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Latin America Equity Research Telecoms & media July 2012
abc
Telecoms & media
Telecoms & media team Richard Dineen Analyst HSBC Securities (USA) Inc. +1 212 525 6707 [email protected]
Sean Glickenhaus Analyst HSBC Securities (USA) Inc. + 1 212 525 4131 [email protected]
Enrique Gomez-Tagle,* CFA Analyst HSBC Mexico, S.A. + 52 55 5721 2167 [email protected]
Ivan Enriquez* Analyst HSBC Mexico, S.A. + 52 55 5721 2397 [email protected]
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
Latin
Am
erica Eq
uity R
esearch
Teleco
ms &
med
ia Ju
ly 2012
2
ab
cSector structure
Telecoms, Media & Technology
Telecoms Media Technology
Diversified telcosAmerica MovilTelefonica BrasilOiEntelTelecom Argentina
Mobile operatorsTIMNII (Nextel)
Pay-TV operatorsTelevisa, Megacable
Cable operatorsMegacable, Televisa
Free-to-air-TV operatorsTelevisaTV Azteca
Telecoms equipment vendorsEricsson, Alcatel- Lucent, Nokia
Satellite operatorsTelevisa
Telecoms, Media & Technology
Telecoms Media Technology
Diversified telcosAmerica MovilTelefonica BrasilOiEntelTelecom Argentina
Mobile operatorsTIMNII (Nextel)
Pay-TV operatorsTelevisa, Megacable
Cable operatorsMegacable, Televisa
Free-to-air-TV operatorsTelevisaTV Azteca
Telecoms equipment vendorsEricsson, Alcatel- Lucent, Nokia
Satellite operatorsTelevisa
Source: HSBC
Sector price history (Brazil)
Latin
Am
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uity R
esearch
Teleco
ms &
med
ia Ju
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ab
c
0
200
400
600
800
1000
1200
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
FTSE Braz il Div telecom Viv o Oi TIM
Source: Thomson Reuters Datastream, HSBC
Latin
Am
erica Eq
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esearch
Teleco
ms &
med
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ab
c
Sector price history (Mexico)
0
200
400
600
800
1000
1200
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
F TSE M EXIC O T ELEC OM AM X Telev is a AZT EC A
Source: Thomson Reuters Datastream, HSBC
Latin
Am
erica Eq
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esearch
Teleco
ms &
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ab
c
EBITDA margin – asset turnover chart (2011)
TEF Megacable
Nex tel AMX
Oi
TIM
TEO
Azteca
Entel
Televisa
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
20% 22% 24% 26% 28% 30% 32% 34% 36% 38% 40% 42% 44%
EBITDA m argin (%)
Asse
t tur
nove
r (x)
Source: Company data, HSBC
2011-14e EBITDA CAGR – EV/EBITDA (2012)
M eg a ca ble
E nte l
T EF
TE O
A M X
O i
T elev is a
N ex tel
TIM
Az te c a
0 %
2 %
4 %
6 %
8 %
10 %
12 %
14 %
16 %
0. 0 1 .0 2. 0 3 .0 4 .0 5 .0 6 .0 7. 0 8 .0 9. 0
E V /E B ITD A
2011
-14e
EBI
TDA
CAGR
Source: Company data, HSBC, consensus estimates
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Latin America Equity Research Telecoms & media July 2012
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Sector description
Telecoms sector: Telecoms operators offer mobile and fixed-line services. In mobile, operators offer
voice, messaging and data services. In fixed-line they offer telephony, broadband, and in some cases, pay
TV (via IPTV or satellite broadcast platforms).
Media sector: Globally, the media sector brings together a large range of services. Traditional sub-
segments are pay-TV and free-to-air broadcast TV, communications agencies, publishers and internet-
related players. Satellite and cable operators are effectively linked to both media and telecoms sectors. In
Latin America, as in the rest of the world, technological change is driving convergence of telecoms and
media sectors enabling media players to offer broadband/telephony and telcos to offer pay-TV.
