Oi: The Merger Is At A Stage Of Suspense

Jul. 7.14 | About: Oi S.A. (OIBR)


A merger that is taking too long to implement.

Oi and PT seem to be far from each other in terms of management.

The future has to be different in order to meet the real potential of the company.

Suddenly, another serious problem is affecting the merger process between Oi SA (NYSE:OIBR) and Portugal Telecom (NYSE:PT). In fact, PT recently subscribed a total of €897 million ($1.22B) in commercial paper issued by holding company Rioforte. Rioforte is a member of Espirito Santo Group (GES), a firm that owns 10% of PT. GES has been showing serious financial problems given that it seems to have made ​​some questionable investments in several business areas. The debt is due in 10 days, and it may have dramatic consequences if it fails to be settled.

PT has materialized this operation without giving any information to Oi, which is unacceptable given the size of the operation, and the mutual support that the two companies need to maintain in terms of management and strategy. Furthermore, it's obvious that PT was certainly aware of the current big difficulties GES is facing to get funding. Consequently, it's not admissible that PT could justify the operation as "taking into account the attractiveness of the remuneration offered" (3.6% per year). The real problem here is undoubtedly credit risk.

On the other hand, the evaluation of PT that has been made ​​for merger purposes had indicated that the company would be entitled to 37% of the new entity after the merger. However, if there will be problems with the payment of the sum mentioned, the merger agreement will have to be changed.

But this is just one more huge problem among other disappointing situations around the process of merging the two companies.

From the beginning, particularly minority shareholders have been harmed by the slowness of the various phases of the merger process, and also by the unsatisfactory conditions of this complex operation.

For starters, the design of the transaction has favored Oi's biggest owners who have obtained an extremely large majority premium. Then, following the recent capital increase of R$13.96B ($6.2B) at a particularly low price of R$2.00 ($0.88) per share, dilution has become a much bigger problem than had been anticipated.

To make things more difficult, Oi has reported poor results for the first quarter of 2014. In fact, revenue has decreased 2.3% YoY to R$6.88B ($3.1B), and net profit has fallen 13% YoY to R$228 million. Only EBITDA has increased 37% YoY to R$2.96B, helped by the sale of transmission towers. At the same time, Portugal Telecom's results for Q1'14 were not great either. It has reported revenue decrease of 3.9% YoY to €690 million ($945 million), and net loss of €14.7 million for 1Q14 against net income of €26.7 million in 1Q13.

Returning to the aforementioned purchase of debt issued by GES, it's hard to believe that so large an amount of cash has been put at risk. Due to the current situation, this type of operation should have been considered and decided jointly by both companies.

I have written several articles about Oi and I still have the opinion that the new entity post-merger has a great chance of future development. I believe that its potential will most likely translate into rising share prices for a medium- to long-term time horizon. Nevertheless, risky and controversial decisions can cause serious problems for the company's image and management reputation. Oi's CEO Zeinal Bava has to do something here to show he is in control. Shareholders know that this is a crucial situation and it's all about management.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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