BRP & BTM: Good Calls in Brazilian Telecom

Investopedia Advisor submits: In a surprise move, Telecom Italia announced a couple of days ago that it had hired JP Morgan to start shopping around the 38% stake the company currently holds in Brazil Telecom Participacoes SA (BRP), the holding company whose principal asset is a controlling stake in Brazil Telecom SA (BTM), Brazil's third largest fixed-line telecom operator.

The move was a surprise in light of the fact that Telecom Italia has been fighting for years to control BrazilTel in a bitter struggle that had included allegations of corruption, bribes, corporate spying, late night police raids on the homes of executives and the possible involvement of top ministers in the Brazilian government, including the current President Luiz Inacio Lula da Silva. The whole thing had all the makings of a plot line from one of Brazil's wildly popular sex and scandal television soap opera “telenovellas”, an addictive form of entertainment that has supplanted reality in the minds of many Brazilians.

Whoever JP Morgan finds as a buyer for the BrasilTel stake, the move will be welcome news for the company as it should now be able to expand its cellular operations more aggressively now that Telecom Italia is bowing out. Previously, Telecom Italia had supressed BrazilTel's moves into the rapidly growing Brazilian cellular market in an effort to protect its own direct investment in subsidiary TIM Brazil, the second-largest cellular operator in the country. This should also be good news to Citigroup Inc. (C) the other controlling shareholders in BrazilTel.

Globally, the fixed-line business these days is just a cash cow operation. To grow their top and bottom lines, telcom operators around the world have ramped up their service offering to include cellular operations and broadband internet access. The same story applies in Brazil.

So, now that its growth prospects have improved somewhat, is Brazil Telecom (whose holding and operating company shares both trade as ADRs on the New York Big Board), an attractive investment for U.S.-domiciled investors?

As we’re dealing with an emerging market investment here, we need to consider the country as much as the company. Fortunately, Brazil has come a long way since the 1980’s when it was a World Bank basket case suffering triple-digit rates of inflation. Brazilian inflation is now tracking at only 4.5% a year. Much of the credit for this improvement has been due to the tight money policies of the Brazilian central bank which has produced some of the highest real rates of interest in the world. Despite recently cutting rates to a twenty year low, the benchmark SELIC rate still stands at 14.75%. And you thought the Fed was tough on inflation.

While real rates at these levels would have clobbered most economies, Brazil’s ethanol economy keeps rolling along. Not only does the country have full energy independence, but strong global demand for its agri-products and manufactured goods are expected to boost growth this year and into 2007.

The prospects for continued political stability are also good. Moderate left-of-centre President Lula is virtually assured of re-election this October and has promised to stay the course with his progressive policy mix of social assistance to the poor, combined with pro-business strategies designed to boost Brazil’s export competitiveness and lower domestic rates further.

All this should continue to keep the Brazilian real one of the strongest currencies in Latin America, with good prospects of further appreciation against the U.S. dollar. Confidence in the currency is a necessary pre-condition when investing in a super-yield cash cow like BrazilTel, whose ADRs pay out in the U.S. dollar equivalent of the local currency dividend. As a result of last May’s re-rating sell-off in the emerging markets, BrazilTel’s holding and operating company ADRs are now down approximately 26% and currently offer dividend yields of 12% and 13.5% respectively. Normally, yields at these levels would have been enough to coax me into taking on the country risk inherent in such an investment, but with the added prospect of a future growth kicker coming from expanding cellular operations, the risk return ratio has become even better.

BRP 1-year chart:

BTM 1-year chart:

By Eugene Bukoveczky, Contributor - Investopedia Advisor

At the time of release Eugene Bukoveczky did not own any shares in any of the companies mentioned in this article.