Telemig Celular Participa es S.A. (TMB) is the leading provider of cellular telecommunications services in the state of Minas Gerais in southeastern Brazil. The Brasilia-based company was formed in May 1998 as a result of the breakup of Telecomunica es Brasileiras S.A. (Telebras), which was part of the Brazilian privatization program. The company is well managed and has a dominant position in the state of Minas Gerais, southeast of Brazil, which has a population of nearly 18 million and is the country's third wealthiest state. Minas Gerais is an area full of potential growth opportunities. As of December 2006, the company reached 3. 4 million subscribers, representing an estimated market share of 31.6% in its region. Telemig has been investing in the modernization of its network by implementing a modern Global System for Mobile Communications (GSM) technology. A consortium among Banco Opportunity, a private Brazilian bank controlled by the well-known investor Daniel Dantas, Citigroup, and local pension funds controls Telemig through a domestic and an international CVC fund.
The Brazilian wireless business continues to grow rapidly. According to Anatel (Brazilian National Agency for telecommunications), in the end of 2006 wireless subscribers were over 99 million, a growth of 15.9% from December 2005. During the first quarter 2007 total subscriber base reached 102.15 million. In the second quarter 2007 it reached 106.66 million and in September 2007 it reached 112.75 million. Considering those numbers it is quite clear that the wireless business in Brazil remains heated. Currently, the penetration ratio in Brazil is very close to 60% and has been growing quarter-after-quarter, but it still remains below international levels. We believe this impressive growth will continue in the short-to-medium term, albeit at a slightly lower pace in the following quarters. Below, we can see the growth of the Brazilian wireless subscriber base during 2006 until September 2007:
The continued expansion in the Brazilian wireless market has been fueled by the positive environment for the Brazilian economy. The economic outlook for Brazil for the medium-term remains promising, since we believe that the continued improvement in the Brazilian economic environment will make Brazil reach investment grade within the following 12 months, thus leading to a multiple expansion for Brazilian stocks. However, the Brazilian Central Bank decided to stop cut basic interest rates in the very short-term. Indeed, after the August Central Bank meeting an official report was released with strong comments on domestic inflation pressures. On the October meeting interest rates were unchanged for the first time in more than 2 years. Even though the Brazilian domestic interest rates remain one of the highest in the world at 11.25% per year against an expected inflation rate for 2007 of just 4.0%, we understand that the Brazilian Central Bank is too conservative and will remain on hold for a while. Despite this concern, we understand TMB remains a very attractive stock with a huge upside potential in the very short-term, mainly considering attractive valuation.
The fiercely competitive environment is a problem for the wireless industry in Brazil. However, Telemig has been posting reasonable results that have been much better than most of the Brazilian wireless operators. Telemig has one of the strongest balance sheets in the Brazilian wireless industry. This strategy has been very important for TMB in order to take advantage of the still high interest rates in Brazil, avoiding the risky strategy that other companies followed to finance growth using a large amount of debt. We have few doubts that this wise growth strategy was responsible for the better performance of the stock if compared to other Brazilian wireless companies, particularly Vivo (VIV) over recent years. The company also has more rational attitude towards sales promotions, maintaining its strategy focused on high-value client acquisition and retention, and keeping handsets prices above market's average. This strategy explains why Telemig has been able to keep good profit margins even without major growth in its subscriber base. Third quarter 2007 was no different. The company posted sound results, despite the higher operating costs due to the reversal of some provisions. EBITDA margin was slightly lower than expected. Nevertheless, we do believe it is just a short-term problem that will be reversed in the following quarters. Telemig is an independent company focused in a specific region and not a major national player. Because of this particular situation, Telemig was always focused on profitability rather than growth, as a result, the company has been growing slowly, but has been posting much better results than the Brazilian industry average.
We thought the company was a potential acquisition target during the first round of consolidation in the Brazilian Telecommunication industry. As we already mentioned, a consortium including Banco Opportunity (a private Brazilian bank controlled by the well-known investor Daniel Dantas), Citigroup, and local pension funds controls Telemig through a local and an international fund. Citibank is an important shareholder of Brasil Telecom (BRP), and already stated its interest in selling its stake in BRP in the near future. Thus, we believed Citibank would have no interest in keeping only Telemig, which is a small company. On August 3, 2007, Mr. Roberto Lima, the Chairman of Vivo (VIV), announced the acquisition of Telemig and Amazonia Celular by the amount of R$1.2 billion (US$619 million). In fact, this acquisition was very important for Vivo, since it needs to expand its national coverage to remain a market leader. Telemig is an important player in the State of Minas Gerais, which is a very important region. We believe that in the short-to-medium-term the valuation of Telemig will converge to that of Vivo. Additionally, in the medium-term, we expect Telemig to merge into Vivo. All considered we are keeping our current Buy recommendation on Vivo.