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Morningstar | VIV Updated Forecasts and Estimates from 31 Oct 2018

Brazil is a telecom market where even Telefonica Brasil--in our view, the best operator--is unable to make economic profits for the foreseeable future. We believe that Telefonica Brasil is the best telecom operator in Brazil, but we fear that unfavorable industry dynamics in Brazil will prevent the company from earning excess returns on capital over time. Thus, we now assign it no moat and a positive moat trend, instead of a narrow moat and stable trend. Telefonica Brasil is the largest telecom operator in Brazil, created by merging Telesp, the incumbent fixed-line operator in Sao Paulo state, with Vivo, the largest wireless carrier in the country. The 2015 acquisition of GVT, a phone company with a high-quality fiber network, enabled it to deliver the fastest Internet service in the country.There are three long-term positives about Telefonica Brasil, in our opinion. First, it has a growing cost advantage on operating a high-quality network to address growing demand for data services, thanks in part to its fiber backhaul. Second, the wireless market is moving toward postpaid, with the firm charging well ahead of peers by having close to half of its wireless customers on contracts. High postpaid exposure makes the firm more resilient than its peers that rely heavily on more volatile prepaid revenue. Last, it can offer converged services between wireline and wireless services in Sao Paulo state and because of GVT in many cities outside the state. This allows it to capture growth from the rising adoption of home Internet access in an underpenetrated market.However, such positives are weighed down by price wars that have plagued the wireless market over the past few years. Such intense competition suppressed pricing in both real and nominal terms in most years since 2010 and hampered returns on invested capital for all players. We think that a four-player structure of telecom firms of similar sizes creates a zero-sum mentality that spurs price competition in order to gain market share. In the absence of industry consolidation, which we fear might be difficult within Brazil’s current legal framework, we do not foresee fundamental changes to the industry structure.