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Portugal Telecom


Academic year: 2021

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 We initiate our coverage of Portugal Telecom with a price target of 9.64€ for FY2010, setting a potential upside of 13.1 %. Our recommendation stands for hold. Our valuation implies 5.89 EV/EBITDA FY2010.

 We forecast revenues to reach 7260 mn € in FY 2010 (7% YoY) and 7487 mn € in FY 2011 (3.13% YoY), mainly due to significant growth of VIVO helped by Real strength. We estimate EBITDA increasing to 2519 mn € in FY2010 (4.4% YoY) and 2592 mn € in FY2011 (2.9% YoY). In domestic operations we are not so optimistic since Portugal struggles to control the external balance account. Still, we believe in good results for the group.

 Telefonica increases pressure on VIVO. The bid for PT’s stake on VIVO is now 6.5 bn € (vs. previous 5.7bn €). The offer represents a 40% premium to our valuation and an attractive 9.89 EV/EBITDA FY2010. This time the decision was let to the shareholders (30th June).

 TMN suffers with ANACOM MTR’s cuts (46% until 2011). We forecast FY2010 revenue to fall to 1460 mn €. (-3.83% YoY).  In Wireline MEO had reach 646k customers (24.9% market share) in 1Q2010 representing an impressive 68% QoQ. However we estimate a slight decrease in revenues for FY2010 to 1941 mn € (-0.7% YoY).

 While domestic market is mature VIVO is taking the best of Brazil’s mobile exponential growth. In 1Q2010 customers reached 54 mn (18.2% QoQ). We forecast 76mn customers in FY2014. .

07 JUNE 2010


















“Everything has a price”

Goodbye Brazil?

Recommendation: HOLD

Vs Previous Recommendation

Price Target FY10: 9.64 €

Vs Previous Price Target

Price (as of 7-Jun-10) 8.52 €

Reuters: PTC.LS, Bloomberg: PCT.PL 52-week range (€) 6.15-8.68 Market Cap (€m) 7638.287M Outstanding Shares (m) 896.512M Source: Source: Bloomberg

(Values in € millions) 2009 2010E 2011E

Revenues 6784.6 7260.1 7487.4 EBITDA 2412.7 2519.2 2592.7 Net Profit 683.9 482.4 542.2 EPS 0.76 0.54 0.60 P/E 11.17 17.63 15.68 Debt / EBITDA 2.9 2.9 2.7

Net debt / EBITDA 2.3 2.5 2.3

EV/EBITDA 6.0 5.9 5.6

Source: Bloomberg, Company reports, analyst estimates


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Table of Contents

Investment case...3

Executive Summary...3

Company overview...4

Company description...4 Shareholder Structure...5


Wireline trends for Portugal...6


PT Wireline...10

MEO scenario analysis...13

Mobile domestic – TMN...16

Mobile trends for Portugal...16

Mobile penetration forecast...18


Mobile Brazil – VIVO...23

Mobile trends for Brazil...23

VIVO...25 Valuation...27 M&A VIVO...29 Comparables...31 Stock performance...32 Conclusion...32 Financials...33


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Investment case

Executive Summary.

We value PT using SoP valuation. Our valuation implies a price target for FY 2010 of 9.64€ meaning an upside of 13.1% to the current price. We provide detailed operational and financial analysis for PT main business units: Wireline, TMN, and VIVO. Remaining assets are value through multiples and market value.


Macroeconomic conditions set revenues down -0.7% in 1Q2010. Our revenue forecasts for FY2010 are 1941 mn € (-0.3% YoY) and 1973 mn € for FY2011 (1.6% YoY). 1Q2010 net adds for TV (65k) and broadband (39k) keep good momentum despite not so good financial performance. Fixed phone net

disconnections (-14k) still continue but at a much slower rate than in the past. In the medium term we believe in good operational performance for PT Wireline leading to significant gains in subscribers and consequently revenues (2.86% CAGR 2014-2019 ) and EBITDA improvement (3.77% CAGR 2014-2019). We believe FTTH investment reinforce PT wireline leadership position in Portugal. Our scenario analysis for MEO suggests the significant importance of MEO for PT.


MTR cuts set our revenue forecast for FY2010 down to 1460 mn€ (-3.83% YoY) and 1488 mn€ in FY2011. 1Q2010 revenues were down -6.5% QoQ. ARPU keeps following fast. (1Q2010 -8.3% QoQ). We believe ARPU to stabilize in FY2012/2013. The Portuguese mobile market has high values of penetration (149.9% vs. Europe aver.121.9%).Yet, we forecast subscribers to growth but at a slower rate (4.42 pp a year from 2010-2015 vs. 9.9 pp on 2004-2009 period). We believe data will be responsible to increase part of subscribers and balance ARPU’s fall. However competition will keep pressure on ARPU’s recover.


Customer boost in Brazil allow us to forecast circa 7mn (13.4% YoY) new customers for FY2010. We estimate 85Mn customers in 2019. Revenues should reach 18.2 mn ₨ (4.8% YoY) and 19.34 mn Rs (6.3%YoY) in FY2011. However


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Telefonica wants to buy PT’s amulet on Brazil and is currently offering 6500 mn € for PT’s stake on VIVO. This value represents a 40% premium to our valuation.

Company overview

Portugal Telecom is the leader telecommunications company as well as one of the largest companies in Portugal1. PT started as a fixed phone state company and later was privatized2. Today PT provides services covering a wide range of the telecommunications sector and has a strong presence worldwide, especially in Brazil.

Company description


Portugal Telecom currently provides services in fixed phone, fixed broadband and pay TV through PT Comunicações and PT Prime. Portuguese mobile telecommunications are assured by TMN. Figures 1 & 2 show the historical performance of Wireline (PT Comunicações together with PT Prime) and TMN



In Brazil PT has its major presence international trough VIVO. In 2002, PT together with Telefonica created a joint venture in Brazil: Brasilcel, which currently holds 59.42% of VIVO. PT and Telefonica hold both 50% of Brasilcel. Historical performance of VIVO is presented in figure 33. In Brazil PT also holds a 29% stake in UOL (Universo Online, an Internet service and content provider) and Dedic (call centre). PT has a strong presence in Africa trough Africatel4, which detains participations in Angola (Unitel, provides mobile communications, 25% stake), Green Cape (CVT, provides fixed and mobile communications, 40% stake), São Tomé and Principe (CST, provides fixed and mobile communications, 51% stake) and Namibia (MTC, provides mobile communications, 34% stake). Remaining representative international assets are in Timor (Timor Telecom, provides fixed and mobile communications, 41.12% stake) and Macau (CTM,


PT is currently the third largest company in market capitalization on PSI20 behind EDP (Energias de Portugal) and Galp.


The privatization process started in 1995(first privatization phase) until 2000(fifth and last privatization phase). 3

VIVO revenues and EBITDA at 100%. Portugal Telecom has a direct participation of 29.71% and an indirect participation of 50%. PT consolidates VIVO at 50%.


PT has a 75% stake on Africatel. The effective participation on Africa operations is 18.75% on Unitel, 25.5% on MTC, 30% on CVT and 38.25% on CST.

Figure 1: Wireline revenues and EBITDA (2004-2009) €M

1995-2004; 2005-2009; forecast

Figure 2: TMN revenues and EBITDA (2004-2009) €M

1995-2004; 2005-2009; forecast Source: Company reports


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provides fixed and mobile communications, 28% stake). Table 15 summarizes historical performance of Africatel participations, Timor Telecom and CTM.

Shareholder structure

Shareholder structure is presented in figure 4. Main shareholders are Telefonica (telecommunications-Spain), Brandes Investment Partners (financial-Canada), Grupo Espírito Santo Portugal), Caixa Geral de Depósitos (financial-Portugal) and Ongoing Strategy Investments (financial-(financial-Portugal).

