The last year has been a challenging one for America Movil (NYSE:AMX). While profits are improving in the Brazilian operations, a softer Mexican economy impacted results as regulators increasingly look to clip America Movil's wings. A recent decision to assume operating control of Telekom Austria (OTCPK:TKAGY) is not at all surprising, but the company has yet to clearly outline the value proposition for expansion into Europe as opposed to other Latin American markets. All told, America Movil is likely undervalued today on the basis of is long-term cash flow generation potential, but the company will likely have to show that it can deal with the new regulatory system in Mexico and extract value from Telekom before the Street gives it the full benefit of the doubt.
Brazil Generating Most Of The Company's Growth
Low single-digit revenue growth has become something of the norm of late from America Movil's Mexican operations, as the company already has commanding share in the market and overall growth has been constrained by a weaker economy. Top-line growth has been more impressive in Colombia (around 8% in local currencies the last two quarters), but regulatory changes in this market have compressed EBITDA growth to the low single digits.
That leaves Brazil as the driver. As I wrote about a year ago, I thought that Brazilian market conditions were due to get better, as punishing price competition was compressing economic returns for everybody. America Movil hasn't really gained meaningful share on TIM (NYSE:TSU) or Vivo/Telefonica Brasil (NYSE:VIV), but better operational efficiency has supported mid-teens EBITDA growth and margin expansions into the mid-20%'s. With that recent EBITDA margin of 26%, America Movil's Brazilian operations (operating as Claro) are still lagging the low-to-mid 40%'s EBITDA margins of Mexico and Colombia.
It's also worth noting that America Movil's success in Brazil is not all, or even mostly, about its wireless business. Wireless revenue growth was 4% in the first quarter and wireless operations generated about one-third of the company's revenue in Brazil. The company's fixed-line and TV operations are still the much bigger, more successful (in market share terms), and faster-growing part of the Brazilian business, with revenue up more than 11% in local currency.
Mexican Regulators Bring The Pain
Analysts and investors expected punishing regulatory changes in Mexico and that's what has happened. The gist of the regulatory changes is that America Movil is going to be punished with an uneven playing field as a result of its 70% market share in the Mexican wireless market.
As of April, America Movil will be collecting MXN 0.20/min for mobile termination rates (or MTRs), while paying MXN 0.30/min to rivals like Iusacell and NII Holdings (NASDAQ:NIHD). Later on, given America Movil's status as the "preponderant carrier", those received MTRs could go to zero. America Movil is also going to be prevented from exiting low-profit markets where it is the sole carrier.
Making matters worse, it doesn't look like America Movil is going to be allowed to enter the television market for two years and even when it does, Grupo Televisa (NYSE:TV) is not going to be required to share content, while America Movil may be. I would also say, and this is purely my own opinion and interpretation, that the regulations were written with a not-so-subtle subtext of "if you play nice and don't fight this, we may let you into the TV market a little sooner".
With these changes, Telefonica (NYSE:TEF), Iusacell, and NII Holdings and can compete more aggressively with America Movil, particularly on price. The objective here is for America Movil to lose share, and they probably will, and also some margin as well. I would estimate 10% of the company's share is likely at risk and maybe eight to 10 points of EBITDA margin. Even so, I would suggest writing off America Movil is risky - the company has done alright in the rough-and-tumble Brazilian market and I think there's more to America Movil's business in Mexico than just price.
Going To Austria For Growth?
America Movil has been dabbling in Europe for a while, owning strategic stakes in both Netherlands-based KPN (OTCPK:KKPNY) and Telekom Austria. America Movil has been repeatedly frustrated in its attempts to take over KPN, so if it can't own the one it wants, it will want the one it can own - reaching an agreement with the Austrian government to assume control over Telekom and tender for the free float (about 45% of shares).
America Movil has initially offered a 7% premium (EUR 7.15/share) and even if that isn't enough for a full tendering, the company will effectively get what it wants. The price for this move looks to be around $3 billion, with $2 billion going to the cash tender and $1 billion to a capital increase for the company. Even after the deal, the Austrian government will own 25% and a blocking interest, as well as the right to nominate the CEO and Chairman.
This is a curious move in my book. Telekom Austria has some assets that could generate some growth (including positions in Bulgaria, Belarus, and Croatia), but the company's Latin American markets will still be growing faster than these new (to the company) markets. I'm also curious as to America Movil's ability to generate better operating performance here, particularly since it will not control the CEO.
The Bottom Line
I would have much preferred to see America Movil take the cash it is spending in Europe and put it towards share repurchases, higher dividends, or acquisitions in Latin America (buying assets from Millicom, perhaps, or other pay TV assets in existing wireless markets). That said, expansion into Europe has been an obvious goal of this company for some time, so this is not really an incremental negative at this point.
Between European investments and changes to the regulatory environments in Mexico and Colombia, I've gotten less bullish on my assumptions for America Movil. Even so, I believe the company can grow FCF at a long-term rate of around 6% a year, with some upside there if the progress in Brazil continues and the company enters the Mexican pay TV market. Discounted back (at a higher discount rate than before), that works out to a fair value of around $22.50 per share today.
With that level of undervaluation, America Movil is worth watching, but I do have my concerns about the long-term growth strategy and the company's relationship with regulators and politicians in Mexico. All told, I think there are better plays on Mexico and Latin America, but the market is likely still underestimating the long-term potential of this proven market leader.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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