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LISBON/RIO DE JANEIRO (Reuters) - Brazil's Grupo Oi SA (OIBR3.SA), facing growing competition from foreign telecom carriers, will combine with Portugal Telecom SGPS SA PTC.LS 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 skeptical 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 (TEF.MC), Telecom Italia SpA's TIM Participações SA (TIMP3.SA) and Mexico's America Movil SAB (AMXL.MX).
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 finalized 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 later.
Preferred shares of Oi (OIBR4.SA) rose as much as 11.8 percent on the news, but closed up 5.2 percent at 4.44 reais. Oi's common shares (OIBR3.SA) 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 (BBTG11.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.
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 Galloway