Portuguese shareholders own 36% of total capital (figure 5),

We also highlight the fact that the Portuguese Government owns 500 shares, which give the government special rights6 in Portugal Telecom. Among these rights, there is the right of not allowing shareholder positions higher than 10% among PT’s total capital and also the power of veto on decisions considered strategic for PT. These “golden shares” have been considered illegal by the European Commission and there is still a final decision pending from the European Court of Justice. While the “golden share” remains active hostile takeover bids will have one big obstacle to overcome.


EBITDA presented assumes 100% of total EBITDA. Refer to footnote 4 for effective participations hold by PT. 6

Detailed description of those rights could be read in http://www.telecom.pt/NR/rdonlyres/BE504923-9F47-4F1C-ACDE-D756EF58669B/1430409/form20F2009.pdf on page 11.

Company FY2007 FY2008 FY2009

Unitel 391 524 738 MTC 62 53 66 CVT 42 44 41 CST 2.8 3.0 3.3 Timor telecom 11 14 18 CTM 42 44 41

Table 1: PT’s International assets EBITDA (2007-2009) €M

Figure 3: VIVO revenues and EBITDA (2004-2009) €M 1995-2004; 2005-2009;

Source: Company reports

Source: Company reports

Figure 4: PT’s shareholder structure by owner in FY2009.

Figure 5: PT’s shareholder structure by country/region in FY2009.

Source: Company reports Source: Company reports


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PT Wireline delivers services in three areas: fixed broadband internet, fixed phone and more recently pay TV. PT leads in fixed broadband internet and fixed phone and is currently the second largest player in pay TV. Its main competitor is ZON (former PT Multimedia7) across all sectors. There is a third player,

Cabovisão, which is currently losing considerable market share. The market is seen as mature but has been suffering a huge transformation as bundle offers invade the market. Investments in NGN8 have been made during 2009 and will continue in 2010. Currently the market shows positive trends in all areas.

Wireline trends for Portugal

Wireline market has been completely changed by the success of bundle offers. All players have now double and triple play offers which we believe will be the standard offer for the future. The reason for this success is mainly explained by the possibility of offering double and triple play packs at a much lower price than a single product, which results in lower prices for consumers and higher ARPU9 for companies.

Wireline sector had registered strong performance during 2009. We believe that number of subscribers in fixed broadband, fixed phone and pay TV will continue to increase during 2010 due to the success of bundle offers.

The 2009 macroeconomic environment in Portugal (table 2) did not encouraged a good performance of the wireline sector, but the sector has remained resilient and showed good results. We therefore think that poor macroeconomic forecasts will have a negative effect on the wireline sector but not enough to contain bundle offers momentum. However we do believe that the effect of the current

Portuguese stability program in order to correct the high deficit will play some pressure on the sector and therefore on PT. The stability program will decrease available income to households and therefore decrease demand in non essential products. We believe pay TV will suffer the most, especially premium services. During 2009, Portuguese fixed phone market has inverted decreasing trends, both in subscribers (6.8% YoY) (figure 6) and in minutes (0, 04% YoY) (figure 7), which were continuously decreasing in the past years.


ZON was created in 2006/2007 spin off of PT multimedia from PT. The spin off was mainly due to regulatory issues. 8

New Generation Networks (high speed cable (Eurodocsis 3.0) and fibre, whether FTTH/B(fibre to the home/building), FTTC(fibre to the cabinet), FTTN(fibre to the node), FTTP(fibre to the premises))


Average revenue per user. ARPU in wireline increase with bundle offers due to the increase in the number of services subscribed, despite lower price per service or lower revenue per access.

Table 2: Portuguese macroeconomic indicators. (historical and forecasts) 1995-2004; 2005-2009; forecast

FY2009 FY2010 FY2011 FY2015

GDP growth -2.7 0.3 0.7 1.4 Consumer prices -0.8 0.8 1.1 1.8 Unemployment rate 9.5 11 10.3 n/a

Figure 6: Evolution in fixed phone subscribers: 1Q2007 – 4Q2009

Figure 7: Evolution in fixed phone minutes 2004-2009 (in

thousands) Source: IMF

Source: Anacom


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The inversion in subscribers is evident while minutes seem to be stabilized during 2009. VoIP10 clients would be responsible for increasing subscribers in the coming years as both bundle offers from PT FTTH through MEO or ZON are in VoIP. Minutes should increase slightly due to the increase in clients. Fixed broadband (figure 8) has showed good performance in 2009 (13.2% YoY). Portugal has a relatively low penetration of broadband fixed access (figure 9/10) which in turn is compensated for high levels of mobile broadband penetration (figure 24).

Pay TV market has seen considerable development in 2008 and 2009(10.6% YoY), after been relatively stable until PT got in with MEO.

Cable subscribers have been stable while subscribers using technologies such as DTH IPTV and FTTH have grow significantly during 2009(figure 11). Portugal has already a significant % of pay TV penetration (61% assuming 4.1 mn houses11) (figure 12), thus suggesting that the market could be close to saturation. However we still believe that during 2010 bundle offers momentum will even further increase the number of pay TV subscribers, despite the lack of supporting macroeconomic environment. We also believe that the lack of free-to-air channels/ Digital terrestrial free channels12 support high levels of pay TV penetration.

10 Voice on Internet Protocol. 11

Portugal as 5 536 865 houses according to INE(Instituto Nacional de Estatística). There are between 900k and 1.2 M second houses depending on the source. There are also estimates pointing in 500k houses that have no use.


(Portugal has only 4 free to air/ digital terrestrial channels; Spain has 20 + channels; France 18 +; UK 30 +(pays a TV annual owning license), Germany 10 +;(the amount of channels assumed represent the minimum TV channels available since there are regional channels not broadcasting across all country)

Figure 8: Evolution in fixed broadband subscriber’s 1Q2007-4Q2009

Figure 9: Europe broadband penetration per habitant in January 2010

Figure 11: Evolution in pay TV subscribers (in thousands) 2Q2008-4Q2009

Figure 12: Pay TV penetration per house in Europe in FY2009 Source: Anacom

Source: 15th communications

progress report (European Commission)

Source: Anacom Source: Company reports

Source: Company reports

Figure 10: Broadband penetration per house in Europe in FY2009


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Portugal Telecom had in FY2009 965 k houses connected with FTTH/B thus making Portugal one of Europe’s leading countries in houses connected with FTTH (figure 13).

We estimate FTTH capex to pass and connect a home to be close to 380 €13 while ZON Eurodocsis 3.0 upgrade per home should be close to 16 €14. Despite the clear advantage of ZON to integrate NGN, we do think this investment was quite inevitable as ADSL is limited in its best use to 50Mb15. Also the current network had reached its limit use in some areas which is currently causing 40%16 of MEO possible clients to not subscribe the service. Although the FTTH

investment sacrifices cash flow generation in the present and in near future we believe that not investing in FTTH would left PT in a fragile position against ZON. Eurodocsis 3.0 is currently capable of offering speeds up to 200 Mbps17 and there is already the possibility to upgrade for 400 Mbps or even 1Gbps if necessary. This makes medium/long term capex recovery possible in the sense that we think that PT would not have capability to compete against ZON with the current network.

