I have written a letter to the SEC, FINRA, the NY State Financial Regulator, Bank of America Merrill Lynch, Citigroup, Goldman Sachs and Morgan Stanley to alert them that a merger deal between Oi S.A. and Portugal Telecom, which would otherwise make sense, also results in a massive, unfair transfer of wealth from Oi S.A. common and preferred shareholders to a holding company, Telemar Participacoes. Telemar owns only 17.7% of the total Oi shares, but would receive a payout equal to 77.23% of the existing market capitalization of the whole company at the expense of the non-control shareholders. The following contains relevant excerpts:
I have previously made a complaint on the website of the SEC; but given that time is short, I am writing to all of you. Aside from the three regulatory agencies which have jurisdiction and the NYSE, I have also written to the Chief Compliance Officers of the above four investment banks, because they are participating in the Oi S.A. fundraising, which is currently slated to facilitate a transaction which will result in the illegitimate transfer of the property of non-control common and preferred shareholders to a control group of large shareholders who are united in a holding company, Telemar Participacoes S.A. This entity currently controls 290,549,788 voting common shares, according to Oi company documents. The Telemar shareholders include a subsidiary of Portugal Telecom, which is a party to the merger. The above common shares only represent 17.7% of the total shares of the Company.
As part of the convoluted transactions involved with the above merger, Oi will raise at least R$7 billion (US$2.99 billion) through the selling of new common shares of Oi S.A. At the current market price (US$1.60 per common share and $1.54 per non-voting preferred share), the entire market capitalization of the current Oi S.A. equity is approximately US$2.49 billion. Thus, dilution for existing non-control shareholders would be massive.
Of the new funds to be raised, R$4.5 billion (US$1.923 billion) will be used to purchase a convertible debenture from Telemar Participacoes. The debenture will backed by the Oi S.A. common shares owned by Telemar (nearly its only asset). This R$4.5 billion will be used to pay back Telemar debt used to originally acquire the Oi S.A. common shares. While there are doubtlessly some non-transparent internal transactions within the Telemar control group (since Portugal Telecom ends up with some Oi shares to distribute to its shareholders), if one simply divides the R$4.5 billion Convertible Debenture by the 290 million-plus shares owned by Telemar, the control shareholders will collectively receive the equivalent of US$6.62 per share, while the non-control shareholders receive 1 new Oi S.A. share currently worth $1.60 (non-voting preferred shares will be converted at an approximate 8% discount). The unfairness is clearly seen by comparing the $6.62 per common share which the Telemar control shareholders receive in cash, and the $1.60 the non-control common shareholder gets to keep. Another way of looking at this is that 77.23% of the current market capitalization Oi S.A. is transferred to control shareholders holding only 17.7% of the shares.
Brazilian Regulatory Decisions
There apparently have been some protests from Brazilian minority shareholders, primarily about the value of the Portugal Telecom assets which will be transferred to the new Oi S.A. Thus, the Brazilian regulator, which has approved the merger transaction, has also said that the Telemar control shareholders cannot vote on the valuation of the Portugal Telecom assets. The value of the PT assets, however, is not controversial, and has been verified by Banco Santander Brasil and accepted by the Oi Board. I am sure that Oi shareholder approval of the valuation will be a mere formality. However, importantly, there will apparently be no shareholder vote on the Convertible Debenture transaction, which transfers the bulk of the value of Oi S.A. to the Telemar control shareholders. I have tried to go through the voluminous merger documentation issued by Oi, and can assure you that this convertible debenture transaction is now well-hidden in a mountain of documentation (I got my figures from the original information about the merger several months ago).
PT Shareholders Likely to Benefit
The Portugal Telecom shareholders get only a small portion of the value of their shares in the form of Oi S.A. shares. The bulk of their value will be their pro rata share of the PT net assets in euro translated into new Oi S.A. shares at the price of the offering. Thus, they will suffer very little dilution from this transaction. In fact, they are likely to gain, since a near-book value valuation of the PT assets will be exchanged for new Oi S.A. shares at a big discount to book.
US Regulators Need to Act
I write to the three U.S. regulators in the hope that they will protect U.S. preferred and common shareholders of Oi S.A. by preventing an unfair transfer of company value to Telemar control shareholders, who hold a minority economic interest in Oi S.A. I point out that the Oi S.A. management and board of directors, who are recommending this transaction, are violating their fiduciary duty to represent and protect the interests of all of the shareholders of Oi S.A.
I write to the CCOs of the four U.S. investment banks in the hope that they will see that a transaction of such stunning unfairness may well be the subject of a future class action lawsuit, which may expose their banks to large liabilities.
I have seen some comments from a Brazilian brokerage firm that Oi S.A. is over-leveraged and that this is the only way to save the company. I would like to point out only two facts:
a) The reason that Oi S.A. is over-leveraged is that the control shareholders have caused a payout of imprudent dividends for years, thus draining the company. The market price of Oi shares has declined pretty much in lockstep with the payment of extraordinarily large dividends; and this proposed transaction bails the control shareholders out from the decline of value which they caused.
b) Even after the merger is completed, the new Oi S.A. will still be badly over-leveraged, because the proceeds of most of the newly-issued stock will not be used to reduce leverage, but to bail out control shareholders.
What is to be Done?
In view of the above facts, it is clear that if the merger with Portugal Telecom could be re-structured to eliminate the unfair disproportionate payment to the Oi control shareholders, the common and preferred shares of Oi would be likely to increase significantly in value. If that were done, then any new money raised in a share offering could be used to pay down debt and invest in the network. However, because the Brazilian regulator has already approved significant aspects of the PT merger, it is now up to U.S. regulators and Oi S.A. non-control shareholders to protest and protect Oi common and preferred shareholders from unfair treatment by the control shareholding group.
Disclosure: I am long OIBR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.