Telefonica Move Rewires Potential in Latin America

In the land rush to get into the Latin American telecom business, property just got a little bit more scarce.

Telefonica de Espana (TEF Quote) announced late Wednesday an all-stock tender offer to acquire all the shares of its Latin American subsidiaries in Peru, Brazil and Argentina, setting off what is likely to be a new wave of telecom consolidation in the region. The Spanish phone giant, the largest shareholder in each of the four companies, will give minority holders of Telefonica de Argentina (TAR Quote), Telefonica del Peru (TDP Quote) and Brazilian cellular companies Telesp Participacoes (TCP Quote) and TeleSudeste Celular Participacoes (TSD Quote) shares in itself at an exchange ratio implying a 40% premium over each company's average price over the five trading days prior to the deal.

Unsurprisingly, investors in the companies, all of which trade as ADRs in New York, made out well on the news. TeleSudeste ADRs traded in New York rose 31%; Telefonica de Argentina, 29%; Telefonica del Peru, 23%; and Telesp Participacoes, 7.54%.

All this will give Telefonica an incredible amount of leverage in region -- one that will force competitors to act. Once the deal clears, Telefonica will likely spin off its global cellular business and perhaps its data services businesses as well. Companies like to call such initial public offerings "unlocking value," and in this case that may actually be an apt term.

The spinoff of a cellular company, for example, would have the potential to become a dominant force in a region short on fixed-line connections. With the deal, Telefonica controls two of Brazil's eight cell operators -- and shares in the other six acted Thursday like they would be bought out by either Telefonica or a Telefonica competitor.

It's clear that competitors will have to act if they want to be part of the Latin American telecom business. One of the first companies to follow Telefonica's lead is likely to be Telecom Italia (TI Quote), which has a sizable foothold in the region already. But it will need to act quickly.

While Italia could easily take leadership of its Brazilian cellular subsidiary, Celular Sul (TSU Quote), it may be more difficult for it to consolidate its stake in Telecom Argentina STET-France Telecom (TEP Quote), where it has a minority stake, says Rizwan Ali, managing director of Latin American telecoms at Bear Stearns. And Italia, which is about to be merged into Italy's Olivetti, does not have the drive, according to Brad Radulovacki, senior Latin American telecom analyst at Robert Fleming Securities, to cobble together and float its own subsidiary like Telefonica. (Such worries did not keep ADRs of Celular Sul from gaining 2, or 5.7%, to 37 1/16 on Thursday or Telecom Argentina from adding 4 7/16, or 13.35%, to 37 11/16.

The struggle these companies are undertaking in their quest to carve out a piece of Latin America's telecom business mirrors the challenge of international investors, who now face an environment where fewer shares are available for purchase in what is expected to be one of the world's hot markets. Telefonica's deal, if completed, effectively shuts investors out of four companies poised to benefit from the region's growth.

"If I'm a portfolio manager looking for pure Latin American plays, Telefonica has just taken $20 billion in market cap out of the market," says Mickey Scheien, Latin American telecom analyst at Lehman Brothers. "It also makes the potential for IPOs out of the region more interesting because these same investors will be looking for more opportunities."

The news of Telefonica's buyout was not wholly unexpected. Regional telecom analysts have been looking at Telefonica's relationships with its subsidiaries, particularly TeleSudeste. That company has a 70% market share and aggressive subscriber growth.

Analysts say those investors who find a way to pitch a tent on Latin America's telecommunications frontier land may be well-rewarded. Even with the recent run-up, valuations, according to many analysts, are still attractive compared to global counterparts.

"If the market is rewarding global and regional businesses which have scale and synergies, like Telefonica, it's going to make everyone think" about their future growth, says Robert Fleming's Radulovacki.