Brazil - Oi
Brazil - Contax
Other International Assets
Non-Core Assets & Eliminations
2.188
1.305
719
39
55
69
2.340
1.191
958
75
57
59
2.223
1.036
1.007
74
58
47
2.095
894
1.035
72
58
36
2.522
1.087
1.241
82
59
53
2.696
1.168
1.329
84
59
56
2.844
1.240
1.404
82
60
58
Costs with Retirement Benefits
59
59
59
59
59
59
59
1.326
1.413
1.398
1.348
1.453
1.491
1.430
Operational Result
804
868
766
688
1.010
1.146
1.355
Non Operational Costs
60
53
49
45
49
53
57
EBIT
Portugal
Brazil - Oi
Brazil - Contax
Other International Assets
Non-Core Assets & Eliminations
744
484
261
16
8
-25
816
394
340
44
8
30
718
227
421
44
8
17
643
75
512
42
8
5
961
251
632
48
8
22
1.093
308
704
49
9
24
1.298
356
860
48
9
25
Financial Results
-213
-288
-87
-90
-50
13
165
EBT
Portugal
Brazil - Oi
Brazil - Contax
Other International Assets
Non-Core Assets & Eliminations
531
560
-30
18
9
-25
527
496
-54
46
9
30
631
249
310
45
9
17
553
142
352
44
9
5
911
315
515
50
9
22
1.106
358
665
51
9
24
1.464
416
963
50
9
25
Income Taxes
108
119
178
161
272
338
461
Net Result
Minority Interests
Controlling Interests
423
84
339
408
48
361
453
51
401
392
56
336
639
80
559
768
98
671
1.003
132
871
Depreciations and Amortizations
Source: Company Reports, Analyst Estimates | Unit: Millions of Euros
PAGE 34/38
COMPANY REPORT
PORTUGAL TELECOM
Table 11 - Consolidated CF Statement
2011
2012 E
2013 E
2014 E
2015 E
2016 E
2017 E
EBIT
Adjusted Taxes
Tax Adjustments
Depreciations
Operational Gross CF - Portugal
CAPEX
Change in NWC
Changes in Other Assets and Liabilities
Operational Investing CF - Portugal
FCF Portugal
459
-108
6
703
1.060
640
-51
427
-1.016
45
424
-107
4
686
1.007
418
68
-113
-372
634
245
-74
2
702
875
444
27
44
-516
359
81
-26
3
715
774
438
31
36
-506
268
273
-84
-3
729
915
440
-35
19
-424
490
331
-102
-7
749
971
514
-38
22
-498
473
381
-119
-13
769
1.018
506
-35
20
-490
528
OI
EBIT
Adjusted Taxes
Tax Adjustments
Depreciations
Operationa Gross CF - Oi
CAPEX
Change in NWC
Changes in Other Assets and Liabilities
Operational Investing CF - Oi
FCF Oi
261
-61
11
458
669
6.942
42
615
-7.598
-6.930
340
-86
11
618
882
809
-72
-633
-104
778
421
-128
11
585
890
578
71
192
-842
48
512
-162
11
523
883
394
64
133
-591
291
632
-194
11
609
1.057
1.163
-47
47
-1.163
-106
704
-218
11
624
1.121
689
-56
35
-669
453
860
-269
11
543
1.145
409
-85
20
-344
801
OTHERS
EBIT
Adjusted Taxes
Depreciations
Operational Gross CF - Others
CAPEX
Change in NWC
Changes in Other Assets and Liabilities
Operationa Investing CF - Others
FCF Others
24
-6
164
183
410
-296
-161
47
230
52
-13
109
148
48
-98
929
-879
-731
52
-16
110
146
110
-1
13
-123
24
51
-16
110
145
107
-3
-7
-96
49
56
-17
116
155
134
7
52
-193
-39
57
-18
118
157
120
-2
-29
-89
68
56
-18
118
157
115
-6
-60
-49
108
NON-OPERATIONAL ACTIVTIES
Change in Non-Operational Assets and Liabilities
Net Financial Result Minus Interest Paid
Taxes
FCF Non-Operational Activities
1.790
425
-100
2.116
-5
502
-127
370
-11
390
-118
261
-26
408
-129
252
-63
420
-129
228
-147
469
-145
177
-341
583
-182
59
NET UNFUNDED PENSION PLANS
Changes in Pension Plans Contributions
Changes in Pension Plans Deferred Taxes
Net Unfunded Pension Plans FCF
-24
-130
153
-679
5
674
592
-19
-574
43
-39
-3
-94
-44
138
75
-11
-64
69
-13
-56
Total FCF to the Firm
-4.386
1.725
119
857
712
1.107
1.440
Change in Excess of Cash
Interests
Tax Shield
Change in Debt
Change in Equity
Financing CF
1.089
-638
150
5.075
-1.289
4.386
3.843
-790
200
-4.876
-102
-1.725
0
-477
144
327
-113
-119
0
-498
158
-419
-98
-857
0
-471
145
-227
-160
-712
0
-456
141
-600
-192
-1.107
0
-417
131
-903
-251
-1.440
PORTUGAL
Source: Company Reports, Analyst Estimates | Unit: Millions of Euros
PAGE 35/38
COMPANY REPORT
PORTUGAL TELECOM
Appendix II – Macroeconomic Forecasts
Table 12 - Portugal Macroeconomic Forecasts
GDP, Current Price (Billion Euros)
GDP Growth
Gross National Savings (% GDP)
Inflation (End of Year, Consumer Prices)
Unemployment Rate (% Total Labor Force)
2010
172.670
1,40%
9,95%
1,10%
10,80%
2011
170.928
-1,67%
10,91%
1,14%
12,74%
2012 E
166.341
-3,01%
13,56%
1,17%
15,47%
2013 E
166.782
-1,02%
14,28%
1,17%
16,04%
2014 E
170.394
1,20%
14,90%
1,19%
15,30%
2015 E
176.070
1,85%
15,74%
1,20%
14,67%
2016 E
182.019
1,89%
16,88%
1,23%
14,15%
2017 E
188.092
1,78%
17,66%
1,24%
13,64%
Source: International Monetary Fund, World Economic Outlook Database, October 2012 | Units: Billions of Euros, unless stated otherwise
Table 4 - Brazil Macroeconomic Forecasts
GDP, Current Price (Billion Brazilian Reals)
GDP Growth
Gross National Savings (% GDP)
Inflation (End of Year, Consumer Prices)