That being said we do not question the operational advantage of fibre over cooper and cable (noise reduction, no need for amplifying the network, signal stabilization), and therefore, significant savings according to PT estimates. (30% of savings both in front and back office when compared to ADSL. Other

examples include Verizon that claims savings around 80% in line maintenance)


PT does not present the capex necessary to build the current network. The only information provided regarding capex to fibre concerns an increase in domestic capex (wireline + TMN) of 10% from 650 M to 715 in 2009 at the time of the investment announcement suggesting 65 M to build the network. However we believe the value is rather low (when comparing to France Telecom investment). The domestic capex in 2009 turn to be 745 Mn despite low capex from TMN. For that reason we consider the difference between 2009 wireline capex and 2008 wireline capex (2008 wireline capex was already high due to pay TV investment) to be the capex invested on fibre. That lead to 162 Mn € to build the network and pass 965k houses. To reach to the value to connect the house we assume that 45% of fibre capex is done to build the network and the other 55% is done to connect the house (according to PT estimates)(We assume 0 houses connected in FY2009 for simplicity while the real value should be close to 9k. PT also does not release the number of houses connected with FTTH). We also have the example of France Telecom (in “Estudo sobre o impacto das redes de próxima geração no mercado” from Ovum consulting which results in 270€ to pass a house. (494€ to connect an house according to our estimates assuming customer capex driven as the same proportion of PT and removing the effect of 15%-20% houses already connected)


We assumed 2009 capex reported by ZON pointed as network upgrade+Cell splitting and assumed that in 2010 the same amount was spent to upgrade the remaining network to Eurodocsis 3.0. ZON has 2.8 mn houses covered with NGN.


vADSL2 used by Deutsche Telecom 16

According to PT. 17

ZON offer does not guarantee that the effective speed on the client home will be the speed contracted, while PT guarantees that the speed contracted is the effective speed on the client home.

Figure 13: Houses passed in Europe by FTTH/B (in thousands) in FY2009


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Currently we think that the high speed offers are above consumer needs and demands. We think 20/50 Mb offer should be enough for the actual needs, and therefore 100 MB, 200 MB and 118 Gbps will not have the best acceptance to the consumers in 2010. However the effect of bundle offers will contribute for the increase in the speeds contracted: by including more TV channels and services in offers of high speed the client does not assume the increase in the monthly fee straight to the rise in the internet speed contracted.

Also the general equipment available: routers19, cables or PCs do not allow the use of the current speeds that are offered. We think however that in the following years, as prices should fall slightly following price/speed trends(figure 15) and as content providers (video gaming, internet content, internet HDTV) will take the most of the capability available by displaying content exclusive for high speed connections the speeds contracted will rise relatively fast. Again bundle offers should play a role on it.

According to “Optical fibre right to the home –Approaches for the broadband connection of end customers with optical fibre on the „Last Mile“, that forecasts bandwidth necessary to provide service to an end user triple play offer using


Provided by ZON. However we believe the availability of this service is currently very restrict. 19

Although there are wireless routers providing high speed (300 Mbps) trough protocol N, the stability of the sign as well as the latency and the distance that could keep the speed announced is still very questionable.

Figure 15: Broadband speed and price evolution in Europe.

Source: 15th communications progress report (European Commission) Figure 14: Internet speed in

Europe on January 2010

Source: 15th communications progress report


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IPTV20 (table 3) suggests clearly that ADSL is unable to deliver top performance in the following years.

It is also worth to mention that Sonae.com and Vodafone had signed an

agreement in order to co-use and develop in Lisbon and Oporto the existing fibre network owned by Sonae.com. The announced numbers suggest 600k houses passed by FTTH/B until FY 2011(Sonae.com as currently circa 200k houses covered with FTTH/B). However Sonae.com was the first to enter FTTH market and that did not bring market share improvement. Sonae.com has currently 1% of market share in pay TV while Vodafone has 0.9%. Vodafone currently uses PT cooper connection to provide triple play offers. We anticipate only minor gains in Sonae.com/Vodafone market share.

PT Wireline

MEO allowed PT to enter the Pay TV market as well as the bundle offers market. MEO currently has 24.9% market share on Pay TV, which is quite an impressive value given that the service had started in 2Q2007. More than providing Pay TV, as a bundle offer, it was able to reduce net disconnections in fixed phone and improve net adds on fixed broadband. We believe the success will continue and we provide a sensitivity analysis to measure the impact of MEO performance in the future.

PT also has significantly improved market share of triple play offers during 2009(figure 1621).


PT uses IPTV (Internet Protocol television) to provide TV services. Table 3: Bandwidth forecast for an end user triple play using IPTV.

Source: Belkin

Figure 16: Triple play subscribers and market share (in thousands) (2008-2009)

Source: Company reports, analyst estimates


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Our estimates for PT wireline PT operational data are presented below (table 4).


Overall, we believe in a good performance in number of accesses in the future due to the good performance in the retail market. We expect a significant decline in the wholesale segment since the market is progessing in a way that players do not share their lines.

In PTSN/ISDN we believe that despite recent success in containing net

disconnections PT will not be able to maintain the current accesses. Figure 1722 shows our considerations for fixed phone market. We believe that PT will be able to stabilize market share close to 50-55%. In this case bundle offers of

competitors will have their effect on PT since it is clearly the leader on this segment. Small increase in fixed phone penetration together with loss in market share will make PT loose 461k access until FY2019 according to our estimates, while 130k comes from carrier pre-selection. In ADSL broadband retail and TV


As PT and Cabovisão do not report their actual triple play subscribers we use the same methodology which ZON uses to report triple play market share. It is assumed that all IPTV customers from PT are triple play customers and for Cabovisão all broadband customers are triple play subscribers. For ZON actual number of triple play subscribers is used. 22

There is a significant difference between subscribers and accesses since technologies like RDIS use multiple accesses and count for only one subscriber. Our forecasts are made in term of accesses but we present subscriber penetration in figure x since the relation between subscriber and houses is more intuitive.

Table 4: Wireline Operational data

Figure 17: Fixed phone penetration and accesses market share (historical and forecast (2006-2019)

Source: Anacom, Company reports, analyst estimates

Source: Company reports, analyst estimates

Operational data FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019

Main accesses (K) 4301 4587 4874 5082 5255 5381 5455 5796 Retail accesses 3867 4189 4510 4750 4955 5111 5220 5656 PSTN/ISDN 2828 2746 2725 2697 2650 2570 2476 2286 Traffic-generating lines 2654 2612 2600 2587 2565 2500 2426 2256 Carrier pre-selection 174 134 125 110 85 70 50 30 ADSL retail 727 862 1002 1115 1231 1344 1445 1692 TV customers 312 581 784 939 1075 1197 1299 1679 Wholesale accesses 434 398 364 332 300 270 235 140

Unbundled local loops 306 281 260 240 220 200 180 100 -11.09%

Wholesale line rental 76 63 50 40 35 30 25 20

ADSL wholesale 53 54 54 52 45 40 30 20 Net additions (K) 125 289 287 240 205 156 108 Retail accesses 184 325 321 240 205 156 108 PSTN/ISDN -182 -96 -22 -28 -47 -79 -94 Traffic-generating lines -119 -56 -13 -13 -22 -64 -74 Carrier pre-selection -63 -40 -9 -15 -25 -15 -20 ADSL retail 75 152 140 113 116 113 100 TV customers 291 269 203 155 136 122 102 Wholesale accesses -59 -35.9 -34.1 -31.5 -32 -30 -35

Unbundled local loops 15 -24.7 -20.5 -20 -20 -20 -20

Wholesale line rental -65 -12.2 -13.4 -10 -5 -5 -5

ADSL wholesale -10 1 -0.2 -1.5 -7 -5 -10

Retail RGU per access 1.37 1.53 1.66 1.76 1.87 1.99 2.11 2.47

ARPU (Euro) 29.55 30.09 29.9 29.9 30 30.2 30.7 32.3


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we expect significant gains in subscribers. Figure 18 and figure 19 shows our expectations for both markets that lead to our forecasts. Significant increases in either market share and market penetration allow considerable increase in TV and broadband subscribers. We expect churn to take effect especially on pay TV which should flatter increase in market share across time. In ADSL broadband we also expect significant increase in market penetration and a slight increase in market share. Since we believe triple-play offers will play a big role from now on, our forecasts for the three sectors converge to approximate values of market share, despite significant different starting positions.

PT’s Wireline ARPU proved to be very resilient in the past to movements in both directions and therefore we believe that it will continue close to 30 €.

Nevertheless, we expect ARPU to decrease slightly in 2010, mainly due to current macroeconomic conditions and to increase slowly reaching 32.3 € in

2019, due to increase in RGU’s. As for the number of employees we expect the number to remain quite stable

after significant cuts during 2004/2008 (Wireline sector had 8311 employees in FY2004), and also since PT declared that it is no longer PT strategy to improve EBITDA through cuts in employees.

