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EMBRATEL

EMBRATEL. Emerging Markets Finance Lorena Navarro Jaime Arriagada Luis De Zabala Fernando Diaz. February 26, 1999. Agenda for Today. Outline and Background of the Case Takeaways / Learning Points Suggested Solutions What happened after?. Case Outline. Introduction

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EMBRATEL

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  1. EMBRATEL Emerging Markets Finance Lorena Navarro Jaime Arriagada Luis De Zabala Fernando Diaz February 26, 1999

  2. AgendaforToday • Outline and Background of the Case • Takeaways / Learning Points • Suggested Solutions • What happened after?

  3. CaseOutline • Introduction • Brazil and its Privatization Process • Telebras and Embratel • Investment Opportunities and Risks • Valuation

  4. 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 ?

  5. Telebras and Embratel The Telebras Transformation TELEBRAS YESTERDAY TELEBRAS TODAY • 12 Privately controlled holding companies: • 3 Regional fixed-line Cos • 8 Regional Wireless Cos. • 1 long distance operator • 1 Government controlled holding company: • 27 local fixed-line subs • 26 local wireless subs • 1 long distance sub

  6. 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

  7. 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

  8. 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 .

  9. Takeaways (I)

  10. Takeaways (II)

  11. Suggested Solution - DCF Model • Build a full valuation model “The Puzzle” • Macroeconomics Assumptions • Market Growth Rates • CAPEX and Depreciation

  12. DCF Model (II) • Ke = Rf + *(Rm-Rf)… and ? • Which Beta?

  13. DCF Model (III) • The WACC under IICCRC is substantially higher than under Sovereign Debt Spread model. IICCRC SDS - Model

  14. 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

  15. Comparable Company Analysis • Key issues: • What multiple? • Which Companies? • How to incorporate country risk?

  16. ADR Vol. as % of local index Argentina* Brazil Chile Mexico Peru Venezuela Average Latin American Telecoms importanceYTD 1998 Market Cap. as % of local index Argentina* Brazil Chile Mexico Peru Venezuela Average * Argentina’s correlation is the average of Telecom Argentina and Telefonica de Argentina Source: Salomon Smith Barney

  17. Each Telecom company has become increasingly a proxy for their home market Correlation Local Market vs. ADRs YTD 1998 Argentina* Brazil Chile Mexico Peru Venezuela Average * Argentina’s correlation is the average of Telecom Argentina and Telefonica de Argentina Source: Salomon Smith Barney

  18. BRAZIL Estimated EV/EBITDA 98E Average Estimated Telebras’ Multiple using IICCR1998 Institutional Investor Country Credit Rating EV/EBITDA 98E Argentina* Chile Mexico USA Venezuela Brazil Source: Salomon Smith Barney

  19. Estimated EMBRATEL Multiple using IICCR1998 EV/EBITDA 98E Company adjusted by country risk =3.3x Sprint MCI WorldCom AT&T Telebras Source: Salomon Smith Barney

  20. Value paid $2.26 Valuation Summary

  21. 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.

  22. What happened ?

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