Tag Archives: capital increase

Update: Portugal Telecom & Oi Merger & Oi capital increase

DISCLAIMER: The stock discussed is again very risky and not a typical “value stock”. Please do your own homework and never commit large amounts of your capital to such investments. The author might buy or sell the shares without giving advance notice. Do your wn homework !!

Last year I had a mini series (part 1, part 2, part 3) about the merger between Portugal Telecom and the Brazilian Oi. My initial idea was a long PTC / short OI deal as the mechanics of the merger seemed to imply a signifcant dilution for OI shareholders.

Interestingly, since I wrote the first post in October 2013, both shares lost siginficantly, however Oi with around -37% more than double than PTC with -15%.

Oi is now in the process of preparing the planned capital increase and it looks that they did push through the share offering though there have been some hickups along the way.

Just as a quick reminder:

Oi was supposed to do a big capital increase first before then the company gets merged with PTC.

Oi seems to have priced the new shares aggresively at the bottom of the expected range:

Grupo Oi SA, Brazil’s largest fixed-line telephone carrier, priced an offering of preferred shares at 2 reais each, at the bottom of the indicative range set by bankers, sources said on Monday.

So at current prices with PTC at ~3 EUR and OI common shares at 2,50 Reais (or ~0,81 EUR) PTC sharesholders will receive “new shares” of OI at the value of 2,2911 Euros plus 0,6330 “CorpCo” shares which should equal common shares. So at 3 EUR there seems to be a small discount but I think this is hardly exploitable as an arbitrage situation.

For me, the current situation is an interesting combination of a special situation (capital increase regardless of price) and Emerging Markets exposure.

However, much more interesting for me is that aspect:

It is pretty clear that Oi wanted to raise a defined amount without really caring about the share price. This looks similar to EMAK and Unicredit in Italy 2 years ago. This is one of the rare cases where we clearly have a seller who does not care about the price but just wants to raise a fixed amount of money.

The “special-special” aspect of this one are the following feature:

1. We do not have subscription rights despite the massive amount of new shares
2. We have the additional complexity of the subsequent PTC merger

In such a situation, it is extremely hard to come up with a solid valuation of the business. Both, OI and PTC look very cheap on a trailing EV/EBITDA basis but honestly, i did not try to figure out how the combined entity will look like. Oi minorities clealry got screwed by this transaction whereas PTC shareholders had been protected to a certain extent.

The good part of the this capital raising is that the entity will have some fresh cash which will allow them to operate for some time. Although there is clearly the risk of further dilutions if they want to bid for instance for additional businesses in Brazil.

Summary:

For me, the Oi capital increase looks very similar to situations like EMAK and Unicredit, where the companies issued new shares regardless of price. This increases the possibility that the price has been pushed significantly below fair value. Buying PTC now looks like an interesting way to get exposure to the merged entity at a depressed price. I will therefore invest a 1% position into PTC at current prices (3 EUR) for my “special situation” bucket.

Portugal Telecom & OI merger – another PIIGS stock transformation ?

It seems like that many PIIGS companies with significant international business operations try to transform their companies in some way or another in order to get rid of the “PIIGS” discount. Basically a first mover was Hellenic Botteling, which delisted in Greece and relisted as Swiss based company in the UK market in 2012. A second, very succesful attempt was made by Autogrill, spinning off the international business.

Now, a few days ago, Portugal Telecom (PTC), the Portuguese TelCo with a large Brazilian subsidiary, came up with a potential new way:

They want to merge with the Brazilian TelCo OI and effectively become a Brazilian Telecom company with a Portuguese subsidiary.

This alone is in my opinion already an interesting special situation. But it gets even more interesting. The structure of the merger is quite complicated, but in general, there will be a merger plus capital increase.

For Portugal Telecom shareholders, it looks like the following:

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.

So on a first look, this looks interesting for Portugal Telecom shareholders. The lower the price of the capital increase, the higher the share in the combined company. Clever Hedge funds might even be able to construct a short OI long PTC trade. Although there is a corridor where either PTC or OI can step back from the transaction if prices would move too strongly in one or the other direction.

Some figures / ratios:

PTC:
Market cap 3.1 bn EUR
P/E 7.4
P/B 1.5
EV/EBITDA 5.5

OI:
Market Cap 6.5 bn BRL (~2.1 bn EUR)
P/E 11
P/B 0.6
EV/EBITDA 4.5

Both companies carry significant debt.

The share prices of both companies reacted at first positively, but in the recent days, OI shares dropped quite significantly and PTC is back to where it was before (after hitting +30% in the first day):

This might be the reaction to the large cash capital increase undertaken by OI in the course of the deal:

As part of the merger, Oi proposes to undertake a cash capital increase of a minimum of R$ 7.0 billion (Euro 2.3 billion), and with a target of R$ 8.0 billion (Euro 2.7 billion) to improve the balance sheet flexibility of CorpCo. Shareholders of Telemar Participações S.A. (“Tpart”) and an investment vehicle managed by Banco BTG Pactual S.A. (“BTG Pactual”), will subscribe approximately R$ 2.0 billion (Euro 0.7 billion) of the cash capital increase

So from an OI shareholder point of view, one could argue that this exercise is somehow quite dilutive.

For some PTC shareholders, the problem might be that the suddenly do not hold a Portuguese/European stock but a Brazilian one. According to the official announcement, the new stock will be listed in Brazil, US and on NYSE Euronext, so technically it should be not a problem for shareholders.

On the “plus side” for this transaction one could argue with the following points

+ A Portuguese company with a potential “PIIGS” discount will be “transformed” into a potential BRIC growth story.
+ The valuation of the overall group might improve as well, as the OI pref shares will cease to exist
+ As PTC shareholder, there is an additional opportunity with regard to the OI share capital increase. The lower the price for the new shares, the higher will be the percentage in the new company
+ it is very likely that the deal will go through. The CEO of both companies is the same guy and regulators will have no reason to object
+ part of the synergies (i.e. lower refinancing costs) might be relatively easy to achieve.

On the other hand, there are also some clear issues:

– Brazil itself is not in the “sweet spot” anymore
– OI itself is struggling. Being only the number 4 mobile operator, especially ROA and ROE is far below the competition
– in the presentation, the CEO committed to pay 500 mn BRL p.a. in dividends. Including the new shares, this will result in a much lower dividend yield going forward from the current 7-8%. As they want to grow, this makes sense, but for some investors this could be an issue
– debt will be relatively high, further capital increase in combination with acquisitions are not unlikely

At the moment, I need to dig a little bit more deeply into this, but in order to keep me motivated and interested, I take a 0.5 % position at current prices (3.40 EUR per share) in Portugal Telecom for my “special situation” bucket.

DISCLAIMER: As always, do your own research. This is not meant to be any kind of investment advise. When publishing this, the author will most likely own the stock already. Do not blindly follow any tips etc. Use your own brain. The author will also most likely sell the stock before posting this on his website.