Although we expect good performance in accesses net adds for 2010 we expect revenues to decrease slightly in 2010 (-0.4% YoY), again, due to macroeconomic conditions.

Source: Anacom, Company reports, analyst estimates

Table 5: Wireline Financial data

Financial data FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019 CAGR

Operating revenues 1931 1948 1941 1973 2004 2049 2101 2419 2.86%

Retail 953 971 980 1005 1040 1076 1114 1324 3.52%

Wholesale 488 495 478 470 455 439 432 405 -1.28%

Data & corporate 287 301 294 308 317 328 340 416 4.13%

Other wireline revenues 203 181 189 190 192 205 215 274 4.97%

Operating costs, excluding D&A 1089 1237 1244 1262 1260 1273 1279 1430 2.26%

Wages and salaries 227 233 232 237 241 247 254 294 3.00%

Post retirement benefits 45 90 72 75 70 75 70 70 0.00%

Direct costs 391 409 414 418 420 422 415 454 1.80%

Commercial costs 113 118 123 118 127 122 125 155 4.40%

Other operating costs 314 388 403 414 402 407 415 457 1.95%

EBITDA 843 710 697 711 744 775 822 990 3.77%

EBITDA pre PRBs 887 800 769 786 814 850 892 1060 3.49%

Depreciation & amortization 366 435 446 451 462 465 454 494 1.67%

Income from operations 477 275 251 260 282 310 368 496 6.15%

EBITDA margin 43.6% 36.5% 35.9% 36.0% 37.1% 37.8% 39.1% 40.9%

EBITDA margin pre PRBs 45.9% 41.1% 39.6% 39.8% 40.6% 41.5% 42.5% 43.8%

Capex 403 565 525 520 405 325 315 335 1.24%

Capex as % of revenues 20.9% 29.0% 27.0% 26.4% 20.2% 15.9% 15.0% 13.8%

Figure 18: Pay TV penetration and market share (historical and forecasts) (2006-2019)


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We expect EBITDA down to 697 M€ in FY2010 and a slight improvement to 711 in FY2011. Costs should stay high due not only to the increase in customers but also due to the continuation of aggressive commercial campaigns in an attempt

to gain market share and keep good net adds momentum. We think however that during 2012/2013 EBITDA margin should invert

decreasing trends, mainly because we believe that good performance in fixed broadband and pay TV net adds will not only increase revenues but also

contribute to decrease cost per customer. This effect should be more noticeable in the pay TV segment, as MEO should reach critical mass23. PT also claims that will reduce costs trough the renegotiation of TV content contracts, as the

increase in customers should give PT more negotiation power. Adding the increase in FTTH customers that should contribute to a decrease in costs, as they are significantly less costly and we expect significant revenue improvement from 2014-2019 (2.86% CAGR) and considerable EBITDA gains for the same period ( 3.77% CAGR).

MEO scenario analysis.

With the reorganization of the wireline market we believe that the three wireline sectors perform with high correlation due to bundle packs. In fact we believe that correlation will increase strongly in the following years as bundle packs will become the dominant offer. Within this thought we believe that the success of MEO is determinant for PT valuation.

We developed a single approach for all the wireline sectors in which we believe Pay TV is the dominant sector while others follow it. Therefore we will only analyze pay TV sector and establish links with the remaining sectors. Supporting our view is the fact that TV is clearly the dominant attribute when choosing a bundle pack (figure 20).

We choose three scenarios for pay TV sector.

In the first scenario we assume PT hasn’t got a leading position in the pay TV market for the future. This could be justified either by dominant position of ZON (marketing strategy/acquisition of Cabovisão) and/or aggressive move from Sonae.com / Vodafone or other player. For this scenario we assume 32% market share in 2019 as we believe that even in these conditions PT has room to improve its current market share.


Critical mass in this case means the number of customers needed to make pay TV self sustainable after all costs had been removed.

Figure 19: Broadband penetration and market share (historical and forecasts) (2006-2019)

Source: Anacom, Company reports, analyst estimates

Figure 20: Relative importance of some attributes when choosing an operator.


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Second scenario considers PT market share in 2019 similar to our previous valuation (47%). Market is close to a duopoly with ZON, and some minor players have reduced market share. The difference to our previous forecasts presented in table 4 is due to different correlations with broadband/fixed phone.

Third scenario places PT in the leading position of pay TV. PT

fibre/brand/marketing factors roll out competitors. For this scenario we assume 62% market share in 2019.

For all three scenarios we assume Pay TV Portuguese market constant to our previous expectations.

To help determining the relation between sectors we regress pay TV net adds vs. ADSL net adds and pay TV net adds vs. fixed phone net adds(in this case disconnections) from 3Q 2007(Pay TV launch) to 1Q2010.

This data suggests a relation between 50%-65%24 of broadband net add per TV add. We stay with 57.7%25 .

We proceed with the same analysis for TV net adds/fixed phone net adds regression. Our relation between both sectors is Y = 0,861X - 76,6526, where Y stands for the fixed phone net adds and X is the pay TV net adds.

We assume EBITDA margin constant to 36.5% in the first scenario, trended to 41 % in the second case and trended to 44% in the third scenario. Our assumptions are derived analyzing historical performance of PT in leading position together with our assumptions that costs per customer decrease as the number of customer increase. However, we do not believe that historical margins above 44%27 will be sustainable, as competition will not allow it. To simplify our analysis we keep ARPU’s constant to our previous forecasts. For capex we consider a 10% decrease to our initial forecast in the first scenario, we maintain the same


Calculated as dividing fixed broadband net adds per TV net adds. 50% and 65% represent the high and the low value for the set of data.


We regressed net adds to intercept 0 resulting in the equation Y=0,577X, and an R-squared of 71%.

In our approach we assume a shift on Y=0,577X to Y=0,85X, across the years until FY2019(In the limit we could assume Y=X, meaning that all customers are triple play subscribers), which is assumed because we believe in higher correlation of bundle offers in the future as well as the diminishing effect of higher number of fixed broadband subscribers then pay TV subscribers (A high number of the first customers to Pay TV already had broadband connections ; pay TV had 0 customers in 2Q 2007 while broadband had 714.8k. As the number of TV customers increase this effect is less notable). The change was done proportionally across the years. (ex: relation in 2011; Y= (0.577 + (2011-2010)*((0.85-0577)/ (2019-2010))) X.


To calculate the relation between fixed phone sector and pay TV we could not simplify the analysis by trending 2009/2010 data to 0 as we did in the fixed broadband sector because PT is losing fixed phone accesses. Therefore we use the standard regression, which results in the equation y = 0,851x - 76, 65 with an R-squared of 0.9655. We adjusted the equation across time as we did in the broadband, to reflect our beliefs. In this case we have to adjust the interception as we believe that as the total number of phone connections decrease the number of net disconnections also decreases. The change was done proportionally across the years ex: relation in 2011; Y= 0.851X – (76-((2011-2010) (76.65/10)). In FY 2019 it will simply stand for Y=0.851



PAGE 15/34

capex for the second scenario and a 10% increase for the third scenario. Table 6 resumes our analysis.

Our valuation using DCF assumptions presented in page 27 result in 3788.8 €M for the first scenario, 5112.8 €M for the second scenario and 6399.5 €M for the third scenario. Although we believe the second scenario is the most likely to occur we do not think that the remaining scenarios are completely far from being possible. As a rough approach we could attribute 25% chance for scenario 1 and 3 and 50% for scenario 2 which will result in a valuation of 5103.3 €M

representing the fair value of Wireline sector, which is 2.08% below our valuation presented in page 27.

All in all, although we are aware of the simplifications of our valuation and as well as the weight of our assumptions what we’d like to highlight is the importance of MEO for the wireline sector and not only for the pay TV sector. What our analysis suggests is that MEO development will be crucial for the future of the Wireline sector and for the future of PT.

