May 12, 2010 / 6:11 PM / 9 years ago

SCENARIOS-Telefonica's options in Brazil

May 12 (Reuters) - Portugal Telecom PTC.LS this week rejected a 5.7 billion euros ($7.2 billion) bid from Telefonica (TEF.MC) to buy out its stake in Vivo VIVO4.SA, Brazil’s top wireless carrier, at a 140 percent premium. [ID:nLDE64A0W0]

Telefonica currently owns 32 percent of Vivo and is keen to gain control in order to integrate it with its struggling fixed-line Brazilian business, Telesp.

Brazil is the main driver of Telefonica’s mobile growth and the most profitable of its Latin American operations.

Following are some options Telefonica could pursue to strengthen its position in Brazil:

RAISE ITS BID FOR THE VIVO STAKE

Telefonica could afford to bid more, and analysts say considering the premium in isolation does not capture the strategic value of the asset to Telefonica, or take into account substantial synergies that could be achieved in a Telesp merger.

Moody’s says Telefonica could fund the deal entirely with debt without endangering its credit rating. However, a higher bid could jeopardise its dividend yield, currently an attractive 6.3 percent, or twice the European sector average.

In its failed attempt to buy GVT last year, Telefonica sweetened its offer once in an effort to preempt a counterbid, but was trumped by Vivendi in any case.

Portugal Telecom may not be tempted even by a higher price. Brazil is the carrier’s only growth market, and Portugal Telecom’s chief executive told Reuters this week: “Disinvesting in Brazil by selling Vivo would mean amputating PT’s future.”

OFFER ANOTHER ASSET IN EXCHANGE FOR VIVO STAKE

Brazil is the most attractive of Telefonica’s Latin American operations and has the most cultural affinities with Portugal, making it unlikely Portugal Telecom would want to swap its Vivo stake for an asset elsewhere.

With Telefonica bent on creating an integrated fixed-mobile operator in Brazil and Portugal Telecom apparently determined not to walk away, the two could combine their assets in a different way.

For example, Telefonica could offer Portugal Telecom shares in Telesp, giving it a share of growth in the combined company but putting Telefonica in charge.

Telefonica’s 88 percent share in Telesp is worth about 10 billion euros, more than what Telefonica is offering to buy Portugal Telecom out of Vivo.

BUY PORTUGAL TELECOM OUTRIGHT

Telefonica owns more than 9 percent of Portugal Telecom already, but the Portuguese government holds a so-called golden share that blocks any one shareholder from owning more than 10 percent of voting rights.

The European Commission has taken the Portuguese government to court over the golden share, saying it breached the principle of free movement of capital in the European Union, and the European Court of Justice now has to rule on the case.

Portugal Telecom rejected a previous takeover bid supported by Telefonica in 2007, but if Telefonica is ever to succeed with a takeover bid now may be the time.

As the Greek debt crisis spreads through the euro zone, and highly indebted countries like Portugal face European Commission scrutiny of their budgets, Portugal needs to do all it can to keep the Commission on its side.

PURSUE TIM BRASIL

Telefonica could make an offer for TIM Brasil — in which it has an indirect interest through a stake in Telecom Italia (TLIT.MI), which controls TIM — and merge it with its Telesp operations in Brasil.

JB Capital Markets argues Telefonica could derive a valuation for TIM Brasil, of which Telecom Italia owns 60 percent, from its bid for Vivo valuing TIM Brasil at close to 13 billion euros.

That would leave close to 8 billion euros for Telecom Italia, which would more than meet its objectives to deleverage by 5-6 billion euros over the coming year, the brokerage said. Telecom Italia has about 36 billion euros in debt.

It also said that merging Telefonica’s Telesp unit with TIM Brasil would deliver slightly less synergies in mobile because the fit was not entirely optimal but TIM Brasil’s fixed line asset would fit very well with Telesp’s.

BID FOR ALL OF TELECOM ITALIA

Telefonica is the biggest shareholder in the Telco investor pact that controls Telecom Italia and has long been considered a logical buyer for the company.

With a market capitalisation of 78 billion euros, Telefonica is nearly four times the size of Telecom Italia, Europe’s No. 5 telecom operator, whose market value is almost 20 billion euros.

The Italian operator is currently a cheap buy with shares languishing at around 1 euro for the past six months and a takeover would give Telefonica control over Telecom Italia’s TIM Brasil — the number three Brazilian mobile company.

However, any deal to take over Telecom Italia would require a green light from Rome as the government is wary of letting the country’s phone network fall into foreign hands.

BUYS OUT TELECOM ITALIA SHAREHOLDERS

The Spanish group could also opt to buy out the other shareholders in Telco holding company, which holds 22.45 percent of Telecom Italia and includes Italian banks Intesa Sanpaolo and Mediobanca and insurer Generali.

That would give it control of the board and allow it to merge TIM Brasil with Telesp. Again, this would most likely lead to a divestment of its Vivo stake. (Reporting by Georgina Prodhan in London, Nicola Leske in Frankfurt, Robert Hetz, Axel Bugge, Judy MacInnes and Elisabeth O’Leary in Madrid and Andrei Khalip in Lisbon) ($1=.7872 euros)

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