Oi Telecom’s ambitious path to recovery

. Jul 19, 2019

Once dubbed a “national champion” in the field of telecommunications, Oi Telecom has become a cautionary tale on the perils of mismanagement and crony capitalism. Thanks to close ties with politicians during the Workers’ Party era, Oi received billions to expand beyond its means, in a strategy that ended up biting it on its rear end in 2016—when the company filed for court-supervised recovery. At the time, it was the largest filing of its kind, with Oi unable to pay debts amounting to BRL 65 billion (the figure would be topped this year by another scandal-riddled company, Odebrecht).

Three years after its darkest chapter—during which the company went through a rotating door of  CEOs—Oi has survived the harsh recovery process; though not without having to deal with disgruntled shareholders and creditors. It now hopes to convince investors that it is ready to turn a new leaf. But will investors ever trust the company again?

</span></p> <p><span style="font-weight: 400;">Judging by shares performance, it is hard to say. The initial optimism following the company&#8217;s release of a new business plan pushed stock prices up in the early hours of July 16. But investors quickly reserved the trend—and Oi stocks have lost 9.8 percent in just two days. Analysts at BTG Pactual and Levante Investimentos say that’s because the plan is as ambitious as it is hard to accomplish—requiring an ability to deliver results close to perfection.</span></p> <div class="flourish-embed" data-src="visualisation/518983"></div> <p><script src=""></script></p> <p><span style="font-weight: 400;">Oi’s new strategy is focused on increasing its already large </span><a href=""><span style="font-weight: 400;">leadership position</span></a><span style="font-weight: 400;"> in Brazil’s fiber internet market, and becoming a 5G supplier for other carriers. For that, it intends to reach 16 million homes with access to fiber-to-the-home (FTTH) technology by the end of 2021 (versus 1.7 million last March), while positioning themselves as an ICT provider and integrator, which they hope to achieve by transforming and adapting their massive structure.</span></p> <p><span style="font-weight: 400;">On the financial side of the equation, they intend to cut at least BRL1 billion in expenses per year, plus the cost-cutting measures applied since 2016. They also rely on the sale of non-core assets earning up to BRL 7.5 billion, and tax credits to the sum of BRL 3.1 billion. Alongside the BRL 4 billion capital increase plan approved by shareholders this year, Oi would have up to BRL 14.5 billion on hand to advance the plan.</span></p> <p><span style="font-weight: 400;">“Our FTTH-related revenues will grow more than 30 percent a year and will be able to deal with the fall in the number of fixed phone lines, while also compensating for the fall in copper technology lines, and therefore stabilizing total revenues until 2021. We will also expedite our operations in wholesale, increasing our significative advantage and exploring the opportunities to the most, doubling our wholesale revenue in the next years,” explained Chief Financial Officer Carlos Brandão, in a webcast this week.</span></p> <p><span style="font-weight: 400;">Despite the optimism, it won’t be easy for a company so focused on fixed telephony to implement such a leap. Helping their case, the massive increase in homes with FTTH access may become easier due to reuse strategy—there are already </span><span style="font-weight: 400;">12.5 million homes with the majority of the infrastructure in place, so only minor technology investments would be required. Moreover, Oi envisages being able to offer their services to somewhere around 32 million homes.</span></p> <p><span style="font-weight: 400;">According to BTG Pactual strategists’ calculations, &#8220;even if average penetration remains around 10 percent, with 16 million homes passed, Oi would have 1.6 million FTTH clients by the end of 2021—11 times more than what it has today.&#8221;</span></p> <p><span style="font-weight: 400;">On the other hand, as newspaper</span> <i><span style="font-weight: 400;">Estado de S.Paulo</span></i><span style="font-weight: 400;"> flags, it may also take some time to sell non-core assets like Angolas’ carrier Unitel, or even properties, towers and other assets that had already been put on sale previously. To understand how big the divestments plan is, it basically amounts to between 70 to 80 percent of the companies’ market cap—a much-needed boost to investments.</span></p> <p><span style="font-weight: 400;">This is all without mentioning that, while Oi had to stop putting money into operations, other carriers kept investing, leaving it way behind. Just for the sake of comparison, Vivo, the leading carrier in Brazil, invested BRL 8.1 billion last year, versus BRL 6.1 billion by Oi.