Telecom Italia Deal Has Brazilian Downside

News that Telefónica has increased its indirect ownership of Telecom Italia has drawn criticism from regulatory authorities in both Brazil and Argentina , where the two companies have been fierce competitors for almost two decades . The increased investment in Telecom Italia do es not - yet - jeopardise Telefó nica's Latin American business. However, further entrenchment may prove unavoidable, in which case BMI believes there are significant potential long-term downside risks with which the operator will need to contend.

The Spanish incumbent has agreed to increase its ownership of Telco - the holding company owning the single largest stake (22.4% ) in Telecom Italia - to 66%. The move is aimed at both protec ting its long-held strategic in vestment in the Italian incumbent and preventing Telecom Italia from falling victi m to a hostile take-over bid . Increased ownershi p of Telco does not raise Telefónica's voting rights: these remain at 46.2% of Telco, meaning that there has been n o substantive increase in Telefó nica's ability to influence management-level strategic decisions, includin g those invol ving TIM Brasil , Telecom Italia's Brazilian fixed and mobile unit.

Nevertheless, Telefónica does have the right to convert its non-voting shares in Telco into ordinary shares with commensurate voting rights for 70% of the holding company . Such a move would give it the opportunity to buy out the rest of the shareholders in Telco. Although Telefónica says it has no plans to do so, it could be forced down this route if the remaining Telco shareholders were to withdraw for any reason. If Telefónica became the dominant shareholder of Telco, it would become a direct investor in Telecom Italia and contravene competition laws in both Brazil and Argentina, wherein it is forbidden for a single entity to own or control more than one specific telecoms concession in the same service area.

Which To Choose To Keep?
Mobile Market Shares By Operator, Q213

News that Telefónica has increased its indirect ownership of Telecom Italia has drawn criticism from regulatory authorities in both Brazil and Argentina , where the two companies have been fierce competitors for almost two decades . The increased investment in Telecom Italia do es not - yet - jeopardise Telefó nica's Latin American business. However, further entrenchment may prove unavoidable, in which case BMI believes there are significant potential long-term downside risks with which the operator will need to contend.

The Spanish incumbent has agreed to increase its ownership of Telco - the holding company owning the single largest stake (22.4% ) in Telecom Italia - to 66%. The move is aimed at both protec ting its long-held strategic in vestment in the Italian incumbent and preventing Telecom Italia from falling victi m to a hostile take-over bid . Increased ownershi p of Telco does not raise Telefónica's voting rights: these remain at 46.2% of Telco, meaning that there has been n o substantive increase in Telefó nica's ability to influence management-level strategic decisions, includin g those invol ving TIM Brasil , Telecom Italia's Brazilian fixed and mobile unit.

Which To Choose To Keep?
Mobile Market Shares By Operator, Q213

Nevertheless, Telefónica does have the right to convert its non-voting shares in Telco into ordinary shares with commensurate voting rights for 70% of the holding company . Such a move would give it the opportunity to buy out the rest of the shareholders in Telco. Although Telefónica says it has no plans to do so, it could be forced down this route if the remaining Telco shareholders were to withdraw for any reason. If Telefónica became the dominant shareholder of Telco, it would become a direct investor in Telecom Italia and contravene competition laws in both Brazil and Argentina, wherein it is forbidden for a single entity to own or control more than one specific telecoms concession in the same service area.

Brazilian telecoms regulator Anatel and competition watchdog Administrative Board of Economic Defense (CADE) are reviewing the issue but have already warned Telefónica that it would be forced to sell one or other of its Brazilian operations - market leader Vivo or second-ranked TIM Brasil - within 12 months of it taking control of Telecom Itali a. A similar choice faces Telefó nica in A rgentina where directly-owned Móvistar and Telecom Italia-owned Personal compete in the mobile market.

The Latin American businesses are both highly important cash generators for both Telecom Italia and Telefó nica. Although highly saturated and extremely competitive, both Argentina and Brazil continue to record robust subscriber and service revenue growth, thanks to efforts to migrate customers to 3G/4G mobile broadband networks, offering converged service packages and encouraging consumption of premium value-added services. Shedding two of the four units would jeopardise future growth needed to counter faltering or negative growth in both Spain and Italy as well as perilously high debt piles.

While BMI appreciates T elefó nica's decision to increase its ownership of Telco is most likely motivated by the desire to protect Telecom Italia long enough to manage unmolested the completion of its restructuring process - including the disposal of non-core assets for fair prices - events could yet push it in unwanted directions and compromise its carefully cultivated investments in Latin America. As it would not be permitted to sell those dominant operators to existing rivals, Telefónica would need to deal with new entrants with less cash and the power to drive a hard bargain, BMI believes.

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Sector: Telecommunications
Geography: Brazil, Brazil, Argentina, Spain, Italy, Brazil, Brazil
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