Development Business / July 16, 1998
By Larry Luxner
São Paulo may be South America's largest metropolis, and Rio de Janeiro its most famous, but for now the eyes of the world's telecommunications giants are trained on Brasília -- the remote, futuristic capital city where lawmakers and regulators are charting the course of Brazil's exploding telecom industry.
In late June, the government of President Fernando Henrique Cardoso fixed a minimum price of $11.7 billion for the privatization of state-owned Telecomunicações Brasileiras S.A. (Telebrás), the mammoth entity that controls around 90% of local telephone traffic and 100% of long-distance traffic in this nation of 160 million people.
In preparation for the July 29 auction -- which will rank as the largest privatization in Latin American history -- the 27 regional phone companies making up Telebrás were earlier this year consolidated into three fixed-line entities, eight cellular operators and one long-distance company, Embratel. The 12 new holding companies were incorporated with a total shareholders' equity of around $27.9 billion.
Besides raising money for the central government, the purpose of selling off the state's remaining 21.5% stake in Telebrás (representing just over 50% of the company's voting shares) is to dramatically boost Brazil's basic telephone density. Currently, the country has 16 million lines in service, translating into a teledensity of only 10 per 100 inhabitants -- far less than the teledensities of nearby Argentina, Chile and Uruguay.
Yet even that ranges dramatically from region to region. In relatively wealthy São Paulo, phone penetration is 13.6 per 100, while in the impoverished northeastern state of Pernambuco, it's only 3.7 per 100 lines. And 45% of Brazilian businesses are still without phone service at all.
Part of the problem is that Telebrás has traditionally been limited by law to investing only 0.6% to 0.8% of Brazil's gross domestic product into the telecom system each year. Most economists agree that a significant increase in teledensity can happen only with investments from the private sector -- and the infusion of foreign capital.
Brazil's telecom expansion program envisions 40 million fixed lines by 2003. Of the 24 million lines to be added over the next five years, one-third are likely to adopt wireless local loop (WLL) -- a technology that allows fast implementation and minimal investment. Lucent Technologies has already begun manufacturing WLL equipment in Brazil, while Finland's Nokia, Japan's NEC and South Korea's Samsung are considering doing likewise (please see box on Brazil's telecom equipment manufacturing boom).
Under the new consolidation, Brazil's three fixed-line entities are Telesp (covering São Paulo state), Telenorte-Nordeste (including the states of Rio de Janeiro, Minas Gerais and all of northern and northeastern Brazil) and Telesul (covering southern Brazil including the states of Paraná and Santa Catarina).
While an $11.7 billion minimum price sounds like a lot of money compared to the book value of phone monopolies in smaller countries such as Bolivia, Paraguay and Peru, it's significantly less than the $30 billion at which analysts had valued Telebrás only a few years ago.
"We are selling Telebras as a competitive company. The value has been reduced due to the fall in financial markets," conceded Communications Minister Luiz Carlos Mendonça, the former head of Brazil's National Economic and Social Development Bank who assumed his post several months ago following the death of Sergio Motta, one of Cardoso's closest friends and political allies. "It's the largest privatization in the world, so we need to have a responsible attitude."
Meredith Persily, a Latin American analyst with the EIU's Pyramid Research division in Cambridge, Mass., says several factors account for the devaluation of Telebrás.
"After the Asian currency crisis, people started looking at emerging markets with less rose-colored glasses than before. Ideally the Telebrás privatization should have happened a lot earlier," she said. "In addition, there have been serious questions raised about the ability of the Brazilian financial markets to finance this kind of bid. The money's just not there."
Another reason Telebrás is worth less is the government's decision to break the company's monopoly and allow free competition in the telecom sector within four years.
"The new minister of communications has done a good job trying to make the privatization more attractive," says Persily. "Now there are no limits to foreign capital -- in contrast to the 49% foreign limit imposed in the previous sale of Brazil's B-band private cellular licenses -- and that increases foreign interest."
So far, seven U.S. and European multinationals have visited "data rooms" set up by Telebrás: AirTouch Communications, MCI, SBC Communications, Portugal Telecom, France Telecom, Italy's Stet, Telefonica de España and Telecom Italia,. In addition, two Brazilian firms -- Lightel and Andrade Gutierrez -- are among the potential bidders.
From all accounts, European operators are likely to have a better crack at the three fixed-line companies than their U.S. rivals.
"There hasn't been as much interest as the government expected -- particularly from U.S. companies -- on the wireline side," said Persily. "On the wireless side, however, there still remains quite a bit of interest," probably due to cellular's smaller required investment and faster buildout time.
Jason Dyett, a Pyramid analyst in São Paulo, told Development Business that "European operators have [traditionally] been very strong here. The existing telecom infrastructure has been influenced by the European market, so it's expected the Europeans will make a stronger play. Perhaps U.S. companies would be more interested in the mir-rored companies" that would provide competition to the three privatized fixed-line entities.
