Telecom Argentina (TEO) is a volatile stock with an 84% share price increase over the last 52 weeks interspersed with repeated daily pops and drops of 5-10% during the course of this significant overall rise. Despite this rapid rise TEO remains tremendously under-valued with a current price just under $20 and a fair value of $42. In addition, TEO has a $1.2B share buyback program underway with $310,000 already spent, retiring 10.8 million shares as of September.
TEO's Q3 earnings results announced October 31st was very strong with a 41% net income increase and 24% consolidated revenue growth over the same quarter in 2012. Non-voice average revenue per user was up by 34%. Operating income before depreciation and amortization was up 18% year-over-year. Margins were down slightly from 29% to 28%, so this needs to be watched, but is hardly alarming. Operating expenses were up 26% year-over-year, but not surprising given the sales and income growth numbers along with large wage and tax increases.
There are some cost concerns. Taxes were up significantly. Consolidated costs as a percent of revenue were up from 70.6% for the first three quarters of 2012 versus 72.1% for the same period in 2013. Wage agreements with the unions called for a 25% overall increase with a 15.5% increase starting in July of 2013. Wages are currently 20% of total costs so this number will bear watching in future updates. Although this increase will impact TEO's margins going forward the magnitude of the increases is not altogether shocking given the general growth of the middle-class across Brazil and continued inflation. TEO's CEO, Stefano de Angelis, noted they are actively engaged in cost management efforts to offset the wage and tax increases. As an example, TEO has reduced handset subsidies without impacting growth.
TEO's subscriber base was up 5% year-over-year to 19.9 million, but there is probably still some room to run with just over 200 million people in Brazil to be shared by competitors and much stronger growth in usage across existing and new subscribers. TEO is also expanding at a slightly faster rate in Paraguay. The issue of "saturation" is raised by some analysts, but each quarter there seems to be less evidence the ceiling is near.
The government has pressured TEO to improve the quality of telecom service through infrastructure investments. Whether in response to this pressure or simply as a result of business necessity, TEO's CAPEX investments rose 55% year-over-year.
Mobile usage continues to grow, up 28% year-over-year. 3G usage is up 77% year-over-year.
Shares were up 4.37% after the earnings announcement so investors were a bit surprised by the magnitude of the improvement.
There is a looming issue with the dividend. At their April 2012 general meeting Telecom Argentina shareholders voted a P$ (Argentine Peso) 1 billion reserve for potential 2013 dividend payments. If this reserve is paid out the dividend yield would be about 4.5%, roughly in line with previous years. The dividend was last paid in May of 2012 against the request of the Argentinean government.
On their 2nd quarter conference call this June, transcribed by Seeking Alpha, TEO stated money was set aside for dividend payments, but had not yet been distributed. This reserve is in line with prior distributions, although there has not been a final determination as to whether this reserve will be paid out in 2013, or ever. The 2010 allocation was P$ 1,053 million in two installments, 2011's allocation was P$ 915 million with P$ 807 million paid in May of 2012. If the full amount is paid it would be spread across a little under one billion shares or roughly P$ 1.02 per common share or P$ 5.10 per ADR (one ADR = 5 common shares) or $USD 0.87. This would be a very respectable 4.5% dividend yield. In response to two questions from analysts on timing, TEO's CEO Stefano de Angelis said the final decision was the purview of the Board and the Board needed to consider the matter before the end of the year. Please note that TEO did not commit to a dividend in 2013, they simply noted their desire to pay a dividend. This is a very sensitive issue with the Argentine government. The government wants dividends suspended and investments made in improving the telecom infrastructure in the country.
On the Q3 earnings call transcription provided by Seeking Alpha, TEO's CEO restated his answer from the Q2 call:
"I confirm in the second quarter conference call I told that we were acting in order to bring to the we have a reserve of 1 billion pesos and we have the ability to approve the dividend distribution in the Board of Directors and our impression is confirmed to bring the decision to pay the dividend by the year end, meaning the year end of 2013."
Again, the CEO is not committing to a dividend payment, he simply stated the board can make, or not make, that decision before the end of 2013. So, the clock is ticking. At this point I am not holding my breath on getting any of this dividend in 2013. TEO is making a significant capital investment in Argentina and we'll have to wait and see whether the money set aside for a dividend is in fact paid out in 2013 or invested in future growth.
The single looming strategic issue for TEO is government intervention. Caiman Velores provided some additional background on the company and these issues in a very insightful Seeking Alpha article from 2012. When the government nationalized an oil company in 2012, TEO was rumored to be a target for further nationalization. The stock price dropped like a rock and created some very attractive buying opportunities. The government wants service improvements, capital investments, and quality enhancements, but tariffs for fixed line services in Brazil have been frozen since 2001. At some point there may be a realization capital investment requires capital returns and capital investment is almost always required as a precursor to growth. My analysis of CEMIG, a Brazilian utility with excellent growth opportunities, but facing similar and significant strategic issues with the government highlights this point.
There is pressure on TEO to increase investment in Argentina and pressure to increase cash for investment by reducing or curtailing dividend payments. If the government intervention were not an issue we would have a nice telecom investment growing at 10-20+% per year, paying a 4-5% dividend, with bright prospects in one of the larger economies in Latin America. There are some concerns about saturation of the existing subscriber base, but humankind appears to have an indefatigable appetite for communication services and it's not clear there is any realistic ceiling on consumption save the various telecoms' ability to put capital into the ground and over the airwaves sufficiently quickly to meet the new demands.
There are also macro-economic concerns with the Brazilian economy. TEO notes in their investor presentation that real wages declined across Brazil although government programs and tax reductions basically kept spending levels up. The Brazilian economy and the actions of the government introduce an element of risk investors have to assess against the value of companies like Telecom Argentina.
At this point, the bet I'm making is that TEO may not pay a dividend in 2013, however, I believe this contingency is already baked into the current price and the current share buyback program may provide a floor for the share price. The potential for capital appreciation as the company approaches fair value is more than sufficient recompense for a, hopefully, temporary dividend impairment. If TEO does pay a dividend this may well signal a rapprochement with the government and very strong opportunities going forward. If the dividend is not paid, despite being fully reserved, then the risk associated with an investment in TEO increases accordingly. This outcome would signal, to me, their communication with the current government is strained and future investments may ultimately be strained as well limiting future growth.