EMBRATEL Emerging Markets Finance Lorena Navarro Jaime Arriagada Luis De Zabala Fernando Diaz February 26, 1999
Dec 31, 2015
EMBRATEL
Emerging Markets Finance
Lorena Navarro Jaime ArriagadaLuis De ZabalaFernando Diaz
February 26, 1999
Agenda for Today
• Outline and Background of the Case
• Takeaways / Learning Points
• Suggested Solutions
• What happened after?
Case Outline
• Introduction
• Brazil and its Privatization Process
• Telebras and Embratel
• Investment Opportunities and Risks
• Valuation
Brazil
• History of Instability
• 20 years of military rule
• Unstable political environment
• Capital controls, high tariffs, high interest rates
• Cardoso Era
• Plan Real as Minister of Finance
• President of Brazil in 1994
• Privatization Plan
• Where are we ?
Telebras and Embratel
The Telebras Transformation
TELEBRAS YESTERDAY TELEBRAS TODAY
• 1 Government controlled holding company:
> 27 local fixed-line subs> 26 local wireless subs> 1 long distance sub
•12 Privately controlled holding companies:
> 3 Regional fixed-line Cos> 8 Regional Wireless Cos.> 1 long distance operator
Telebras and Embratel
• EMBRATEL OVERVIEW
•Embratel Provides:> Domestic Long-Distance (DLD) Inter-region + Intra-region> International Long-Distance (ILD)> Data transmission> Others (Internet, etc)
•Total Assets of R$ 7.9 billions
•Total Revenues of R$ 2.2 billions
Investment (I)
Opportunities • New access charges to the fixed line network
• Based on a flat rate that will have positive effects on earnings
• High growth in Long Distance Market• Domestic long distance represents bulk of the revenues.• Small international LD market if compared Brazil with other countries.
• Good opportunities for cost cutting and cost control• Synergies brought by the buyer
Investment (II)
Risks• Competitive environment coming ahead
• Concession of a “mirror company” in 1999• Industry completely open in 2002• Fixed line companies as competitors in intraregional market•Cellular companies are potential competitors
• Big one-time charges against earnings: • Write-off of assets to adjust to the new competition.• Accounting policy changes: depreciation, pension obligations and tax management .
Takeaways (I)
High Priority Medium Priority Low Priority
Discounted Cash Flows
Nominal vs. Real vs. Dollars
Time horizon
Terminal Value (constant growth, comparables)
Drivers benchmarks (projections)
Investment schedule
Taxes (Investment credits)
Legal constraints
Takeaways (II)
High Priority Medium Priority Low Priority
Discount Rate
Alternative Methods to incorporate country risk
Beta (CAPM) - Comparables (leverage-unleverage)
Market Risk Premium
Time horizon of key drivers (eg. Sovereign Debt)
Optimal Capital Structure (historical, industry average)
Comparables
Country Risk
Current or Trailing
Price horizon
Value Ratio (P/E, Value/Ebidta, Rev/Subs.,other)
Suggested Solution - DCF Model
• Build a full valuation model “The Puzzle”
• Macroeconomics Assumptions
• Market Growth Rates
• CAPEX and Depreciation
DCF Model (III)
• The WACC under IICCRC is substantially higher
than under Sovereign Debt Spread model.
IICCRC SDS - Model
DCF Sensitivities
• Company risk should be incorporated through the FCF
• Country risk should be included in the Cost of Equity (Ke)
* Value of 52% in Embratel’s equity
Comparable Company Analysis
• Key issues:
– What multiple?
– Which Companies?
– How to incorporate country risk?
Latin American Telecoms importanceYTD 1998
21%
37%
23%
23%
14%
18%
32%Argentina*
Brazil
Chile
Mexico
Peru
Average
Venezuela
Market Cap. as % of local index
* Argentina’s correlation is the average of Telecom Argentina and Telefonica de ArgentinaSource: Salomon Smith Barney
72%
67%
68%
57%
52%
71%
86%
ADR Vol. as % of local index
Argentina*
Brazil
Chile
Mexico
Peru
Average
Venezuela
Correlation Local Market vs. ADRs YTD 1998
0.84
0.96
0.92
0.65
0.82
0.98
0.77Argentina*
Brazil
Chile
Mexico
Peru
Average
Venezuela
Each Telecom company has become increasingly a proxy for their home market
* Argentina’s correlation is the average of Telecom Argentina and Telefonica de ArgentinaSource: Salomon Smith Barney
Estimated Telebras’ Multiple using IICCR1998
38.7
36.1
92.6
45.2
63.2
41.6Argentina*
Brazil
Chile
Mexico
USA
Venezuela
Institutional Investor Country Credit Rating
Source: Salomon Smith Barney
4.1
3.3
8.9
5.2
6.9
5.3
EV/EBITDA 98E
Average
3.5
3.7
4.5
4.2
4.9
4.2
BRAZIL Estimated EV/EBITDA 98E
Estimated EMBRATEL Multiple using IICCR1998
4.1
8.7
15.2
8.0
0.0 5.0 10.0 15.0 20.0
Sprint
MCI WorldCom
AT&T
Telebras
Company
Source: Salomon Smith Barney
4.1
8.7
15.2
8.0
0.0 5.0 10.0 15.0 20.0
adjusted by country risk = 3.3x
EV/EBITDA 98E
Valuation Summary
0.7 1.2 1.7 2.2 2.7
IICCRDiscount rate
SovereignDebt spreaddiscount rate
Comps
Billion US$ (52% stake)
Value paid $2.26
What happened ?
• July 1998: MCI Worldcom won auction with a bid of $ 2.3 bn.
• This amount represented a premium of 47% of minimum price set by the government.
• Sprint offered the best price in sealed envelope, R$2.499 bn. vs. R$2.477 bn offered by MCI.
• The auction went to open outcry; MCI acquire Embratel in less than a minute for R$2.650.