Table 6: Scenarios operational (in k) and financial summary in (€M).

Source: Company reports, analyst estimates

1st Scenario FY2010 FY2011 FY2012 FY2013 FY2014 FY2019

Main accesses (K) 4497 4448 4358 4293 4261 4356

Retail accesses 4134 4116 4058 4023 4026 4216

PSTN/ISDN 2548 2382 2221 2087 1986 1841

ADSL retail 914 971 1011 1050 1093 1239

TV customers 671 764 827 886 947 1136

2nd Scenario FY2010 FY2011 FY2012 FY2013 FY2014 FY2019

Main accesses (K) 4769 4874 4966 5060 5132 5731

Retail accesses 4406 4542 4666 4790 4897 5591

PSTN/ISDN 2643 2530 2432 2352 2285 2303

ADSL retail 979 1073 1160 1241 1313 1609

TV customers 784 939 1075 1197 1299 1679

3rd Senario FY2010 FY2011 FY2012 FY2013 FY2014 FY2019

Main accesses (K) 4823 5070 5301 5578 5832 7067

Retail accesses 4460 4738 5001 5308 5597 6927

PSTN/ISDN 2662 2598 2547 2529 2524 2747

ADSL retail 992 1121 1243 1374 1495 1980

TV customers 806 1018 1210 1405 1579 2200

Revenues FY2010 FY2011 FY2012 FY2013 FY2014 FY2019 1st Scenario 1921 1918 1898 1876 1886 1974

2nd Scenario 1928 1937 1974 2014 2031 2398


PAGE 16/34

Mobile domestic - TMN

The mobile market in Portugal is quite mature, with high penetration and relevant competition. There are five operators in Portugal: TMN from Portugal Telecom, Vodafone, Optimus from Sonae.com, ZON Mobile from ZON and CTT, from Portuguese postal services. Only the first three have relevant market share. Although it is a competitive market, shares and finance margins have remained relatively constant in the recent past.

Mobile trends for Portugal.


The Portuguese mobile market, although at a very mature state, had gained 883 k new subscribers in the last two quarters of 2009, after remaining almost flat for the first 2 quarters of the same year. The mobile penetration rate* has reached an impressive value of 149.9, well above the Europe average penetration rate of 121.928 (figure 22).

Mobile broadband subscribers

Mobile broadband subscribers have significantly improve during 2009(figure 21) , with an increase of 1664k possible users29 and even more significantly an increase of 1296k active users30. Mobile broadband subscribers include users of mobile broadband by both 3G phones or network cards/usb pens/modems to be


Progress report on the single European electronic communications market (15th report) 29

Users who have the possibility to use the service. 30

Users which made at least one connection within the relevant quarter. Figure 21: Subscriber evolution (in

thousands) of UMTS 2007-2008; 1Q2009-4Q2009

Figure 22: Mobile penetration rate in Europe in October 2009

Source: 15th communications progress report (European Commission)


PAGE 17/34

used in laptops. Mobile broadband penetration is currently above the European average (figure 23 and figure 24)

Minutes and data traffic.

Minutes have been consistently growing (Figure 25) since the 3 existing players have been offering products that allow unlimited free mobile-on-net calls (Moche in TMN, Extreme in Vodafone, Tag in Optimus). Minutes referring to mobile-international calls, mobile-fixed and mobile off net have been growing at a slow pace.

Mobile data traffic (figure 26) is increasing fast (38% YoY) and should continue so in the upcoming years.


Despite recent MTR’s cuts, following Europe trends (figure 27), ANACOM on January 10th 2010 scheduled new decreases until 2011 (table 7), and will most likely act again to continue decreasing MTR’s after 2011. We think MTR’s are going to be the main reason for the decline in ARPU in the following years. The announced cuts represent circa 46% drop on MTR’s from 31 December 2009 to April 2011


Mobile termination rates.

Figure 24: Dedicate mobile broadband penetration rate in Europe in January 2010 (includes

cards/modems/keys) Figure 23: Mobile broadband penetration rate in

Europe in January 2010 (includes

cards/modems/keys and users of 3G phones )

Source: 15th communications progress report (European Commission) Source: 15th communications progress report (European Commission)

Source: Anacom

Figure 25: Total mobile outbound traffic in Portugal (2003-2009) (thousands of minutes

Figure 26: Evolution of data traffic in Portugal 2007-2009


PAGE 18/34

Mobile penetration forecast

Mobile penetration is currently very high when compared to Europe and therefore we believe that it will not grow at the same rate as in the past. We forecast number of subscribers to reach 18309k32 in 2015, corresponding to a penetration rate of 172%, assuming population constant.


Despite the number of subscribers having historically been following a very significant linear trend (figure 28), we believe it cannot follow it forever. The number of mobile subscribers loses momentum as penetration increases. However In 2004 penetration had reached 100.4% and mobile subscribers kept


To reach this value we assume 95% phone penetration in Portugal in 2015, 26% penetration of dedicated mobile broadband and more 7.5 percentage points of penetration reflecting second SIM’s adds (either by using of personal/job phone or by using two different operators) and also by new products using SIM’s. 3G phones are not consider as an increase in penetration since they reflect just changes in the mobile phone / operator plan.

Figure 28: Evolution in number of mobile subscribers 1995-2009 (in thousands)

Figure 29: Evolution in number of mobile subscribers

(1995-2004; 2005-2009; forecast 2010-2015) (in thousands)

Source: Anacom Source: Anacom, analyst estimates

Source: Anacom Date TMN,Vodafone,Optimus 31 December 2009 0.065 01 February 2010 0.060 01 April 2010 0.055 01 July 2010 0.050 01 October 2010 0.045 01 January 2011 0.040 01 April 2011 0.035

Table 7: MTR’s reduction plan (in €cents)

Figure 27: MTR’s evolution in Portugal and Europe (in €cents) (2006-2009)

Source: 15th communications progress


PAGE 19/34

boosting almost at the same speed until 2009(figure 29). We explain this for two reasons:

• Mobile broadband subscribers were able to keep number of subscribers

growing at a fast pace33. • Phone penetration (figure30) had room to improve34.

For 2010-2015 we believe that mobile subscribers will still grow but not as fast as before.

We believe mobile broadband subscribers will somewhat still increase in the following years, especially after 2011, when LTE35 reaches the market. We believe that LTE will not only convert current subscribers of UMTS

(HSPA/HDSPA) but will be able to gather new users for mobile broadband services. Phone penetration (figure 30) from now on will be very resilient to improvement, since it is already at a very high level. Few subscribers will come

from new clients using a new cell phone.

Also, some additional subscribers will come from new products that will use SIM cards, like automobiles, appliances and consumer electronics. However we only expect these new clients to start having a noticeable effect in 2014/2015, as we think the industry will take some time to make these products common to the average consumer. For 2015-2020 we do believe that new clients will come majorly from these so called new products with SIM cards. In fact the automobile industry is already presenting cars that allow access to high mobile broadband, either for security, entertainment or navigation reasons, and also, as a way of upgrading software in the car without the necessity of moving the car to the garage. Audi already plans to include 3G in some cars later this year. If the implementation of mobile broadband in the car industry succeeds we could easily find ourselves in the in presence of penetration rates in the range of 190-220%36 in 2020.


We account for 1706 k adds in the period(2004-2009) for dedicated mobile broadband users, or 16.1 percentage points in penetration


This effect accounted for 1488k adds in the period according to our estimates. If we remove the sum of this effect with the effect on footnote 18 we can get an estimate of 2nd card adds for personal/job use or by using two different operators in the period of 2004-2009. The estimative is 2150 k or 20.2 percentage points. In fact we only assume 7.5 percentage points for the period 2010-2015 as we believe that this effect will be much smaller than in the period of 2004-2009. 35

Long term evolution. TMN already demonstrated the use of speeds reaching 100 Mb d using this technology. 36

We estimate a possible 0.8 M cars using 3G in Portugal if the technology succeeds on the car industry. Portugal has currently 5.7 M cars. We simplify the approach assuming that in premium car marks on 2020 3G will be on 35% of cars and in the remaining 3G will be on 15%, assuming number of cars constant. Industrial/commercial cars assumed 0% for simplicity. Source of data was Portal lnforma.