</span></p> <p><span style="font-weight: 400;">As BTG Pactual’s Carlos Sequeira, Bernardo Teixeira, and Osni Carfi summed up, “</span><span style="font-weight: 400;">the plan makes a lot of sense; the big challenge is execution.” In a note to clients, Levante’s Eduardo Guimarães also expressed concern about other points of the plans, like the planned savings. “We believe that the operational cost-cutting plan is hardly a trivial undertaking,” he wrote, adding that the company’s focus on FTTH makes sense, but that it will have to “work really hard to meet those goals.”</span></p> <p><img class="alignnone size-full wp-image-20907" src="" alt="connections map brazil" width="774" height="832" srcset=" 774w, 279w, 768w, 610w" sizes="(max-width: 774px) 100vw, 774px" /></p> <h2>Understanding Oi</h2> <p><span style="font-weight: 400;">The analyst&#8217;s caution may be explained by looking at Oi’s troubled history. The company was formed after the privatization of Telebras—Brazil’s state-owned telecommunication holding—and acquired its current shape after a merger between Telemar (the gathering of Telebras’ branches focused in the North, Northeast, and Southeast, except São Paulo) and Brasil Telecom, focused in the South.</span></p> <p><span style="font-weight: 400;">The deal, closed in 2008, was strongly supported by former President Luiz Inácio Lula da Silva, and included in his initiative to create “national champions.” The idea was to boost Oi, allowing it to compete with foreign players like Spain&#8217;s Telefónica. The Brazilian National Development Bank (BNDES) alone lent Telemar more than BRL 2.5 billion (at very friendly interest rates) for the deal to go through.</span></p> <p><span style="font-weight: 400;">Although Oi was born large, covering 26 of 27 Brazilian states after the merger, it was also founded on a questionable strategy. The company’s strong point was fixed telephony, a segment that, by that time, was already becoming obsolete.</span></p> <div class="flourish-embed" data-src="visualisation/518816"></div> <p><script src=""></script></p> <p><span style="font-weight: 400;">Management has also been an issue. In the beginning, Oi’s major stakeholders were BNDES bank, the construction company Andrade Gutierrez and the Jereissati </span><a href=""><span style="font-weight: 400;">family</span></a><span style="font-weight: 400;"> (owner of several industrial and commercial ventures). In other words, no telecom experts. </span></p> <p><span style="font-weight: 400;">The arrival of Portugal Telecom, a Portuguese carrier, ended up not helping much. The plan was an attempt to expand overseas, but both companies buried themselves in debt, making the combined company net debt reach BRL 41.2 billion, against BRL 37.5 billion in revenue. As weekly magazine </span><i><span style="font-weight: 400;">Época </span></i><span style="font-weight: 400;">recalls, “the financial troubles of the Portuguese in Europe increased Oi’s financial debt even further.”</span></p> <p><span style="font-weight: 400;">The company&#8217;s erratic command was also to blame. Oi went through a dozen chief executive officers and, as a consequence, a dozen different strategies. This level of inconsistency was a recipe for disaster—which eventually occurred in June 2016.</span></p> <h2>On the radar</h2> <p><span style="font-weight: 400;">A possible merger with TIM Brasil, the local branch of Telecom Italia, has been speculated about for years. </span><a href=""><span style="font-weight: 400;">Investors and analysts consider</span></a><span style="font-weight: 400;"> that matching Oi’s strong base of fixed telephony (a lure to more profitable offers) and internet, to TIM’s large mobile presence, would bring great competitive advantages to the combined company, as well as synergies.  </span></p> <p><span style="font-weight: 400;">In the past, the deal did not go through due to Oi’s internal crisis, while Telecom Italia itself faced problems, with a power dispute between shareholders Vivendi and Elliott, leaving issues concerning subsidiaries in the background. </span></p> <p><span style="font-weight: 400;">For BTG Pactual analysts, the mobile business may be on the table again—judging by Oi’s comments in the new plan presentation—for either a potential sale or partnership which could, in their words, “</span><span style="font-weight: 400;">create tremendous opportunities for value creation.”</span></p> <p><span style="font-weight: 400;">Another hot topic for telecom companies is a bill (PLC 79/2016) updating Brazilian telecommunications law. Eventual approval would be seen as a major boost for the companies, giving them a legal basis to invest in more profitable technology, such as broadband.

Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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