Unemployment Rate (% Total Labor Force)
2010
7.534
8,03%
18,03%
5,41%
6,74%
2011
2.733
3,23%
18,45%
6,00%
5,97%
2012 E
1.474
1,97%
17,62%
4,47%
6,00%
2013 E
3.952
4,45%
17,98%
4,60%
6,50%
2014 E
4.197
4,70%
17,85%
4,00%
7,00%
2015 E
4.203
4,70%
18,20%
4,00%
7,00%
2016 E
4.109
4,61%
18,60%
4,00%
7,00%
2017 E
4.138
4,64%
19,11%
4,00%
7,00%
Source: International Monetary Fund, World Economic Outlook Database, October 2012 | Units: Billions of Euros, unless stated otherwise
Appendix III – International Comparables
Table 13 - African/Asian Comparables
Name
Bezeq The Israeli Telecom Co
Cellcom Israel Ltd
Emirates Integrated Telecomm
Emirates Telecom Corporation
Etihad Etisalat Co
Jordan Telecom
Maroc Telecom
Mobile Telecommunications Co
Mtn Group Ltd
National Mobile Telecommuni
Omani Qatari Telecommunicati
Oman Telecommunications Co
Partner Communications Co
Qatar Telecom (qtel) Q.s.c
Safaricom Ltd
Saudi Telecom Co
Telecom Egypt
Vodacom Group Ltd
Currency Adjusted Enterprise Value
3.930
1.700
3.682
16.147
12.255
1.224
10.123
10.302
29.282
3.231
679
2.157
1.569
14.686
1.819
22.678
2.573
16.597
Curr EV/T12M EBITDA
4,60
4,44
4,76
7,49
7,00
6,91
6,64
6,38
5,69
4,17
3,71
5,04
4,48
4,50
4,34
5,18
4,29
7,57
Source: Bloomberg
PAGE 36/38
COMPANY REPORT
PORTUGAL TELECOM
Appendix III – Impact of Leverage on Credit Rating89
Graph 58 - Effect of Leverage on Rating
BBB+
391%
306%
BBB
BB+
140%
Telefónica
Telecom Italia
D/E - Market Values
PT
Rating
Source: Bloomberg
Graph 59 - Impact of Country Rating on Company Rating
BBB+
BBB+
BBB-
BBB
BB+
BB
Telefónica
Telecom Italia
Country Rating
PT
Company Rating
Source: Bloomberg
89
All ratings are S&P ratings. The analysis is obviously simplified, since it only looks at the effects of one variable over
the credit rating, when this is determined by a number of other factors simultaneously, particularly the country rating,
which is why we have included the second analysis as well. Regardless, we believe the analysis still serves for the
illustration purpose that, in general and in ceteris paribus terms, the higher the amount of leverage, the worse the rating
of a company.
PAGE 37/38
COMPANY REPORT
PORTUGAL TELECOM
Disclosures and Disclaimer
Research Recommendations
Buy
Expected total return (including dividends) of more than 15% over a 12-month
period.
Hold
Expected total return (including dividends) between 0% and 15% over a 12-month
period.
Sell
Expected negative total return (including dividends) over a 12-month period.
This report was prepared by Francisco Martins, a student of the NOVA School of Business and
Economics, following the Masters in Finance Equity Research – Field Lab Work Project, exclusively
for academic purposes. Thus, the author, which is a Masters in Finance student, is the sole
responsible for the information and estimates contained herein and for the opinions expressed, which
reflect exclusively his/her own personal judgement. This report was supervised by professor Rosário
André (registered with Comissão do Mercado de Valores Mobiliários as financial analyst) who revised
the valuation methodology and the financial model. All opinions and estimates are subject to change
without notice. NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report nor
for any consequences of its use.
The information contained herein has been compiled by students from public sources believed to be reliable,
but NOVA SBE or the students make no representation that it is accurate or complete, and accept no liability
whatsoever for any direct or indirect loss resulting from the use of this report or its content.
The author hereby certifies that the views expressed in this report accurately reflect his/her personal opinion
about the subject company and its securities. He/she has not received or been promised any direct or indirect
compensation for expressing the opinions or recommendation included in this report.
The author of this report may have a position, or otherwise be interested, in transactions in securities which
are directly or indirectly the subject of this report.
NOVA SBE may have received compensation from the subject company during the last 12 months related to
its fund raising program. Nevertheless, no compensation eventually received by NOVA SBE is in any way
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The Nova School of Business and Economics, though registered with Comissão do Mercado de Valores
Mobiliários, does not deal for or otherwise offers any investment or intermediation services to market
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PAGE 38/38