Figure 30: Portugal evolution in phone penetration (2004-2009)

Figure 31: Portugal phone

penetration by age and sex. 2009

Source: Marktest Source: Marktest


PAGE 20/34


Table 8 shows our forecasts for TMN operational data.

We believe ARPU will decrease until FY 2012 due mainly to the MTR impact. All mobile players ARPU’s have been experiencing declining ARPU’s (Figure 32) due to declining MTR’s, penetration in bottom levels of market and competition forcing prices down. We expect not only TMN ARPU, but all players ARPU’s to keep falling until FY2012, as we think that mobile broadband growth and subscription of additional products like “mobile TV” will not be able to

compensate the reasons for the current declining ARPU. After 2012 we believe that with the traditional voice market almost fully penetrated and therefore no more relevant increase in customers due to bottom market clients together with the major impact of MTR’s in revenues fulfilled ARPU’s can recover, but not by much, as competition will not allow it. We also believe that the 2010 customer bill ARPU that we estimate for TMN reflects the impact of the current

macroeconomic conditions already referred in Wireline. We believe in a slight positive macroeconomic impact for the following years.

To balance the decreasing voice ARPU, data will play a big role. In fact we think data revenues will growth very fast to represent 36% of revenues in FY2014 and 43% in FY2019. We do believe that mobile broadband either as 3G phones and as mobile broadband network cards will be the reason for the slight ARPU growth in the future..4G networks that should arrive in the form of LTE in 2011/2012 should emphasize the effect of data on ARPU. Also we think as data gain more relevance the current KPI’s37 will make no more sense in the future. As VoIP will


Key performance indicators.

Operational data FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019 CAGR

Customers ('000) 6944 7252 7478 7595 7724 7819 7888 8524 1.56% Net additions ('000) 683 319.30 226.00 116.85 129.15 94.30 69.70 MOU (minutes) 115 117.20 118.50 119.00 121.00 124.00 126.00 132.00 ARPU (Euro) 18 16.21 14.70 14.60 14.55 14.60 14.60 15.42 1.10% Customer bill 15 13.99 13.00 13.10 13.20 13.30 13.40 14.55 0.00% Interconnection 3 1.92 1.50 1.30 1.15 1.10 1.00 0.67 -7.63%

Data as % of service revenues 20.3% 23.1% 25.6% 28.7% 31.3% 33.0% 36.0% 43.0% 3.62%

Employees 1082 1004 1000 1000 1000 1000 1000 1000 0.00%

Figure 32: ARPU’s evolution for TMN, Optimus and Vodafone; 4Q 2007-4Q 2009Q (in €)

Source: Company reports, analyst estimates

Table 8: TMN operational data


PAGE 21/34

probably dominate and as new products will start using SIM cards MOU’s38 and ARPM39 will make no sense. In fact we think the relevant KPI’s will concern the amount of traffic transferred and not minutes as they do now.

For now we assume MOU will increase to 121 in FY 2012 and to reach 132 in FY2019 due to the increase in data.

Also we think the increase in percentage of post paid subscribers (figure 33) could contribute slightly for the increase in ARPU’s, as their ARPU is

considerable higher. Portugal has traditionally a low level of post paid clients. All and all, the reasons we present for the increase in ARPU will have just a balancing effect on the competition effect which forces ARPU down. For that reason our 2014-2019 CAGR ARPU is 1.1%, which should be below inflation. Based in our assumptions for subscribers presented before we think TMN will continue to increase customers but not as fast as it did in 2009. However for the period of 2015-2019 a lot of uncertainty remains whether new products that use SIM cards, with focus on automobiles, will be common to the medium-high user or not.

Our best guess for employees is that will remain stable for the same reason

explained in wireline.


Minutes of usage. 39

Average revenue per minute.

Financial data FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019 CAGR

Operating Revenues 1601 1518 1460 1488 1514 1542 1561 1782 2.69% Services rendered 1433 1360 1299 1320 1338 1362 1376 1566 2.62% Billing 1175 1173 1149 1185 1213 1240 1263 1477 3.19% Interconnection 231 161 133 118 106 103 94 68 -6.25% Roamers 26 26 26 28 31 33 35 55 9.46% Sales 159 144 140 145 150 152 153 161 1.00%

Other operating revenues 9 14 12 13 14 15 16 21 5.59%

Operating costs, excluding D&A 912 844 838 873 914 931 948 1074 2.52%

Wages and salaries 52 48 46 47 49 50 52 60 3.00%

Direct costs 279 259 257 275 302 305 308 357 3.00%

Commercial costs 324 277 295 305 311 317 324 357 2.00%

Other operating costs 257 259 240 246 252 258 265 300 2.50%

EBITDA 682 674 622 615 600 612 613 708 2.94%

Depreciation & amortization 232 221 211 216 222 208 203 221 1.67%

Income from operations 450 453 411 399 379 403 410 488 3.54%

EBITDA Margin 42.8% 44.4% 42.6% 41.3% 39.6% 39.7% 39.3% 39.7%

Capex 245 180 180 195 255 195 185 185

Capex as % of revenues 15% 12% 12% 13% 17% 13% 12% 10%

EBITDA minus Capex 437 494 442 420 345 417 428 523 4.11%

Figure 33: Evolution in Portugal% of post paid clients to total clients

Figure 34: EBITDA margin evolution for TMN, Optimus and Vodafone; 1H2007-2H2009

Source: Anacom

Source: Company reports, analyst estimates

Table 9: TMN financial data € mn Source: Company reports


PAGE 22/34

Concerning financial data (table 9) in our view TMN will decrease considerable revenues on FY2010, mainly due to macroeconomic conditions and the impact of MTR’s. We estimate a decrease in revenues from 1518 mn € FY2009 to 1460 mn € FY2010 (-3.97% YoY). EBITDA margin (figure 34) should fall due to the same reason as revenues and we believe will stabilize after MTR major impact. Capex should increase significantly in 2012 due to LTE investments and should therefore return to a “steady state” of 180-200 M€.

In our view, market shares both in subscribers (figure 35) and in minutes (figure 36) are quite defined and probably will continue that way. We do not see any more players coming in the near future and we think both ZON and CTT, the 4th and 5th player will play no threat for TMN leading position. Optimus after an aggressive strategy in 2008 and 2009 reducing prices, which lead to a slight increase in total minutes, should maintain prices stable for 2010. Overall, Optimus is the main operator with an incentive to deviate prices to gain market share. However Optimus current EBITDA margin do not allow major cuts. As for TMN and Vodafone any change in prices will be followed by the other operator leaving subscribers unchanged and resulting in lower EBITDA margin.

Figure 35: Evolution in market share of subscribers by operator; 4Q2007-4Q2009

Figure 36: Evolution in market share of minutes by operator; 4Q2007-4Q2009


PAGE 23/34

Mobile Brazil - VIVO

Vivo is the leading mobile company in Brazil and in our opinion will be the vehicle for PT’s growth in following years. While domestic market is close to saturation, Brazil presents interesting figures for PT. Main competitors are Oi (Telemar); Claro (owned by América Móvil), and TIM (Telecom Italia Mobile hold by Telecom Italia).

Mobile trends for Brazil.

Brazil mobile market , like most of Latin America countries have been

experiencing exciting growth in the past years, and in our believe will continue through the following years. Figure 38 shows mobile penetration for major Latin America countries including Brazil.

