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Telefónica’s $500 million sale of a 40% stake in operating units in Guatemala, Panama, El Salvador and Nicaragua to the local conglomerate CMI does not hint at a withdrawal from Latin America. It shows how the Spanish group is increasing its focus on more profitable, core operations, as it seeks to reduce a heavy debt situation from $67.1 billion to $61.5 billion.
The decision to offload Central American assets comes a year after the announcement that Telefónica’s earnings in Latin America had surpassed European earnings for the first time. By that time, the operator had already started an asset disposal program comprised of less profitable and less strategic businesses across its footprint in Latin America as well as in Europe. In fact, the March sale of the Brazil-based Atento call center business to the U.S. private equity firm Bain Capital for $1.3 billion was the biggest debt reduction initiative Telefónica has undertaken to date, an move more than five times larger than its recent offload of the U.K. fixed broadband business to Sky for $310 million.
By divesting in Central America, Telefónica is inverting the trend in recent years that has seen the Spanish Group and another Latin American telecom giant, América Movil, increase ownership to 100% across their assets. With the exception of Nicaragua, three of the four countries involved in the deal, Panama, Guatemala and El Salvador, are all highly competitive mobile markets by regional standards, each one having presence of at least three of the five major regional groups: Telefónica, América Movil, Millicom, Cable & Wireless and more recently, the aggressive new entrant, Digicel.
Exhibit 1: Mobile market share, Guatemala, El Salvador, Panama and Nicaragua, year-end 2012
Source: Pyramid Research Q1 2013 Mobile Operator KPI Forecast, Latin America
When it started operations in El Salvador in 1998 and in Guatemala the following year, Telefónica entered the market along with other major groups and against strong incumbents. To date, the Spanish group is only third-placed in Central America’s largest market, Guatemala, the stronghold of Luxembourg-based Millicom. Telefónica is the market leader in Panama, but even there it is facing increasing competition since back in 2008 when the market ceased to be a duopoly and new mobile licenses were awarded to Digicel and Claro.
Faced with challenging market conditions, Telefónica has opted for keeping control of its Central American business while bringing on board a partner with local knowledge and a long-established presence in the retail business and from which Telefónica can benefit in terms of marketing and sales initiative know-how. Nonetheless, the asset valuation appears to be highly favorable to CMI. Based on the $500 million that CMI is investing for 40% of Telefonica’s Central American operations, the total asset valuation, excluding the recently launched Costa Rican unit which was not part of the deal, stands at $142 per subscription. This amount is considerably lower, for example, than the $241 per subscription that Chilean operator Entel recently offered NII holdings to take over the mobile operator Nextel in Peru, the fastest growing Latin American economy. Moving to mature broadband markets in Europe, the above mentioned Telefónica’s disposal of the U.K. fixed line and broadband business to Sky meant that the Spanish group was able to extract $544 per subscription from the deal.
Despite good growth prospects, the lower valuation of Central American assets is directly related to the lower profitability of Central America when compared to all other Latin American operations. In 2012, in the five markets of Guatemala, Panama, El Salvador, Nicaragua and Costa Rica, Telefónica saw 24% revenue growth from $710 million to $879 million. Nonetheless, the combination of strong competition, price pressures and lower data service penetration, means that Central American markets generated the lowest operating income in the region before depreciation and amortization margin (20.9%). This compares with the 37.9% margin of its largest operational unit, Brazil, and with the 27% margin in Mexico, which is arguably the most challenging Latin American market for Telefónica, given the local domination of América Movil. Overall, Telefónica’s Central American operations show the lowest ratio of operating interest before depreciation and amortization per subscription across its entire Latin American portfolio.
Exhibit 2: OIBDA per subscription (U.S.$), mobile, fixed and pay-TV, Telefónica Latin America, year 2012
Source: Telefónica, Economist Intelligence Unit, Pyramid Research.
To further reduce debt, Telefónica is looking at additional asset disposal, but it is more likely to turn immediately to Europe, starting with the Czech Republic and Ireland. Last year, operations in the latter country saw revenue decline 13% from $1 billion to $800 million and the lowest OIBDA margin at 20.7% across all Telefónica operating units. As for further disposals in Latin America, Telefónica is considering a public listing in Colombia to sell a minority share of the local operator.
Arguably Colombia does not fit the description of peripheral or non-strategic. In 2012, Colombian revenue expanded 13% from €1.6 billion to €1.8 billion, representing 6% of total Latin American revenue with OIBDA improving 10% to €607 million and stable margins over the previous year at 34.4%. We believe that an asset disposal in the third largest country in Latin America, which has a GDP growth projected at an annual average of 4.5% for 2013-17, would again call attention to the overall positioning of the group in the region.
Daniele Tricarico is an analyst for Latin America at Pyramid Research. He conducts research for Pyramid on operator strategies and business models for online content, over-the-top (OTT) video and communication services. He also covers the Latin American region as part of Pyramid’s emerging market team.