"Tenders for the mirrored companies will be released by Anatel on the day after the privatization, maybe even the same day as the privatization," explained Dyett, "the idea being they want to get competition out there as soon as possible."
One European company likely to lobby heavily for Telesul is Spain's Telefónica, which led a consortium that last month (June 19) paid $1.023 billion for a 50.1% slice of the voting shares of Companhia Riograndense de Telecomunicações (CRT).
One of only four Brazilian phone providers not under the Telebrás umbrella, CRT is the principal operator in the southern state of Rio Grande do Sul, with over 1.37 million fixed lines and 400,000 cellular lines in service.
Following the June 19 auction in Pôrto Alegre, the Telefónica do Brasil consortium -- which also includes Telefónica de Argentina, Compañía de Telecomunicaciones de Chile and Brazilian multimedia group RBS -- now holds 85.1% of the voting shares of CRT, equivalent to 32% of the total share capital. It therefore becomes Brazil's first telecom operator to be totally privatized
"This is a great day for the shareholders of Telefónica," said the company's chairman and CEO, Juan Villalonga, upon learning the outcome of the auction. "This award is a recognition of Telefonica's management of CRT over the past 18 months. Winning this bid opens new opportunities to create value for our shareholders, given the high growth potential of Rio Grande do Sul and the Brazilian market."
Nevertheless, cellular telephony appears to represent the biggest opportunity for foreign companies trying to crack the Brazilian telecom market.
In 1990, there were only 11,000 cellular phones operating in Brazil -- a number which has since risen to 3 million and should hit 10 million by 2002, by which time Brazil's population will reach 172.5 million. In the past six months, São Paulo, which didn't initiate cellular service until August 1993, issued as many new cellular lines as Chicago has in the past five years.
"Besides the novelty factor, many paulistas turn to cellular out of desperation and frustration," says one U.S. Embassy official. "A new Telesp cellular line costs $200, while a fixed phone line from Telesp runs $1,200 after up to three years on the waiting list."
The minimum bids for Brazil's eight A-band cellular holding entities are as follows: Telesp ($950 million); Telesudeste ($495 million); Telemig, Telesul and Telecentro (all $200 million); Telenordeste ($195 million); Teleleste ($108 million) and Telenorte ($78 million).
Those prices are considerably lower than the amounts paid for B-band cellular concessions in the same geographic regions, even though the A-band companies are existing networks and the B-band concessions only existed on paper at the time Brazilian and foreign companies bid for their licenses.
For example, BCP, a cellular company led by Atlanta-based BellSouth International and Brazil's Grupo Safra, paid $488.6 million (or $19 per pop) to provide B-band service in Region 10, which includes Recife, capital of the northeastern state of Pernambuco; service has already started there, and will soon be extended to Alagoas, Ceará, Paríba, Piauí and Rio Grande do Norte. In May, the same consortium turned up service in São Paulo after paying a whopping $2.6 billion (341% over the government's minimum price of $527.7 million for the concession). It's already signed up 140,000 clients there.
The BellSouth-Grupo Safra venture, which also includes three Brazilian companies -- RBS, O Estado de São Paulo and telecom equipment maker Splice -- has so far invested $3.5 billion, including license fees, to launch cellular services in the two areas.
Persily says Telesp, which competes with BellSouth in São Paulo, "is an existing network with hundreds of thousands of subsciribers. There's a tremendous amount you can do with just that subscriber base. Many [similar A-band] networks are well developed, including Telemig [Minas Gerais], Telesc [Santa Catarina], Telest [Espirito Santo] and Telebrasília," she said. "Rio is a total disaster. The problem in São Paulo is that the analog network is oversaturated, but that's easy to solve with additional investment."
Not everything is going smoothly, however. Development of B-band cellular service in the interior of São Paulo state has slowed to a crawl while the two primary members of the Tess consortium -- Brazilian construction company C.R. Almeida and the Swedish government-owned company Telia -- fight each other in court over which of them controls the consortium.
Almeida filed a complaint against Telia on Apr. 6 claiming that Telia coerced it to cede its consortium voting rights. Almeida further claimed that this resulted in Telia gaining control of more than 49% of the voting rights -- a direct contravention of Brazilian law. On Apr. 13, the court ruled in Almeida's favor and nullified the agreement ceding voting rights. Telia appealed the decision and claims that a capital increase reallocated shares so that majority ownership remains in Brazilian hands. A more serious confronidebar --
U.S. companies worry their competitive edge could be eroded further because of a statement made by Mendonça de Barros on June 17 criticizing Code Division Multiple Access (CDMA) technology. The minister, among other things, was quoted in the Brazilian press as saying that CDMA is not the best technology and that cellular subscribers shouldn't sign up for it. He praised Time Division Multiple Access (TDMA) technology, which is primarily European. Two U.S. firms -- Qualcomm and Motorola -- say the minister's comments "could have a devastating impact" on their business plans.