As we can see from figure 38 Brazil mobile penetration despite been growing at fast pace is still below Latin America mobile penetration. Figure 39 shows the difference of mobile penetration in percentage points between Brazil, Latin America and Europe. These differences suggest aproximately 12M40. new subscribers when comparing to Latin America penetration and 60.5M when comparing to Europe penetration


Assuming 192 924 506 population in Brazil. Source IBGE (Instituto Brasileiro de Geografia e Estatística) Figure 37: Mobile penetration in Brazil, Latin

America and Europe in 2009

Figure 38: Evolution of mobile penetration in countries of Latin America.

Source: Teleco, European Commission, analyst estimates


PAGE 24/34

3G mobile broadband (figure 39) is increasing exponentally and in 1Q 2010 is already above fixed broadband. (Fixed broadband penetration per habitant in 1Q 2010 was 6.12% which compares with 6.6% penetration from mobile broadband.) Europe has currently a mobile broadband penetration of 121.9% which make us believe that there is still a large potential for growth.

Macroeconomic forecasts also (table 10) encourage the development of mobile sector in Brazil.

Figure 40 shows our believes to population and mobile penetration evolution. We expect penetration rate to reach 139%41 in 2019 and population to reach 207 M assuming IMBG forecasts.


Our forecast it is not detailed as the Portuguese market mainly due the lack of data available. We assume that Brazil will behave similar to Argentina which has currently higher levels of mobile penetration and that will converge to a similar state as Europe. Also we believe that the deficit in fixed phone lines in Brazil is consistent with high levels and fast grow of mobile penetration.

FY2008 FY2009 FY2010 FY2011

Brazil GDP 5.10% -0.20% 5.50% 4.10%

Consumer Price Index 5.70% 4.90% 5.10% 4.60% Current account balance -1.70% -1.50% -2.90% -2.90% Source: Teleco

Figure 39: Evolution of mobile broadband accesses (left)(in thousands) and mobile broadband penetration (right) in Brazil

Table 10: Brazil macroeconomic forecasts

1995-2004; 2005-2009; forecast

Figure 40: Population (left) and mobile penetration rate (right) historical evolution and forecast

Source: IMF


PAGE 25/34


We expect customer to keep boosting reaching in FY2019 85670M subscribers. Our forecasts are based on constant market share(figure 41) close to 30%, as we believe VIVO has proven that can hold its market share relatively constant despite fierce competition. Recent net adds(figure 42) and churn(figure 43) reinforce our view. Customer cumplaints (figure 44) also places VIVO with clear advantage with the remaining competitors. We therefore believe that VIVO will be able to sustain some level of leadership above a perfect competitive market where four players split the market.

Table 11: VIVO operational data

Figure 41: Market share evolution for VIVO, Claro, TIM, and Oi; 2007-2009; 1Q2010; April 2010

Figure 44: Number of complaints per 1000 subscribers for VIVO, Claro, TIM, Oi;1Q2009-1Q2010

Operational data FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019 CAGR

Customers (K) 44945 51744 58729 64628 69303 73419 76361 85670 2.33% Net additions (K) 7475 6799 6985 5899 4675 4116 2942 MOU (minutes) 87 92 112 117 121 121 120 120 ARPU (R$) 29.19 26.41 24.8 23.7 23.2 23 23 24.5 1.27% Customer 16.85 15.87 15.4 14.7 14.5 14.5 15 17 2.53% Interconnection 12.1 10.31 9.2 8.8 8.5 8.3 7.8 7.3 -1.32%

Data as % of service revenues 10.2% 13.6% 18.5% 23.3% 28.1% 32.3% 35.1% 51.0%

Figure 42: Net adds market share evolution for VIVO, Claro, TIM, Oi; 2007-2009; 1Q2010

Figure 43: Churn evolution for VIVO, Claro, TIM, Oi; 1Q2009-1Q2010

Source: Teleco

Source: Teleco Source: Teleco Source: Teleco


PAGE 26/34

We foressen ARPU’s(figure 45) to keep decreasing as competition will drive prices down, together with penetration in the bottom level of the market. We believe ARPU to fall to 24.8 ₨ in FY2010, and 24.5 ₨ in FY2019. Data in our believe will be able to boost ARPU, but just enough to balance the decrease that we forecast. We believe data to reach 51 % of service revenues in FY2019, following world trends

and also benefiting by the deficit in the current fixed broadband market. Macroeconomic conditions will also contribute to a minor decrease in ARPU as we

believe that Brazil will increase consistently GDP per capita until 2019. The effect of a rellatively high forecasted CPI42 also balances decrease in ARPU’s. For these reasons we believe customer ARPU will stabilize between 2013-2014 and grow slowly from there on to FY2019.

Concerning financial data we believe revenues will growth 4.78% in 2010 vs 6.85% in 2009. Revenue growth will be impulsionated by increase in customer as we believe ARPU’s will drop considerably. We expet EBITDA margin to stay relatively constant despite ARPU’s drop, since costs per customer should

decrease based on scale factor. Capex should stay high due to improvements on the current network coverage as

well as investments on 3G and 4G.

It is worth to mention that the depreciation presented in the table 11 is quite different from VIVO income statements, as we consider depreciation that PT


Consumer Price Index Figure 45: ARPU’s evolution (in ₨) for VIVO, Claro, TIM, Oi; 1Q2009-1Q2010

Table 11: VIVO financial data (In Mn of ₨)

Financial data FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019 CAGR

Operating revenues 16255 17369 18200 19362 20542 21663 22707 27342 3.79%

Services rendered 14310 15681 16438 17541 18643 19696 20670 25022 3.90%

Sales 1568 1299 1360 1414 1485 1545 1606 1844 2.80%

Other operating revenues 377 389 402 406 414 422 431 476 2.00%

Operating costs, excluding D&A 11803 12126 12717 13458 14043 14619 15136 18045 3.58%

Wages and salaries 771 891 1009 1089 1176 1235 1285 1561 3.98%

Direct costs 3028 3395 3804 4108 4359 4620 4782 5603 3.22%

Commercial costs 4252 3994 3944 4181 4306 4435 4569 5379 3.32%

Other operating costs 3752 3845 3961 4079 4202 4328 4501 5502 4.10%

EBITDA 4452 5243 5483 5904 6499 7044 7571 9297 4.19%

Depreciation & amortization 3320 3981 3957 3640 3120 3129 3118 3298 1.13%

Income from operations 1132 1261 1526 2264 3379 3915 4452 5998 6.14%

EBITDA Margin 27.4% 30.2% 30.1% 30.5% 31.6% 32.5% 33.3% 34.0%

Capex 2729 2330 2355 2655 2585 2525 2355 2150 -1.80%

Capex as % of revenues 16.79% 13.41% 12.94% 13.71% 12.58% 11.66% 10.37% 7.86%

Source: Teleco


PAGE 27/34

reports. The difference concerns the depreciation in goodwill that was registed at aquisition.


Our DCF assumptions are described in table 12. Real/EUR exchange forecasts are showed in table 13.

DCF Inputs Wireline/TMN VIVO

Risk free43 4.5% 6.3% Cost of debt44 5.4% 6.1% Return on equity (levered) 9.7% 12.1% Market premium45 6.5% 7.5% Levered beta46 0.84 0.93 Unlevered beta 0.65 0.72 Debt/Entreprise Value47 38.2% 10.1% Tax rate48 23.9% 34.0% WACC 7.6% 10.9% g 0.5% 2.5%

We value PT as SOP49 using DCF for Wireline, TMN and VIVO, multiples for Africatel50 , Timor Telecom51 and CTM52, market capitilization for UOL53 and book


OTC 10 year’s average in the last 2 years for Portugal and the Brazil government 10 year bond last 2 years average for Brazil.


FY 2009 interest paid / total debt from PT/VIVO reports 45

Damodaran 2009 for Portugal, Damodaran January 2010 for Brazil. 46

For Wireline/TMN beta was computed as the average beta between PSI20 and PT for the last 5 years using weekly and monthly data. For VIVO beta was computed as the average beta between BOVESPA and VIVO for the last 5 years using weekly and monthly data. Both betas were adjusted assuming mean reversion as Bloomberg(1/3 + 2/3 beta) 47

Assuming value of book debt equal to market value. 48

For Wireline/TMN we use the last 5 years effective tax rate, excluding 2006 (PT Multimedia spinoff) For VIVO corporate tax was assumed.