Barriers to entry in telecoms are intrinsically very high, given high levels of capital investment required to
build network infrastructure (and in mobile to also acquire radio spectrum). Telecoms markets in Latin
America are generally dominated by a small number of players, with the subsidiaries of regional giants
America Movil and Telefonica typically figuring among the market leaders as scale and investment are
key determinants of success. However, Latin American telecoms regulators are seeking to reduce barriers
to entry with initiatives such as unbundled local loop (ULL), which gives new entrants access to existing
fixed broadband infrastructure, easing the path for the entry of MVNOs (mobile virtual network
operators), and enforcing spectrum caps or offering low-priced set-aside spectrum to new mobile entrants.
In the media space, the need for dedicated distribution platforms (terrestrial, satellite or cable broadcast
systems) has been a powerful barrier to entry, but in future we believe that viewers will increasingly turn
to the internet to receive their video content “over the top” via broadband. This will open up the media
market to a broader range of players, in particular to internet, telecoms and other consumer brands.
Telecoms and media are coming together – converging in some instances and colliding in others. Telecoms
service providers in many Latin American countries (most recently in Brazil) are now allowed to offer pay
TV. Mexico is an obvious exception for now though as America Movil’s fixed-line subsidiary Telmex is
still awaiting regulatory approval. On the media side, cable/satellite TV operators are vying for telecoms
customers through converged “triple-play” packages, offering voice and broadband alongside pay TV.
Overall, long term, we believe converged players will have significant advantages over single-play
competitors, not only from a customer perspective (bundling, cross-selling and churn reduction), but also
from a network cost perspective, as backbone and backhaul network capacity can be shared across fixed
and mobile. We therefore expect mobile-only players to increasingly seek to add fixed-line capabilities.
This process has already begun with America Movil merging its fixed and mobile subsidiaries throughout
the region, as Telefonica Brasil is doing by merging Telesp (fixed-line) with Vivo (mobile) as well as
driving TIM’s acquisition of AES Atimus’s regional fiber networks in Brazil. We also expect integrated
telcos to seek to expand their content capabilities through acquisition of smaller content/application
companies (as America Movil has started to do) and for media companies to expand into wireless as with
Televisa’s 50% stake in Mexico’s third-placed mobile operator Iusacell.
Richard Dineen Analyst HSBC Securities (USA) Inc +1 212 525 6707 [email protected]
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Latin America Equity Research Telecoms & media July 2012
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Key themes
Data explosion, capacity crunch and pricing power
The widespread adoption of smartphones, tablets and laptop dongles has translated quickly from
developed to emerging regions like Latin America, helped by sharply falling device prices – the result of
ferocious competition among Asian electronics manufacturers. This is driving strong growth in mobile
data revenues too. However, these new bandwidth-hungry smart devices are putting unprecedented
pressure on mobile networks (Ericsson forecasts global mobile network traffic will rise ten-fold by 2015).
Some expect the arrival of 4G LTE (with spectrum auctions held in several Latin American countries in
2012) to provide long-term capacity relief. However, our research indicates that 4G LTE provides only a
minimal (c30%) capacity boost versus today’s HSPA 3G technology on a true like-for-like basis, as
network efficiency gains are plateauing, increasingly constrained by the hard laws of radio physics
(known as the “Shannon Limit”).
As a result we believe that adding mobile capacity in Latin America going forward will be relatively
expensive – either via overlaying new spectrum or by increasing the density of existing cellular networks
(in order to reduce contention for increasingly limited network capacity resources). We therefore expect
capex levels in mobile to remain relatively elevated longer-term and typically trend them to a 12-14%
capex/sales range. Even so, it is still unlikely that operators can fully meet what is effectively multi-year
exponential growth in mobile capacity demand, given the various constraints on supply (limited spectrum,
plateauing network efficiency, capital intensity and other barriers to increasing network density). We
therefore believe the only option will be for operators to ration mobile data usage, most likely via price.
