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Morningstar | Telefonica Brasil Reported Mixed Results with Weak Revenue, but Strong Margins; Shares Fairly Valued

Telefonica Brasil reported mixed third-quarter results with further deterioration in its revenue but continued improvement in its margins. We expect these items to offset each other and to maintain our $12.50 per ADR fair value estimate and no-moat rating. We believe the shares are fairly valued after today’s 12% jump in the stock price.

The firm’s net revenue fell 1.1% year over year in the quarter but remains positive for the nine-month period versus our 1.3% full-year projection. Mobile revenue grew 1.8% as the firm continues to convert prepaid subscribers into postpaid ones. This led to a 10.5% increase in postpaid customers but a corresponding drop of 10% in its prepaid base, and it brings the postpaid base to 53% of the total 74.6 million wireless subscriber base. We are pleased with Telefonica’s continued focus on postpaid customers, which use more data and generate higher average revenue per user, or ARPU. Unfortunately, voice ARPU fell 26.1%, which more than offset the 7.4% gain in data ARPU, pulling total ARPU down 1.7%. That said, data ARPU now accounts for 79.6% of mobile ARPU, so voice declines will become less meaningful. Importantly, Telefonica remains the dominant Brazilian wireless operator commanding 31.8% of wireless customers, and more importantly, 41.1% of postpaid subscribers.

Telefonica’s fixed-line business continues to shrink, though this is partially intentionally. As the firm continues to extend its fiber-to-the-home, or FTTH, base, it is focusing on high end broadband customers and IPTV subscribers at the expense of low value DSL based broadband customers and satellite TV subscribers.

The company also continues to focus on cost-cutting and is benefiting from the acquisition of GVT. This led to an adjusted EBITDA margin of 35.9% versus our full-year projection of 35.3%.

While Telefonica grew its FTTH base 9.9% to 4.8 million subscribers, its total broadband base only improved 0.3%. Although in TV its IPTV base grew 52.7% to 536,000, its satellite TV base fell 16% to 1.1 million. That said, these subscriber movements led to ARPU gains of 13.7% in broadband and 2.3% in pay TV. Unfortunately, these were offset by an 11.6% ARPU decline in traditional voice services, which along with a 5.7% drop in its traditional fixed-line base pushed total fixed-line revenue down 5.4%. Ultimately though, we are happy with Telefonica’s strategy, and it is well positioned if the political situation stabilizes now that the presidential election has completed.