Sum of the parts. 50

We used EV/EBITDA multiple. We used the value 5.9 to value Africa operations. We computed this value as the simple average from telecommunications companies in Middle East/ Africa, provided by Bloomberg.


We used EV/EBITDA multiple. We used the value 6.1 to value Asian operations. We computed this value as the simple average from telecommunications companies in Asia, provided by Bloomberg.

FY2009 FY2010 FY2011 FY2012 FY2013 FY2014 FY2019

EUR/REAL 2.77 2.48 2.53 2.61 2.78 2.92 3.10

Source: Bloomberg, company reports, analyst estimates

Source: Bloomberg, analyst estimates Table 12: DCF assumptions


PAGE 28/34

value with goodwill for Páginas amarelas. Table x resumes our valuation. Our valuation implies a FY2010 price target of 9.61 €, 13.1% above 3 June 2010 closing price. Therefore our recommendation is hold. However we believe that the M&A possible movements described in the topic below deserve special attention.

We provide sensitivity analysis concerning WACC and g in for PT (table 15), for PT mainland operations (TMN + Wireline) (table 17) and for VIVO (table 16).


Refer to footnote 51. 53

Market capitalization in 3 of June, adjusted to € using 3 June Euro/Real exchange rate. WACC -2.0% -1.0% 0.0% 1.0% 2.0% -0.5% 15.99 11.53 9.09 7.22 5.73 g 0.0% 16.77 12.39 9.49 7.65 6.05 0.5% 17.70 13.40 10.38 8.13 6.41 1.0% 18.84 14.61 11.18 8.69 6.81 SoP (in €M)

Valuation value weight weight to PT EV to PT

DCF Wireline 5211.6 100% 100.00% 5211.6 DCF Tmn 4856.0 100% 100.00% 4856.0 DCF Vivo 15592.9 100% 29.71% 4632.7 7000.0 3050.0 Africatel 75% multiple Unitel 25% 18.75% 868.4 multiple MTC 34% 25.50% 112.8 multiple CVT 40% 30.00% 74.3 multiple CST 51% 38.25% 7.4 multiple CTM 28% 28.00% 133.2

multiple Timor Telecom 41% 41.12% 34.3

market cap UOL 29.00% 138.6

book value w/goodwill Páginas amarelas 25% 86.0

enterprise value 14572.7

net debt 2010 4857.0

unfunded post retirement liability 1211.6

equity value 8504.1

price target 2010 9.49

Table 14: PT Sum of the parts valuation in € mn

Source: company reports, analyst estimates

Source: analyst estimates

Table 15: Sensitivity analysis concerning WACC and g for PT (in €)


PAGE 29/34


On the 10th of May Telefonica had made an hostile bid worth 5700M€ for the 29.71% PT’s stake on VIVO. According to our valuation it implies a 23% premium and an EBITDA2010/EV of 8.67. (PT in 2009 had sold to Telefonica the 32.18% stake in Medi telecom for 400M€, implying an 8.4 EBITDA/EV). The bid was rejected by PT board. From there on sucessive movements have been played by the two operators from which we highligh Telefonica threat to adquire PT, intead of VIVO, which lead the Portuguese prime minister to said that “the golden share exists to be used”. This comment, in our opinion completely set aside the possibility of Telefonica to buy PT. While the golden share can even stop the selling of VIVO we believe that if

shareholders agree the government is unlikely to stop the sell.

On the 1st of June Telefonica increase its previous offer to 6500M€. This offer implies a 40% percent premium over our valuation and an EBITDA2010/EV of 9.89,

WACC -2.0% -1.0% 0.0% 1.0% 2.0% -0.5% 13.36 10.96 9.22 7.90 6.86 g 0.0% 14.34 11.61 9.49 8.22 7.10 0.5% 15.55 12.37 10.17 8.57 7.35 1.0% 17.03 13.27 10.74 8.98 7.64 WACC -2.0% -1.0% 0.0% 1.0% 2.0% -1.0% 10.84 10.02 9.38 8.87 8.45 g -0.5% 11.12 10.22 9.52 8.98 8.54 0.0% 11.44 10.45 9.49 9.10 8.62 0.5% 11.82 10.70 9.87 9.23 8.72 1.0% 12.26 11.00 10.08 9.38 8.84

Table 16: Sensitivity analysis concerning WACC and g for VIVO (in €)

Table 17: Sensitivity analysis concerning WACC and g for domestic operations (TMN+Wireline) (in €)

Figure 46: Weights of PT SoP Valuation in total PT value.

Figure 47: Split between sum of DCF in 2010-2019 and perpetuity.

Source: analyst estimates Source: analyst estimates


PAGE 30/34

a multiple that we consider already very atractive54. PT this time set the final decision for its shareholders55. Shareholder will meet on the 30th of June to decide if they will sell at the current offer or any offer that could be made meanwhile. The deadline for PT to decide Telefonica’s offer coincide with the day of the shareholder meeting.

Telefonica’s interest on VIVO goes far from just VIVO control. Telefonica plans to merge its fixed line business Telesp with VIVO. Telefonica wans to capture not only capital structure and tax synergies but also operative sinergies from which we highligh the synergies captured in terminal rates, that still very high in Brazil. Telefonica claims sinergies to reach 2800 M€56. From this value we could assume that if Telefonica decide to keep 50% of the expected synergies the fair bid according to our valuation implies a value of 6032 M€. In the limit the offer could reach 7432 M€ assuming that Telefonica sacrifices 100% of sinergies.

However if we remind last acquisition in Brazil, in the end of 2009, GVT(provides fixed line services) was sold to Vivendi by 13 EBITDA/EV and Telefonica had bid a value which implies an EBITDA/EV of 11 in a business that should not have the same sinergies than the consololidation between VIVO and Telesp. Therefore we believe that there is still a possibility of a raise in the current offer. At 11 times EBITDA/EV the offer would be around 7225 M€ assuming our EBITDA forecast of VIVO for 2010.

As we believe that there is a considerable probability of the business to suceed we try to analyse the impact on PT. Assuming that PT sells its stake for 6500M€ the immediate effect on PT shares according to our model implies a price target of 13.33 €57, an upside of 38.7% vs our price target and 56.5% vs the curent price. Assuming a 7 bn € our model implies a price target of 13.89 €, 38.7% above our price target and 56.5% above the current price. However we do not expect the money to stay in “Cash”. We estimate two possible scenarios, where we believe the second is the most likely in case of PT selling its stake at VIVO.

Scenario 1.

First, we could assume that PT leaves Brazil and distributes a special dividend without investing in another company. PT, in order to keep debt to EBITDA equal to the current multiple will have to reduce some of its current debt. We estimate that without Brazil PT will have to reduce 1293 M€ to keep the ratio stable. The

remaining value could be distributed as a special dividend which will result in 5.81€


In last 7 years in the telecom sector there were 37 deals on Brazil, which had a median EBITDA/EV of 3.97. The smaller transaction was done by 1.46 EBITDA/EV while the higher was done by 13.87. Although it is a reference every deal has different synergies implying different EBITDA/EV multiples. Source: Bloomberg.


Telefonica owns 10% of PT. It is still not decided if Telefonica will have voting rights or not. 56

From a consensus with 13 analyst estimates, with a minimum value of 2bn € and a maximum value of 4bn €. 57


Figure 3: VIVO revenues and  EBITDA (2004-2009) €M  1995-2004; 2005-2009;
Figure 8: Evolution in fixed  broadband subscriber’s  1Q2007-4Q2009
Figure 13: Houses passed in  Europe by FTTH/B (in  thousands) in FY2009
Figure 15: Broadband speed and price evolution in Europe.


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