In other words we expect a mobile network “capacity crunch” to introduce a degree of pricing power for
mobile data – something the sector has conspicuously lacked in the voice era hitherto. We see signs of
this important transition underway with the bulk of developed region mobile operators (e.g. AT&T,
Vodafone Europe) having already migrated customers from unlimited data offers to tiered volume-based
plans. In Latin America, operators like America Movil’s Telcel in Mexico have recently switched from
unlimited to tiered plans for postpaid customers, while remaining “unlimited” offers like TIM Brasil’s
Infinity plans constrain usage by throttling data speeds after a certain volume threshold has been reached.
The importance of scale and fixed-mobile diversification
The transition from a narrowband mobile voice world to a broadband mobile data world also hands a
distinct competitive advantage to operators that are (1) large relative to rivals, and (2) have both fixed-line
and mobile assets. First, for technological reasons, mobile data is scale-friendly in a way that mobile
voice is not. Voice services operate at a uniform bit rate, meaning that voice quality does not vary
according to the caller’s proximity to the cell tower. By contrast, data services operate at a variable bit-
rate with the user’s speed increasing or decreasing sharply based on the distance to the tower.
Consequently whereas it never benefited larger players to build voice networks more densely than those
of smaller rivals (as this would not have delivered superior voice quality), it will very much benefit scale
leaders to build much more dense mobile data networks which will be able to offer materially faster data
speeds to their customers.
Second, the rising tide of mobile bandwidth demand will, over time, force operators to change the underlying
architecture of their networks, with the traditional system of large outdoor cell towers replaced or overlaid over
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time with multiple lower-power small cells (<100m radius each perhaps). Small cell products like Alcatel-
Lucent’s LightRadio “cube” are, we believe, a clear indication of this future direction for mobile networks.
However, each of these small cells will require a high-capacity backhaul link (to carry traffic from the cell
tower to the mobile core network for onward routing and transport), which should benefit diversified fixed-
mobile operators who already have (or who can easily deploy) fiber-based fixed broadband down every street.
Regulation
Another key determinant of media and telecom sector company performance and returns is regulation.
Latin American telecoms and media markets have until recently been barely touched by regulation.
However, industry watchdogs in key markets like Mexico and Brazil are becoming more active with the
objective of facilitating more competition. Regulatory developments in Latin America include
interconnection rate cuts, managed spectrum auctions (giving favorable bidding status to small,
challenger operators), number portability, as well as supporting the introduction of mobile virtual network
operators (MVNOs). Arguably most significant is the threat of unbundled local loop (ULL) in the fixed-
line sector. ULL is a regulatory framework designed to stimulate broadband competition by providing
new entrants with access, at regulated cost-based prices, to the incumbent’s local access infrastructure
(which is otherwise not replicable due to the massive expense involved). In regions like Europe, ULL has
been the dominant mode of competition in broadband for the past decade, and in our view, has been a
major factor in the underperformance of the European incumbent peer group over this period.
Over-the-top (OTT) video
Similar to what is already happening in the developed world, we believe that pricing power will be a key
differentiator between the different subsets of the media sector in Latin America. Demand for content is
growing and the media sector has historically commanded a good deal of market power due to the limited
number of conduits to the consumer. However, the ability of existing media owners to monetise this
demand for content is being threatened, as users can access an increasing level of content via the internet.
In the past, broadcasters faced little competition: they used to control the ‘what’, ‘when’ and ‘how’ of video
content delivery. An initial shift occurred with the transition to digital TV increasing the number of channels
available. But another shift began, driven by the internet, applications and networks. Through internet-
enabled devices and connected TVs, consumers can now increasingly control the ‘what’, ‘when’ and ‘how’
thanks to the capabilities of broadband networks. The OTT trend is starting in Latin America too: at the end
of 2011, Netflix started offering its popular online video streaming service in the region. This fragmentation
is expected to gradually impact both market power (diluted by the increase in market participants) and
pricing power (related advertising and subscription fragmentation) for free-to-air broadcasters and
eventually pay-TV operators. Partially offsetting this, free-to-air broadcasters like Televisa (which has other
business segments) and TV Azteca produce most of the content they transmit. While OTT may over time
undermine traditional broadcast and even pay-TV revenues, it should benefit content owners by enabling
them to distribute globally without requiring traditional TV channel aggregators.
