* Newcomer faces tough competition, debt reduction issues
* Oi CEO Bava, a Portugal Telecom veteran, to lead carrier
* Oi, Portugal Telecom shares soar on news of combination
* Analysts sceptical Bava can attain cost savings targets
(Updates with detail on new company; share performance)
By Andrei Khalip and Luciana Bruno
LISBON/RIO DE JANEIRO, Oct 2 Brazil's Grupo Oi
SA, facing growing competition from foreign telecom
carriers, will combine with Portugal Telecom SGPS SA to
form a new company with more than 100 million subscribers and
almost $19 billion in annual revenue.
The new company, known as CorpCo, will be based in Rio de
Janeiro, where Oi is headquartered. Zeinal Bava, the 47-year-old
engineer who in June became chief executive at Oi after a
five-year stint as head of Portugal Telecom, will lead it. He
expects CorpCo to yield cost savings of 5.5 billion reais ($2.5
billion) though analysts were sceptical the target is doable.
Oi's largest shareholders, most of them local groups and
pension funds as well as Portugal Telecom, are confident the
move will give the struggling group more clout to compete inside
Brazil with bigger rivals such as Spain's Telefonica SA
, Telecom Italia SpA's TIM Participações SA
and Mexico's America Movil SAB.
The merger is in some ways akin to throwing a lifeline to
Portugal Telecom, which has suffered in recent years along with
a flagging Portuguese economy. Bava must also fix Oi's complex
shareholder structure, cut debt at both companies and figure out
how Oi can cope with the demands of a Brazilian market that may
be ripe for consolidation. Telefonica agreed to up its stake in
Telecom Italia recently.
"We are now creating a company with global ambitions. If we
fail to do that now, it will be rather hard to stay
competitive," Bava told reporters in Rio de Janeiro, adding he
expects the combination to be finalised by mid 2014.
He will also have to persuade investors, who have seen their
holdings in Oi lose 36 percent of their value in the past 12
months, that he can extract such ambitious savings.
"Markets are unlikely to pay upfront for synergies," said
Andree Baggio, a senior analyst at JPMorgan Securities. "It is
unclear to us if there are fiscal synergies in the operation and
if they are included in this net present value calculation."
Oi was born after Tele Norte Leste Participações SA's
purchase in 2008 of Brasil Telecom Participações SA - a move
sponsored by then-President Luiz Inacio Lula da Silva to face
growing competition from Telefonica and Mexican billionaire
Carlos Slim's America Movil. Portugal Telecom entered Oi's
controlling bloc after exiting Vivo, a mobile carrier now fully
owned by Telefonica, in 2010.
Oi and Portugal Telecom have discussed how to tie up since
the latter bought a 25 percent stake in the Brazilian company
three years ago, sources with knowledge of the situation told
Reuters on Wednesday. The market value of both companies has
fallen more than 50 percent over the past three years, a sign
that investors bet that a merger would take place sooner or
Preferred shares of Oi rose as much as 11.8
percent on the news, but closed up 5.2 percent at 4.44 reais.
Oi's common shares were up as much as 9.8 percent,
but ended 3.6 percent higher on Wednesday. The shares of
Portugal Telecom rose as much as 23 percent before paring gains
later in the session to close 6.5 percent higher.
The groups had combined revenue of about $19 billion last
year and core operating profit of $5.7 billion. Debt is likely
to remain high at 3.3 times combined 12-month earnings before
interest, tax, depreciation and amortization despite the capital
increase, JPMorgan's Baggio said.
"The new entity will have significantly greater ability to
raise further equity, enabling it to participate in any moves to
consolidate Brazil's wireless market," Goldman Sachs Group
analyst Tim Boddy wrote in a note. "Overall implications for
Portugal Telecom are mixed at first glance, as its investment
case will now center on the ability to turn Oi around."
Regulatory approval in Brazil should be smooth, government
officials told Reuters on Wednesday. A source at industry
watchdog Anatel said the structure of the deal envisions a
corporate restructuring rather than a change of control, which
will facilitate approval of the transaction.
Under terms of the deal, Oi will sell up to $3.1 billion in
new stock and use proceeds to cut debt. Portugal Telecom will in
turn contribute its assets, excluding its stake in Oi, and own
38 percent of CorpCo. Oi will have as much as 30 percent of the
new company and other investors such as investment bank Grupo
BTG Pactual SA and a number of Brazilian pension
funds will own the rest.
Each Oi common share will be exchanged for 1 share in
CorpCo, and each Oi preferred share will be swapped for 0.9211
CorpCo stock. Each Portugal Telecom share will be the equivalent
of 2.2911 euros in CorpCo shares to be issued at the price of
the capital hike, plus 0.6330 CorpCo shares.
The group will be listed on the São Paulo Stock Exchange, on
the NYSE Euronext bourse in Lisbon, and in New York.
BRAZIL AT THE CENTER
The proposed transaction coincides with a broader shake-up
of Brazil's local mobile market of 268 million customers that is
in the works.
Telecom operators in Brazil are betting they can grow as
more consumers adopt smartphones to surf the Web on the go, and
get broadband access at home. Smartphone adoption in Brazil
stands at 16 percent of the population, roughly half of that in
Portugal or the United States, while only 10 percent have
broadband at home.
Spain's Telefonica, now Telecom Italia's biggest
shareholder, is pushing for the indebted Italian group to sell
off TIM Participações. Bankers and analysts have speculated that
TIM Participações could be split up and sold to the other local
carriers since none would likely be allowed to buy the whole
group for antitrust reasons.
The combination "may be seen as an intermediate step for a
future potential break-up scenario of TIM among Oi, Telefonica
and America Movil," said Giovanni Montalti, an analyst at UBS
Securities in London.
Oi holds a leading 41 percent market share in Brazil's
fixed-line phone market and a 29 percent share in broadband. It
is Brazil's fourth-largest mobile carrier with an 18.6 percent
share behind Vivo's 28.7 percent, TIM Brasil's 27.2 percent and
America Movil's Claro with 25 percent, according to Anatel data.
Bank of America Merrill Lynch advised Portugal Telecom on
the deal, along with Morgan Stanley & Co and Banco Espirito
Santo SA. BTG Pactual advised Oi in the transaction.
($1=2.20 Brazilian reais)
(Reporting by Andrei Khalip in Lisbon, Luciana Bruno in Rio de
Janeiro, and Guillermo Parra-Bernal in Sao Paulo; Additional
reporting by Leila Abboud in Paris; Sergio Gonçalves and Filipa
Lima in Lisbon; Leonardo Goy in Brasilia; and Alberto Alerigi
Jr, Asher Levine and Silvio Cascione in São Paulo; Editing by
Louise Heavens, Jane Merriman, Leslie Gevirtz and Peter