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Is a Reversal of Fortune Imminent in Latin America?

If Mexico has maxed, could Brazil be beckoning?

Imari Love, 06/11/2010

Last October 19, the Brazilian government imposed taxes on foreign purchases of the country's stocks and bonds. The government levied the taxes to slow down the colossal run on the Brazilian real, which had appreciated by more than 26% during the 10 months prior. At that time, we recommended looking at Mexico, rather than Brazil, for Latin American investment prospects. While that call has worked out well, the real question is, what's the best move going forward?

Before the imposition of the foreign investment tax, Brazil was massively outperforming Mexico, and for good reason. After all, Mexico was in the midst of a severe economic contraction, industrial production and consumer confidence were at multiyear lows, unemployment was at multiyear highs, and the currency was getting decimated.

That was pretty much the opposite of what was happening at the time in Brazil, where despite the global downturn, the economy was holding steady on the back of strong commodity pricing, lower interest rates, and winning the 2016 Summer Olympic bid. But that's was just it. All the good news had been baked into to Brazil (and all the bad news was embedded into the story in Mexico), so in terms of relative upside, Mexico made a lot more sense.

Now that the gap has been closed, it might be time to start looking into Brazil once again, especially when it comes to your Latin American telecom exposure.

When the taxes were first levied last fall, the Brazilian real predictably depreciated against the dollar, but has now begun to stabilize. Thanks in part to a strong automobile industry, the country's industrial output was up more in April (+19.74% year over year) than it has during the past six years. Unemployment has declined to 7.3%, and consumer confidence is on its way up. Private bank lending is now at record highs and, thanks to higher wages and greater disposable income, default rates are dropping. Most importantly, equities in Brazil are now cheaper than those in Mexico, despite the fact that Brazil is growing more rapidly.

The economic viability of the consumer is key for telecom carriers, who are trying to extract maximum value from a region that is over 90% penetrated. Despite the high penetration rate, the Brazilian wireless sector offers an intriguing risk/reward dynamic.

VIVO Holding Company VIV
While we weren't overly enamored with what we saw from Vivo in the first quarter (average revenue per user was down more than 9%, and EBITDA per user fell by more than 12%), there are still plenty of reasons for optimism. Vivo took 70% of share of the country's net postpaid additions last quarter, even though it shaved 32% off of its subscriber acquisition costs (SAC). The firm's market share has risen for seven consecutive months through March, and it still leads the sector in both postpaid and overall market share. Vivo also offers the highest-quality service in the industry. Lastly, the stock is down by more than 10% year-to-date, and is now trading below its historical valuation levels.PAGEBREAK

The other thing to keep in mind with Vivo is the fact that Telefonica TEF is in hot pursuit to buy out the remaining 50% of Vivo it doesn't already own from Portugal Telecom PT. Telefonica would like to fully acquire a wireless unit in Brazil so it could merge it with its fixed line assets and generate considerable cost synergies. The offer that Telefonica made last month valued Vivo at a premium  of more than 140% to what it was trading at (actually, to be specific, the offer is for 50% of Brasilcel, a holding company that directly controls Vivo). Telefonica increased the offer on June 1, by another 14%, after Portugal Telecom dismissed the original proposal. It has even been rumored that America Movil's AMX chief, Carlos Slim, could be interested in buying into Vivo (indirectly through PT), if only to block Telefonica's purchase. With all of these potential suitors, there are plenty of potential triggers for Vivo's share price.

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