Friday, August 2, 2013

My OI S.A. Fiasco

May a year ago I found a Brazilian telecom company that paid more than 10% dividends. I was amazed, and bought it without understanding too much about it. The company ticker was TNE. I watched the stock as it climbed while still giving me 10%. And even when it dropped I thought oh ok I still made good money on this stock considering the huge dividends I got over the year. Then about a year ago, the stock started a incredible slide. And being comfortable being an owner for many years, I bought some more earlier this year. But it continued the slide. The stock has dropped some 80% to date.


Before I continue the story, let me recap the company's history. Brazil is a country with quite a lot of regulations. And company's have complex structures as a result. The company was Tele Norte Leste Participacoes. In 2008 it merged with Brazil Telecom, and after several reorganizations, the company became Oi S.A. (OIBR ticker). Oi is the brand name of the mobile phone service they provide. Oi is one of the four biggest cell phone providers in Brazil, and it has biggest landline network in the country. It is also the second largest telecom company in South America.

As of last year, the company was losing customers. So the company hired a Franciso Valim as the CEO and initiate a turnaround effort with heavy capex spending. In turn the company has slowly started to increase its customer base. But today still, the company's mobile business is not great compared to the other three big mobile providers in Brazil. It's landline business is losing customers, although the company is trying hard attract new business with its internet offerings. In January, Valim was suddenly ousted and replace with an interim CEO.

But the company's biggest problem is its debt. This debt is the result of paying for its acquisitions and its huge dividend. The company currently has net debt of 27.5 billion reais — 1 USD equals 2.2 reais. The company calculates net debt to be total debt minus cash and equivalents. In addition, the company plans to pay about two billion reais per year in dividends. This is the primary reason the stock is depressed: the company's net income is only about a billion reais a year! The company can only dole out such high dividends by adding to debt, and the debt is nearing its limit.

The dividend and debt is this screwed up because the company is majority owned by Telemar and Telemar needs the dividend payments to finance its own debt. And I never realized this until recently! This is a very hard lesson on doing my homework.


Recent Events

The recent bad news started with the first quarter's results in April. Earnings came in at 0.16 reais. But most disappointing was the 2.5 billion reais increase in debt. About 1 billion reais was for dividends, but that still leaves a 1.5 billion reais cash burn. That was the cause for the stock's slide for the recent months.

Then in June came news that a star CEO Zeinal Bava will run Oi. Apparently, Bava is famous in Europe. He ran Portugal Telecom and apparently did a good job. Portugal Telecom is also part owner of Oi and Bava was on Oi's board.

EBITDA9.0 billion reais
Interest coverage>1.75x
Price preferred shr$1.85 USD
Price range Apr'13 $1.44 — $2.50
Total shr outstanding1.6 billion
1 USD2.2 reais
Next, in quick succession, the new CEO did the following:
  1. ousted the CFO and some other key executives 
  2. canceled a planned 2 billion reais debt raise
  3. raised 2.4 billion reais by selling company assets 
  4. and stopped the coming planned billion reais dividend 
With each piece of news the stock yoyo'ed. It was a sickening ride. The table on the right shows the key stats based on the last 4 quarters.

In times like this with so much negative sentiment regarding a stock, it pays carefully and objectively look at the facts. The company's funding has been a persistent issue, but disregarding that company is profitable enough. EV / EBITDA is a common metric to gauge a company's value for a takeover. For Oi it is 3.8x. As a comparison Sprint, which is in buyout talks, is at 6.4x. So, if someone could pay the enterprise value that person would get a profitable business.

And buyout isn't the only option, an equity raise is another, this is just an illustration to put it all in perspective. If the company can fix it's debt problems, what remains is a good company and the stock will naturally appreciate.


But seeing that debt is the key issue, it's good to know how Oi got here. The following shows the increase in debt over recent quarters. Clearly the dividend was a big chunk and removing that from now on will help. It isn't clear what the working capital drain is for, but it should be matched by something else on the balance sheet. The escrow item is mostly judicial deposits. I am amazed at how much Oi is being sued. Maybe that's just how things work in Brazil. Escrow is the requirement by law and is not the same as provisions, and could be reversed in the future. But by far, the largest items that affect the debt are EBITDA and capex. EBITDA has to improve, hopefully Bava will make it happen. Capex was targeted at 6 billion reais this year. Oi needs the capex to be competitive. But hopefully it will go down next year.

And so now, after hearing all the negative sentiment online, I know much more about the company. And now I must objectively decide what to do regarding my Oi position. So, I ask myself, if I didn't own any Oi stock, would I buy? And my answer is I am not sure. Oi has screwed up operationally, but the company has turnaround potential. In addition, the Brazilian stock market has fallen close to a five year low. My feeling is that it is oversold. So, part of Oi's fall was in sympathy with the market, and it will rise also when the market reverses.

In any case, investing in Oi takes faith. I believe that Bava knows what's going on in Oi after having been on its board and he took the CEO job because he was confident that he can turn the company around.

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