The beneficiaries of this audience fragmentation will be the network-based businesses, we believe.
Consumers need the infrastructure to access content whether on a TV, tablet or smartphone. Ideally, these
networks have to be fast and reliable. The supply of so-called “fat pipes” to the home is scarce, controlled by
the telco incumbent and the cable operators (and the mobile operators with respect to usage on the move).
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Latin America Equity Research Telecoms & media July 2012
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We think that the scarcity of super-fast broadband access networks should translate into market power for
fixed telcos and cable operators, which in turn can be translated into pricing power. Cable operators are
upgrading their physical networks to deliver super-fast broadband connections (up to 100Mbps) while
telecom operators are in the process of upgrading their access networks from copper to fibre. While we
expect cable’s traditional pay-TV business to come under pressure, the cable business model has been
evolving, adding new services like broadband to create multi-play bundles. We believe that the higher gross
margin from broadband access should more than offset the cannibalisation of lower gross margin traditional
linear cable TV by OTT services. Strategically, satellite operators sit in between. In some sense, they are
another “fat pipe” to the home, but satellite platforms lack uplink capabilities and therefore cannot fully
compete with cable operators. Still, due to the still low pay-TV penetration rates in Latin America, we
believe that satellite providers can sustain their current pricing power over the medium term.
Sector drivers
Telecoms
The telecoms industry is subject to many drivers, including the affordability and availability of services,
the rate of technological innovation (Moore’s Law exerts a particularly powerful influence) and the extent
of regulatory intervention. And note that, although the sector is not highly geared to the economy, it is
clearly influenced by economic and business cycles.
The level of penetration (fixed, mobile and broadband) is a basic driver for telecom services and is, in
turn, driven by the availability and affordability of services. Strong economic growth, more even
distribution of wealth resulting in expanding middle classes combined with steadily falling prices for user
equipment and services have led mobile penetration in Latin America to cross the 100% threshold. Still,
we believe that these figures are overstated by growing incidence of users with multiple accounts
implying that the underlying level of individual ownership is lower. More penetration growth upside
versus developed markets (which are today practically saturated) has historically led developed-market
operators to take stakes in emerging market names (eg, Telefonica and Telecom Italia in Latin America).
Data services have recently been the key growth driver for mobile revenues, and we expect this trend to
continue. The three main enablers that we think are underpinning the demand for data services are: (1)
better network speed and coverage; (2) increased penetration of data-optimised devices, like smartphones;
and (3) improved packaging and marketing of data offerings. The penetration of smartphones is still quite
low we believe (mid-teens in LatAm is our estimate with Argentina leading the way at around 25% and
Brazil at about 15%, which compares to around 45% in the US for example), so we see considerable
upside potential for the region going forward.
Regulation also plays a very important role. It is one of the main drivers in determining competitive intensity,
as the regulators decide the number of licences to be issued and set the level of many tariffs (in particular, those
relating to interconnection and unbundling). On the mobile side, the regulators set mobile termination rates
(MTR) and roaming tariffs, which have a material impact on mobile revenues and EBITDA.
Technology cycles (and upgrades) influence the capex intensity of the industry, and operators that
upgrade to the new technology early can enjoy competitive advantages over the laggards (but are also
often exposed to the practical problems that inevitably accompany new technologies).
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The economic environment also has an impact on the telecom sector. Consumer spending is usually less
cyclical, while enterprise revenues (eg, roaming and IT contracts) exhibit greater cyclicality. However,
we stress that the relatively high margins seen in the telecom sector mean that, while revenues are tightly
linked to the economy, profits and cash flows are relatively defensive in nature.
