Wednesday, October 23, 2013

My Take on the OIBr and PT Planned Merger

It has been a while since I posted. In part because of work, and in part due to a dearth of news from companies in my portfolio. BTW, the debt ceiling and government shutdown are not what I consider material news.

The only big news is the recent planned merge of OiBr and Portugal Telecom (PT). I have owned OiBr for about 7 years. And in that time, I found it very hard to follow. For one thing it is in a country I have never been to, and it has an extremely complicated ownership structure that has gone through many restructurings. I was drawn to the stock because of the 10%+ dividend yield and the the BRIC story. Stocks from developing countries haven't been very kind to me. I have lost on Cemex (CX) and OiBr. I do have a nice gain in PK Telecom of  Indonesia, but the gain couldn't match the S&P 500. In the future, I will only invest in developed countries.

The PT and OiBr merger is interesting. Both companies command a huge customer base, and both are saddled with high debt. The merger is complex involving both companies as well as many companies that own parts of both companies. I won't try to explain the transaction, but I summarize the bottom line as I understand it. 

  • New company is call Corpco
  • PT share becomes 0.63 Corpco share
  • OiBr common shares becomes 1 Corpco share, preferred shares becomes 0.92 Corpco share, I'll simplify this by saying each old OiBr share is worth a weighted average of 0.95 Corpco share
  • OiBr will issue new shares which in turn will become 0.95 share Corpco in order to generate around 8 billion reais new cash
  • The number of shares issued is yet to be determined
  • PT shareholders will get R$5.5 bil worth of the new shares because they will give OiBr more than R$5.5 worth of equipment as part of the merger
  • PT owns 13% of OiBR
  • OiBr own 10% of PT (confusing enough yet?)

So the bottom line is a new company with containing OiBR, PT and R$8 billion. First, I estimated my dilution by estimating the eventual number of Corpco shares. I assume a weighted average common and preferred Oi share price of R$4.2, which is at the recent trading range.

                                                                                Corpco Shr
PT share conversion 855 PT shr x 0.63 539
    -10% owned by OiBr(54)
PT equipment contribution R$5500 ÷ R$4.2/shr1310
    -10% owned by OiBr      (131)
Total attributed to PT shareholders 1663
OiBr share conversion 1640 OiBr shr x 0.95 1561
    -13% owned by PT(193)
OiBr Capital Raise R$8000 ÷ R$4.2 /shr1905
Total attributed to OiBr shareholders 3198
Total 4861

Note, that the above factors in the cross-ownership of the two companies: I assume the cross-ownership shares will be retired. This is very likely wrong but it is my best guess at what will happen. The merger announcement said the goal is 38% PT shareholder ownership of Corpco. My above calculation winds up with 34%. This means there is probably something wrong with the above assumptions and calculations. But for the purposes of this article, my estimates are close enough.

The above results in a market cap of R$20.4 bil. And I did some valuation calculations on Corpco. The company would have a trailing Ebitda of R$12.8 bil. A net debt of R$41.2 bil, post capital raise. Which means an EV/Ebitda of 4.8. This is a reasonable number. And as a OiBr shareholder, for each of my weighted average shares I have R$8.47 of debt and R$2.60 of Ebitda. Currently each OiBr shares has about R$16 of debt and R$4.50 Ebitda. So the merger is a good idea because it reduces OiBr debt profile. But the debt profile was bad before the merger, and it is still not so great after.

On the operational side, this merger will hopefully give the combined company a better debt profile so that they will get better interest rates. Right now it is running at the 9% range for new debt. And hopefully the two companies can take advantage of synergies so that their fortunes will turn around by 2015. Nonetheless, OiBr is in a complex situation, and both PT and OiBr are in countries that are suffering a downturn or worse,. In the end, I think my time is better spent with easier to understand small and microcaps. Currently, I am reducing my position and hopefully I'll be rid of OiBr completely before the merger.

For more in-depth analysis, I recommend this article

The other news, I found a thorough article on IEHC. Considering the company's tiny market cap ($9 mil) any analysis is wonderful. I didn't get any new information on OiBr — after all, how much news can you get on a $9 mil company — but it did mention some useful facts about the connector business and its competitors. I didn't know the connector business is actually big business! The press is probably helping the stock too. At $4.20, the stock is 40% up from my initial purchase earlier this year.