Media
Given the different type of services provided by the media sector, we believe it lends itself more to stock
picking than to top-down sector-based analysis. While pay-TV operator growth is mainly driven by
consumer and service take-up, with these players generating the majority of their revenues from
subscriptions, free-to-air TV relies predominantly upon corporate advertising expenditure. Pay-TV
operators are more defensive in terms of their revenue-generating abilities during a downturn than are
free-to-air-TV broadcasters given the long-term nature of pay-TV contracts.
Revenue growth is driven by market share gains from competitors, as well as from other types of media
(for example, if advertisers shift money from radio to TV), and GDP growth. Seasonal factors like major
sporting events (eg the soccer World Cup, Olympics) and political elections also tend to have an
important effect on revenues. Top-line momentum, EBITDA margins and the ability to generate free cash
flow each play a critical role in driving the stocks in our view. The sector is generally exposed to
fluctuations in the local currency, as many of its inputs and capital expenditures are done in USD. Media
groups are mostly asset-light, and capital intensity varies according to the platform (eg cable TV is much
more capital-intensive than satellite TV).
Valuation
We value Latin American telecoms and media companies using a DCF-based methodology in order to
attain our twelve-month target prices. We also compare the companies primarily on an EV/EBITDA basis
to normalize variations in capital intensity. We tend to de-emphasize free cash flow yield as this can be
seen to reward companies that under-invest. Since most of the LatAm telecom and media companies are
still in a period of growth, capital expenditure is a critical component for long-term success, in our view.
Latin American telecoms and media
2009 2010 2011 2012e 2013e
Growth Sales 23.8% 14.2% 10.9% -2.3% 3.8% EBITDA -6.0% 16.1% 4.3% -5.0% 4.3% EBIT -25.5% 17.8% 7.4% -4.9% 6.5% Net profits -32.9% 25.0% 9.5% -4.5% 7.2% Margins EBITDA 36.3% 36.9% 34.7% 33.8% 33.9% EBIT 19.8% 20.4% 19.8% 19.3% 19.8% Net profit 10.6% 11.6% 11.4% 11.2% 11.5% Productivity Capex/sales 14.4% 14.5% 18.0% 18.2% 16.6% Asset turnover (x) 0.66 0.59 0.62 0.63 0.66 Net debt/eq 0.60 0.39 0.48 0.53 0.50 ROE 18.8% 15.5% 15.8% 15.6% 16.3% Note: based on all HSBC coverage of LatAm TMT sector aggregate Source: HSBC estimates
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Sector snapshot Key sector stats
Telecom services 9.33% of MSCI EM Latam
Trading data ADTV (USD mn) 221.42 Free float market cap (USD bn) 71.47 Performance since 1 Jul 2002* Absolute 481.16% Relative to MSCI EM Latam -16.66% 3 largest stocks AMX.N, VIVT4.SA, TIMP3.SA Correlations (5-year) with MSCI EM Latam 0.92 Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012 *Performance includes dividends Top 5 stocks
Stock rank Stocks Index weight
1 AMX 'L' 6.81% 2 TELEF BRASIL PN 1.00% 3 TIM PART ON NM 0.61%4 OI PN 0.50%5 ENTEL 0.29%6 OI ON 0.17%Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012 Country breakdown
Country Weights (%)
MEXICO 31.65 BRAZIL 3.63 CHILE 3.33 COLOMBIA 0.00 PERU 0.00 Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012
Mobile data traffic growth forecasts
Source: Cisco Visual Networking Index, June 2012, HSBC
PE band chart
0100200300400500600700800
2001 2003 2005 2007 2009 2011Price 10x 15x 20x
Source: Thomson Reuters Datastream, HSBC, MSCI
PB vs. ROE
0
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2001 2003 2005 2007 2009 2011
0
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P/B (LHS) ROE (RHS)
Source: Thomson Reuters Datastream, HSBC, MSCI
0%20%
40%60%
80%100%
120%
2012e 2013e 2014e 2015e 2016eLatAm Global
